VAT - 27.08.2020

When can your client revoke their option to tax?

Problem

Your client’s issue is that they are struggling to find a buyer for their commercial building because they would need to charge VAT on a sale. The buyers that are interested make exempt supplies, and so the VAT cannot be recovered. This makes a potential purchase 20% more expensive.

Revoking?

As the issue is the option to tax election, you should discuss the possibility of revoking the option with your client. Generally, the reasons why a client might want to revoke an election are as follows:

• they might be planning to rent out the building to a tenant who cannot claim input tax, either because the tenant is not VAT registered (trading below the registration threshold or only making exempt supplies) or is registered but partially exempt
• they might intend to sell the building and the buyer might be unregistered, or registered but exempt or partially exempt
• in the case of a property sale, even if the buyer can claim input tax, there is a stamp duty land tax saving if a deal is exempt from VAT rather than standard-rated because this tax is charged on the VAT-inclusive price of a sale. And not charging VAT also produces a cash- flow saving for the buyer because they will not need to pay VAT at the time of completion and wait up to three months before input tax can be claimed on a VAT return.

Making an election

When your client makes an option to tax election on a building, it will generally remain in place for at least 20 years before it can be revoked. It is therefore a decision which should only be made after all the pros and cons have been considered. Your clients should only opt to tax a property in order to claim input tax, e.g. on the costs of buying or improving a property that would not be claimable without an election being made.

Pro advice. An election applies to all income earned from a building but there is an override for any income earned from residential property. So, for example, a client owning a ground floor shop and first floor flat would only charge VAT on the rental income earned from the shop.

Cooling off period

In limited circumstances, your clients can revoke an election within six months of it taking effect but only if certain conditions are met. The main condition is that no land supplies have been made since the election was notified to HMRC where VAT has been charged and no input tax has been claimed on any costs linked to the property. The revocation is notified to HMRC on FormVAT1614C . It is important to be clear that the six-month clock starts ticking from the date that the election took effect rather than the date that the notification was sent to HMRC.

Pro advice. If your client fails to meet the input tax condition above, then it might be possible to write to HMRC asking for it to allow the election to be revoked if, for example, they agree to repay the input tax already claimed. It’s also possible that the input tax will be repayable in some circumstances anyway, e.g. a change of intention from making taxable rental supplies to those that are exempt.

Six-year rule

In some circumstances, your client might sell a property and then buy it back again in the future. In this situation, any option to tax election made in the past is automatically revoked if the client holds no interest in the property for a period of at least six years.

Example. Jane the florist purchased the freehold of a shop on 1 January 2010 and opted to tax the property from this date because she was subletting part of the building and did not want to have an input tax restriction on any of her costs. She sold the building on 31 December 2012 but then repurchased it on 1 April 2020. Her option to tax election made in 2010 is no longer valid (automatically revoked) because she had no interest in the building for six years and three months, i.e. longer than six years.

Pro advice. There is no problem with your client making a new option to tax election when they repurchase the property more than six years later. In the example of Jane, she might decide that a new option to tax election is appropriate in April 2020 when she repurchases the building, perhaps because she intends to sublet again and wants to avoid an input tax problem with partial exemption.

20-year rule

Your client can revoke an option to tax election on a building once it has been in place for 20 years. As the regulations were first introduced on 1 August 1989, i.e. more than 30 years ago, this means that there are many elections in place that are capable of being revoked under this part of the legislation.

Pro advice. If you have clients who are buying a property where the seller has an option to tax election in place, it’s important that you always ask to see a copy of the HMRC letter confirming the election before the deal takes place. This is firstly because it confirms that the seller is correct to charge VAT on the sale (and input tax can only be claimed if it has been correctly charged in the first place) and also because you can check if it was made more than 20 years ago and can therefore be revoked by the seller before the sale.

Example. Beryl and Betty are partners in a children’s nursery business which is not VAT registered because the income is exempt from VAT. They want to buy a freehold property for £750,000 from Clive. However, Clive has an option to tax in place on the building so will charge 20% VAT on the sale. Beryl and Betty should ask him if he opted to tax the property more than 20 years ago and it can therefore be revoked. f the answer is “no”, then Beryl and Betty should probably seek alternative premises where the seller has not made an election, i.e. they will purchase a VAT-free property.

How to revoke the option

Your client must submit FormVAT1614J (see Follow up) to HMRC. As long as four important conditions are met, the form is a notification process only, i.e. they do not need HMRC’s permission to revoke their election. The four conditions are as follows:

20-year condition. The taxpayer must have held an interest in the property more than 20 years ago and opted to tax it more than 20 years ago.

Capital item condition. The capital goods scheme applies to any property costing more than £250,000 excluding VAT or any improvement, refurbishment or extension to the property exceeding this amount. The scheme requires annual input tax adjustments to be made over a ten-year period. If a property is still subject to these adjustments, condition is not met.

Valuation condition. This condition will not be met if any of the taxable supplies in the previous ten years have been made either below market value or have been made at market value but it is expected that exempt supplies after revocation will be significantly greater than the earlier taxable supplies.

Prepayments condition. This condition is best illustrated by an example.

Example. ABC Properties Ltd intends to revoke an election on a property under the 20-year rule. However, just before revoking its option, it pays a cleaning company £30,000 plus VAT for the next five years’ cleaning services for the building in question and claims input tax on this expense. This advance payment for services means that it has breached the prepayments condition because it relates to services beyond the next twelve months. It will need to seek HMRC’s permission to revoke the election, i.e. it is no longer automatic.

Form VAT1614J