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How to Avoid Pitfalls of the Option to Tax

How to Avoid Pitfalls of the Option to Tax

By Andrew Needham | May 2010
Andrew Needham outlines a few of the many misconceptions regarding the option to tax for VAT purposes that can lead the unwary into difficulties.

Option to Tax

One of the common misconceptions is that once an option to tax has been exercised it stays with the building and passes on to the new owners. This is not the case. The option to tax covers a ‘persons’ interest in a property, once it is sold or sub-let it is up to the new owner/occupier to decide if they want to opt to tax.

It is up to you to decide if you want to charge VAT and then inform HMRC using one of the VAT 1614 series of forms.

If you fail to notify HMRC, but charge VAT on any sub-leases and account for it on your VAT return they will allow a belated notification, but you will have to specifically ask for a belated notification and show that all VAT that should have been charged has been paid.

Anti-Avoidance Legislation

Another common error is made by businesses that do not understand the anti-avoidance legislation in this area. For example, a financial adviser runs his business through a limited company. He buys a new property for his business and is charged VAT on the purchase, he wants to keep the property separate from his business so buys it personally. 

He decides to register for VAT personally, opts to tax and charges VAT on the rents to his business, he then gets to recover all of the VAT on the purchase of the property. However, he has failed to understand how the anti-avoidance legislation works. He and his business are connected parties for tax purposes and as his financial services business is exempt from VAT it cannot recover the VAT on its costs so the anti-avoidance legislation applies and his option to tax is ‘disapplied’.

This means that the rental becomes an exempt supply and he cannot recover the VAT on the purchase. HMRC come for a visit two years later and discover the error, assesses for all the VAT claimed, imposes a 30% penalty for carelessness and charges interest!

Selling a Property After Claiming Back VAT

The final common pitfall is when a full taxable business purchases premises for £300,000 from which to conduct its business and is charged VAT on the purchase. The business claims back the VAT and five years later, after steady growth, decides to move to bigger premises. It sells its existing property and thinks no further about the VAT position.

Practical Tip

The VAT problem is created by what is known as the “capital goods scheme”.  The capital goods scheme covers, amongst other things, the purchase of land or buildings more than £250,000 where VAT has been reclaimed. If you make exempt use of the building during the 10 year adjustment period you have pay HMRC back some of the VAT reclaimed.

If the property is sold without opting to tax, it will be an exempt supply and the business would have to pay back half the VAT it had claimed.

You can solve this problem easily by opting to tax before the sale. If you do this, you change an exempt supply into a taxable supply and you have no money to pay back

This article was first printed in Tax Insider in May 2010.
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