Opting to tax – some common misconceptions

The option to tax is a familiar concept to those occupying, developing or investing in commercial property. However, presenting on this topic at our recent property tax updates, it was clear that there were several misconceptions about some of the practicalities.

What does it apply to?

An option to tax is not made over a building, but over land. Although the rules were less clear before 1 June 2008, legislation applying since then makes it clear that it is the land that is being opted.

In practice, a piece of land may be most easily identified by the building on it. The owner of the office building at 17 Banbury Street might simply use this address to establish the land over which it has opted to tax. However, if the office building were to be demolished and the land sold, the vendor would still need to charge VAT. 

Many people believe that the option to tax attaches to the property and so automatically applies to future owners. This is not the case – it only binds the party that opted (and sometimes other group companies if they are common members of a VAT group). So, if 17 Banbury Street is sold, and the purchaser does not opt to tax, rental income received by the new owner will be exempt.

In practice, the purchaser of an opted property will often want to opt to tax, in order to recover the VAT charged on its purchase, or to enable ‘transfer of a going concern’ (TOGC) treatment.

Can I opt to tax if I do not own the property yet?

About half of our audience thought you needed to own a property in order to opt to tax it. This is not true. Indeed, for TOGC treatment to apply to the transfer of a tenanted property where the vendor has opted to tax, it is necessary for the purchaser to have exercised its own option to tax and sent the relevant notification to HMRC before the transaction happens, otherwise the vendor will have to charge VAT.

What is true is that an option to tax automatically lapses if you do not acquire an interest in the property within six years. This may have caused the confusion.

Over 80% of the audience thought you recorded an option to tax by sending a notification to HMRC. This is not strictly correct. Opting to tax is actually a two-stage process.

1. The first is to make the formal decision to exercise the option to tax. There is no set way to record this, but we recommend something formal like a board minute or director’s resolution – something that confirms what the exact land being opted and from what date, and shows that this decision was made by someone who was duly authorised.
2. The second step is to send a formal notification of this to HMRC. This should be done within 30 days of the effective date. The easiest way to do this is using HMRC’s form VAT1614A. We recommend emailing this to HMRC, putting your VAT registration number and the land details in the subject line. HMRC’s systems should give an automatic response confirming delivery, which can be a useful email should you ever need to prove this.

In practice, many people will exercise the option to tax and send the notification to HMRC on the same date. For this reason, a copy of the notification form is often the only document that records the decision. However, it is good practice to keep these separate.  

In the past, the final stage of the process would be a response from HMRC. HMRC would send a formal letter acknowledging receipt of the option to tax, providing further confirmation of precisely what land had been opted, by whom, and from what date. Helpfully, HMRC used to undertake a thorough review of the notifications they received, comparing land references given to the land registry, ensuring that a form signatory was listed as a director, etc, and would frequently come back with clarification questions.  

Unfortunately, as a result of the COVID pandemic, a backlog of many months built-up. In order to speed-up response times, in 2022 HMRC reduced these checks considerably. This approach was initially temporary, but from 1 February 2023 this has become a permanent change. While we have seen some letters from HMRC noting receipt of the form since the change, these state that the response is not an acknowledgement. It is clear that responses from HMRC can no longer be relied upon as an independent check of all details on the notification form.

It is important to note that it has never been necessary to have received an acknowledgement letter for the option to tax to be valid (for completeness, there are a small number of situations where HMRC’s prior approval is required, but that is a different point). With HMRC’s turnaround times on acknowledgement letters having unnecessarily held-up many transactions over the last few years, most lawyers in the room were aware of this. Reviewing contracts recently, it is notable that they now typically require evidence that the notification was sent, rather than any response from HMRC received.  

Anti-avoidance

The option to tax legislation includes some of the most challenging anti-avoidance provisions to navigate. The final misconception that is commonly made is that you do not need to worry about these rules if you are not setting-out to avoid VAT.

Unfortunately, these rules can be quite a blunt instrument and can catch innocent transactions.  Suppose the developer of the new office at 17 Banbury Street was financed by a bank. After completing the office, they market this to potential tenants and the tenant they sign up just happens to be a subsidiary of this same bank. Anti-avoidance rules would apply, their option to tax would be ineffective, the rents would revert to being exempt and they would have to repay to HMRC all of the VAT on the refurbishment. 

In summary

Deciding whether to exercise the option to tax is an important decision, which can be very costly to get wrong. It is also important that the paperwork is also completed correctly and promptly to avoid uncertainties down the track.

As with other aspects of VAT, the specific facts of each transaction should be considered ahead of time, to avoid unexpected delays or VAT costs arising.

Please get in touch with Adam Cutler, or your usual VAT contact if you would like to discuss this further.