UK: VAT And Property - New Rules For The Option To Tax: Part II

Last Updated: 24 June 2008
Article by Michael Boutell, Peter Mason and Steven Sieff

Last week we provided a brief overview of the changes to the option to tax regime introduced as a result of the re-write of Schedule 10 Value Added Tax Act 1994 and the introduction of tertiary legislation (contained in the revised Notice 742A). To read last week's summary click here.

This week we focus on the scope of the option to tax and the mechanics required in order to ensure the exercise of the option to tax is effective. This will include a look at the new "Real Estate Election" (which replaces the so-called "global election"). To read the article in full see below.

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Full Article

Last week we provided a brief overview of the changes to the option to tax regime introduced as a result of the re-write of Schedule 10 Value Added Tax Act 1994 and the introduction of tertiary legislation (contained in the revised Notice 742A). To read last week's summary click here.

This week we focus on the scope of the option to tax and the mechanics required in order to ensure the exercise of the option to tax is effective. This will include a look at the new "Real Estate Election" (which replaces the so-called "global election").

Some supplies of residential property are zero-rated and some supplies of non-residential property are standard rated (for example, the sale of the freehold in a new commercial building) but most supplies of land are exempt from VAT.

However, ever since the introduction of the current VAT and Property regime, taxpayers have had the option to tax land and buildings. The effect of exercising the option to tax in respect of particular property is to convert supplies made in relation to that property from exempt to taxable. For example, rents paid by a tenant become subject to VAT as would the proceeds from the sale of the property. The benefit of opting to tax is that it converts exempt supplies into taxable supplies, which then allows owners, landlords and sellers to recover as input tax VAT on costs incurred in relation to the property.

There are rules that operate to disapply the option to tax in specified circumstances. In particular, the option to tax is disapplied for supplies made in relation to buildings intended for use as a dwelling or solely for relevant residential or relevant charitable purposes. In addition, the option to tax may be disapplied where it is not being used "wholly, or substantially wholly" for exempt purposes. A future Law-Now will deal in more detail with the circumstances in which the option to tax may be disapplied.

Scope of the option to tax

The option to tax may be exercised in relation to a specified area of bare land or in relation to a specified building or buildings. Prior to 1 June 2008 HM Revenue & Customs ("HMRC") policy was to allow the option to tax to apply separately to land and buildings in certain circumstances (despite the fact that the European Court of Justice in Breitsohl held that the option to tax land could not be separated in this way).

With effect from 1 June 2008 the option to tax (whether exercised before, on or after 1 June 2008) will have effect in relation to the land and any building that is on it. Therefore, even where the option to tax has been exercised in relation to the building but not the land on which it stands the option to tax will automatically apply to the land as well.

However, HMRC has recognised that it would be unfair to ignore its previous practice and reverse the position on options to tax exercised before 1 June 2008. Therefore, where an option to tax has been made in relation to a building (but not the land) prior to 1 June 2008 the taxpayer may elect to treat the option to tax as revoked on demolition of the building. It is not necessary to notify HMRC of this but it will be necessary to retain evidence (for example, a board minute) that the option to tax is revoked on demolition. However, this treatment is only available if it is clear from the notification of the option to tax that the option was made on the building only.

In addition, if a new building is to be constructed on land over which the option to tax has been exercised the new regime permits the new building (and the land within its curtilege) to be excluded from the effect of the option to tax. However, excluding a new building from the option to tax will mean the VAT on construction costs and related expenditure would be irrecoverable and accordingly this is unlikely to be something that would be attractive. However, it is conceivable that this facility might be used where the occupants of the building are exempt or do not carry on a business (although even in these circumstances non-recoverability of VAT on capital costs will usually be less acceptable than non recoverability of VAT on rents payable by the occupying tenant). Where this facility is used the exclusion of the building from the option to tax must be notified to HMRC before the earlier of completion of the building, first use of the building and the date a grant of an interest in the building is first made.

If this facility is used it will nevertheless be possible to exercise the option to tax in relation to the new building subsequently but this will require a separate option to tax and notification and where exempt supplies have been made in the meantime, the permission of HMRC to opt to tax may first be required. A future Law-Now will deal with the circumstances in which the prior permission of HMRC is required before the option to tax may be made.

Real Estate Elections

The new rules introduce the facility to make a "real estate election". Once a real estate election is made any property that is acquired afterwards will automatically be subject to the option to tax. The benefit is that it obviates the need for a separate option to tax and notification every time a property is acquired. The disadvantage is that it means that a decision as to whether to opt to tax is not taken on a property-by-property basis in light of the circumstances of the particular case.

That said, each property is treated as separately opted to tax, which means that the option to tax can be revoked in relation to individual properties provided that the conditions for revocation can be met. In particular, the option to tax can be revoked during the so-called "cooling off period" (which is currently six months). However, this is not an unconditional right to revoke within this period and in particular revocation is not generally available where the option to tax has had effect (either through VAT having been charged or through the recovery of VAT incurred as input tax).

Prior to 1 June 2008 HMRC practice allowed taxpayers to make so-called "global elections" which typically, took the form of an option to tax over all properties owned and properties subsequently acquired. These were less flexible as a global election was regarded as a single option to tax rather than a series of separate options to tax (as is the case with the real estate election). Global elections (made prior to 1 June 2008) will under the new regime be treated as separate options to tax so that a revocation of the option to tax can be made on a property-by-property basis (subject to the specified conditions being satisfied).

Although global elections have been made in the past they have generally been discouraged. It has usually been regarded as preferable that a positive decision to opt to tax in relation to a specific property is made (in the light of the circumstances of the particular case) rather than have an option to tax that automatically applies. Despite the possibility of revocation of the option to tax in relation to a specific property under the real estate election regime it is thought that it will remain preferable in most cases for the option to tax to be made on a property-by-property basis. Before a real estate election is made careful thought should be given to all the implications.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 13/06/2008.

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