The next step

Detailed commentary on the option to tax election

[Memo]

Coronavirus dilemma: should you opt to tax a sublet?

Opted property myth

There is no such thing in the VAT world as an “opted property”. Each person or business with an interest in land or a building makes their own decision on whether to opt with HMRC or otherwise. A sublease is a new interest for these purposes, i.e. the option applicable to the landlord, and our subscriber does not affect any agreement for a new subtenant. It is therefore common for a landlord to opt to tax and charge VAT on rent to a tenant, but the tenant might not opt to tax and charge VAT on rent to subtenants in turn.

Tip. Your decision to opt or otherwise is always driven by input tax motives. In other words, there is a large amount of input tax that you would not be able to claim if your land supplies were exempt from VAT, i.e. a block under partial exemption.

Market value rent

It is important that our subscriber charges a commercial rent to the associated business. A peppercorn rent, or below market value charge, could indicate that it is a non-business agreement, which would affect any input tax they can claim. They should charge rent to the associated business on the same basis as the third-party tenant.

For detailed commentary on the option to tax election, visit https://www.tips-and-advice.co.uk , Download Zone, year 10, issue 11.

Partial exemption

Assuming the trading business is fully taxable, i.e. not partially exempt, it will be able to claim some input tax on the rent charged by the landlord, i.e. for their own floor. But if they don’t opt to tax and charge VAT on the rent to the subtenants, they will be partially exempt and must apportion their input tax using the standard method of calculation based on the total value of exempt and taxable supplies each VAT period.

Tip. The subscriber could ask the landlord to raise three separate invoices for each floor of the building. They will then claim input tax on their own floor but claim no input tax on the other two invoices directly linked to the exempt rent.

Trap. Don’t be tempted to apportion a single invoice from your landlord on a square footage basis, i.e. claiming one third of the total input tax shown on the invoice. This is a special method of calculation and would need to be agreed by HMRC in writing before it is adopted.

Opting to tax

It would make life easier if the subscriber opted to tax the building and charged VAT on future rent to the subtenants. They will then claim 100% input tax on the rent charged by the landlord and also on other building costs, e.g. repairs. The partial exemption challenges have gone away. And hopefully both the third-party tenant and associated business are registered for VAT and able to claim input tax.

Trap. The main disadvantage of an option to tax election is that it cannot be revoked for 20 years once made. This will create an unwelcome VAT charge to future subtenants who might not be able to claim input tax, e.g. an exempt business such as an insurance broker.