When should I opt to tax my commercial property?

19 January 2023

Luke Anderson

Accounting & Compliance, Structuring a Business, Building a Business

This is such a difficult question to answer and it depends very much on circumstances.

The problem is that as a general rule the sale of land or commercial property or the lease or rent of a commercial property is exempt for VAT purposes, leading to the potential block of VAT on expenditure incurred in respect of the land or commercial property.

Lease or rent

Let’s assume you own or even rent a commercial property and you decide to rent or lease the commercial property. You will now invoice the new tenant for the rent with no VAT. The recoverability of any VAT on expenditure you incur, such as repairs or improvements to the property, will be blocked as the supply is exempt. Similarly if you rent the property and then wish to sublet it, any VAT on the rent charged is blocked – the fact that you are charged VAT on the rent does not mean you automatically charge VAT on to your tenant.

There may be circumstances where the VAT is recovered using the de minimis rules but in general the VAT is now irrecoverable.

This also leads to accounting issues as you now need to operate a partial exemption scheme if you have both exempt and vatable supplies.

So how do you resolve this? Very simply you can “opt to tax” the property.

What is opting to tax?

Opting to tax land or building means that all supplies, i.e sales or leasing of the land/building which are usually exempt, would now be taxable.

However, the advantage to this is that you are now able to recover the VAT on any costs relating to the land/building e.g. repairs on the building or in the case of land, recovering the cost of building the site in the first place. This in turn would also avoid any partial exemption issues which could further block the amount of VAT you can reclaim.

It is important to note that you would only want to do this if you are going to make supplies of the building ongoing. A business decision would also need to be made when considering if the customer is VAT registered themselves and how much VAT you would recover in costs.

How do I opt to tax?

You would need to notify HMRC within 30 days of the date that you have decided to opt to tax the land or building. When completing the form it is important that you are specific with the address as this dictates what HMRC are expecting to be taxed. So if you own a plot of land and you only want one specific building to be taxed then you need to make this clear by giving the building name in the application.

Purchase/sale of a commercial property and interaction with the Capital Goods Scheme & Potential Clawback

You may find that you have or are being charged VAT on the purchase of a commercial property. If the property is going to be used by you in your business and not rented or leased out then you can recover the VAT. If you are going to rent or lease the property then you have an exempt supply and the VAT will be blocked unless you opt to tax the property. Therefore if you buy a property and use it in your business you do not have to opt to tax to recover the VAT.

One important thing to consider if you choose not to opt to tax a property is the potential clawback of reclaimed VAT due to the Capital Goods Scheme. Any commercial property over the value of £250,000 falls within the Capital Goods Scheme and remains part of this for 10 years.

Example

You purchase a property for £1,000,000 + VAT and reclaim the full £200k VAT as the building is being used as part of your fully taxable business. At this moment in time there would be no requirement to opt to tax the building as there are no supplies of the building.

Six years down the line you decide you are going to sell the building and move on and this is where there may be a potential clawback. The sale of the building would currently be exempt as you have not opted to tax the building.

Under the Capital Goods Scheme, the remaining four years of the scheme would be considered to be exempt. This would mean that 4/10 of the original VAT reclaimed, would be repayable to HMRC under the scheme.

However, if you were to opt to tax the building before it was sold, you would charge VAT on to your customer and avoid any clawback as per the above.

This would also need to be taken into consideration if the supplies of the business were to change i.e. you added an insurance (exempt supply) department to the building. The building at this point would not have fully taxable supplies and would potentially be hit by the clawback.

Land

Land can also generate problems in certain circumstances for developers. Many developers will buy land with the intention of maybe building several new build houses for resale (which will be a zero rated supply) or a commercial building for resale (which will be a vatable supply). Therefore there will be no requirement to opt to tax the land.

However if the developer decided to flip the land and sell it on with planning permission this is now an exempt supply and any VAT incurred would be blocked. Again to get around this the developer could opt to tax and they would then charge on the land with planning permission to a new developer as a standard rated supply and recover all the VAT expensed.

Opt to tax or not?

With any land or commercial property it is always advisable to take advice. Get it wrong and you could land yourself with a big VAT liability or miss the opportunity to recover VAT suffered. Speak to your professional advisor and if you are client of Friend & Grant please speak to our VAT specialist Luke Anderson.