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Last edited 02 Sep 2021

VAT - Option to tax

For anyone who has an interest in land or buildings and who makes supplies which are normally VAT (Value Added Tax) exempt, the question of how to recover any VAT incurred in relation to that building or land is an important issue.

Where the supply of land and buildings is VAT exempt, as is usually the case, any VAT incurred on making that supply is irrecoverable and is thus a cost to be borne.

Schedule 9 of the Value Added Tax Act provides that the following supplies of land (or buildings) are exempt from VAT:

The grant of any interest in or right over land.
The grant of any licence to occupy land.
In relation to land in Scotland, the grant of any personal right to call for or to be granted any such right or interest

The inability to recover input VAT on such exempt supplies represents a real cost burden for land owners or developers, and so HMRC permits a property owner to charge VAT at the standard rate (currently 20%) on supplies of property which would otherwise be exempt.

This is known as the 'option to tax'

Schedule 10 to the VAT Act deals with the option to tax on land and buildings.

In general the option to tax is limited to non-residential property. However, where the land or buildings are intended to be converted for dwelling, residential or charitable use, there are limits to when an option to tax can have effect

The option to tax has important consequences as it means that a property owner can recover all or part of its input tax. However, the property owner will also have to charge VAT at the standard rate on the supplies which it makes, for example, on the sales price if the property is being sold, or on the rent if the property is being leased. If a purchaser or tenant is registered for VAT and can recover VAT on the purchase price or rent the exercise by the property owner of the option to tax should not be problematic other than from a cash-flow perspective.

However, if the purchaser or tenant does not have full VAT recoverability then it must bear the irrecoverable element. This may affect the marketability of a property to the detriment of the owner. In highly competitive market conditions it may lead to the owner being forced to absorb an element of the VAT which is irrecoverable to the purchaser or tenant in order to complete a transaction.

There were amendments to the option to tax rules introduced in June 2008, and the VAT (Buildings and Land) Order 2009 of July 2009 has introduced further amendments to those rules.The changes are contained in Schedule 10 to the VAT Act and give a property owner the ability to do the following:

Make a ‘real estate election’ - an option to tax will automatically apply to all properties which are subsequently acquired by the entity which exercises the option to tax.
Revoke an option to tax in the first six months after it is exercised without the need to obtain permission from HMRC (previously three months).
Revoke an option to tax after 20 years without the need to obtain permission from HMRC provided certain conditions are met. In addition, there is an automatic lapse of the option to tax.
Where no interest in an opted property has been held for over six years (subject to certain anti-avoidance provisions), treat the option to tax as continuing to apply to the land after the opted buildings on the land have been demolished.
Exclude new buildings on land which has been opted provided that notice of the exclusion is given to HMRC as necessary.

The exercise of an option to tax involves the following:

Firstly, an option must be exercised.
Secondly the HMRC must be notified of the exercise of the option. An option is not valid if it has not been notified to HMRC.

Where a property owner makes a ‘real estate election’ (which must be in a prescribed form) the option to tax will apply automatically to all properties which are subsequently acquired without having to send notification of each election to HMRC and the option will be deemed to apply to the property with effect from the date the interest in the property is acquired.

There is no provision for the revocation of a real estate election. Individual properties within the real estate election can be taken out of the scope of the election under the normal revocation rules.