Last year's changes to the VAT 'option to tax' regime will begin to have a greater impact from August 2009 onwards. Then the twentieth anniversary of the introduction of the option to tax will trigger the ability to revoke options. Landlords should be reviewing their portfolios now to identify properties where the ability to revoke an option to tax presents a value-added opportunity.

  • VAT options to tax can be revoked:
    • within six months of making the option;
    • six years after a property has been disposed of; or
    • twenty years from the decision to opt the property (providing certain conditions are met).
  • Landowners should consider revoking an option where a tenant or potential purchaser is unable to recover VAT. There may be an opportunity to negotiate an increased rent or purchase price in exchange for the revocation.

WHAT IS AN OPTION TO TAX?

Opting to tax, which prior to last year's changes was known as "electing to waive exemption over" a commercial property changes sales and leases of that property from VAT exempt to taxable supplies. This permits the land owner to recover VAT it has incurred, referred to as "input tax", in relation to that property.

WHY REVOKE AN OPTION TO TAX?

For the most part, purchasers or tenants who take a property interest from a landowner will be able to recover the VAT charged on a supply made to them. However, certain businesses that make exempt supplies, such as banks and financial institutions, are unable to recover VAT and therefore have to bear VAT as an additional cost to their business. A property owner may wish to revoke an option if a higher rental return or purchase price may be obtained from a tenant or purchaser unable to fully recover VAT. This benefit should be weighed against the loss of input tax in relation to the property.

Depending on the nature of the landowner's business, revoking an option may also have administrative advantages. If the landowner's only business interest is holding the property in question then, on revoking the option, the landowner may no longer need to be registered for VAT or to complete returns.

WHEN CAN AN OPTION TO TAX BE REVOKED?

During the 'cooling off' period

From June 2008, a landowner can withdraw an option to tax within six months of opting the property. Previously, the 'cooling off' period following an election was limited to three months and revocation required the consent of HM Revenue & Customs ("HMRC"). Now, it is no longer necessary to obtain permission provided HMRC are notified on the prescribed form. The landowner must certify that all of the conditions permitting revocation have been met. Where VAT has been claimed from HMRC as a result of the option, it can still be revoked providing the reclaimed tax is paid back to HMRC.

Six years after disposing of the property

There is no requirement to own an interest in land which is the subject of an option to tax. An option will cover any interest subsequently acquired. This causes problems where an opted property has been sold and any kind of interest in the property is reacquired. Any supplies of the re-acquired interest in the property will be subject to VAT, even though the 'opter' may not realise an option is still in force.

Since June 2008, if a landowner has not held an interest in a particular property for the previous six years, the option over that property is automatically treated as revoked. This should help to resolve the problem outlined above. This rule is subject to anti-avoidance provisions which apply to transactions between members of a VAT group.

Twenty years after opting to tax the property

Apart from the instances outlined above, an option to tax is irrevocable for twenty years. The first options to tax were made in August 1989. Therefore, 1 August 2009 is the first date on which options may become revocable under the twenty year rule.

The legislation introduced in June 2008 regulates revocations under this rule. It also removed the requirement for HMRC to review every case to give permission for a valid revocation.

If twenty years have passed since a property was opted and the taxpayer no longer has any interest in the property, the taxpayer can simply notify HMRC that the option to tax is revoked. If the taxpayer still owns the property, it may still have an automatic right to revoke if all of the following conditions are met:

  • the taxpayer has held the property for twenty years and still owns it;
  • the property is not subject to the capital goods scheme;
  • the taxpayer has not made any supply of the property at below market value in the previous ten years and will not make a supply after revocation for a significantly greater value than supplies made before revocation; and
  • no prepayments have been made by the taxpayer which are attributable to the taxpayer's supplies of the building more than twelve months after the option is revoked.

Condition 3 was included to prevent tax planning using the revocation of an option to avoid paying VAT on the true commercial value of a supply. It does not apply where increases in value of the supply relate to a normal commercial rent review.

Condition 4 was included to prevent an unfair input tax recovery position. For example, it is possible that three years' worth of services relating to a property could have been paid for just before revoking an option. If full VAT on the payment has been deducted from the landowner's output tax then there has been a 'windfall' in respect of the services supplied after revocation. If a taxpayer does not meet all of conditions 1 to 4, it cannot automatically revoke an option. However, a taxpayer can still apply to HMRC for permission to revoke. Permission may be granted if HMRC consider that neither the taxpayer nor a third party has obtained a particular VAT benefit as a result of the timing of the revocation. Essentially, the recovery of input tax in the lead up to the revocation must be fair and reasonable.

CONCLUSION

If you opted to tax a property twenty years ago, it is time to review the position to check whether it is still beneficial to maintain the current VAT treatment. Similarly, if you are the tenant of an opted property and cannot recover all of your input tax, you may wish to open discussions with your landlord. Bearing in mind the difficult market conditions, can a deal be done with a VAT exempt, or partially exempt, tenant to everybody's advantage?