Lauren Walker, a senior associate in the Commercial Property Team explains what an option to tax for property is and what it means for real estate transactions.
What is an option to tax?
In the UK, usually supplies of land and/buildings (for example freeholds and leases) are VAT-exempt, meaning you can’t charge VAT and you cannot reclaim VAT on related expenses. The Option to Tax allows the owner (or interest holder) of non-residential land or buildings to elect out of their default VAT-exempt treatment. By opting in, supplies (such as leasing or sales) become standard rated for tax purposes, enabling recovery of input VAT incurred on costs such as construction costs, professional and maintenance fees.
What this means for real estate transactions?
When selling a non-residential property, the default position is that the sale is VAT-exempt (i.e. no VAT is payable on the purchase price). However, if the seller has opted to tax the property, the sale becomes subject to VAT at 20%. This allows the seller to reclaim the VAT on costs related to the property (as mentioned above) but also means the buyer must pay VAT on the purchase price, which they can only recover if they themselves are VAT registered and using the property for taxable business activities. VAT liability can therefore affect the pricing of the sale, the deal structure and whether the sale qualifies as a Transfer of a Going Concern which may allow VAT exemption if certain conditions are met. We recommend you take the appropriate tax advice for any real estate transaction which may be affected by these matters.
Evidence of Option to Tax
Previously where a property was opted to tax, HMRC would provide a confirmation of the option to tax via a notification receipt letter. Regulations require that businesses retain their VAT records (including options to tax) for a period of six (6) years but it is also recommended to retain this confirmation in your records beyond this for sale purposes as buyers will want to see a copy of the option to tax to evidence the option on any sale.
Since 1 February 2023, HMRC no longer issue these confirmations by post for each application. Instead, they now send an automated email confirmation when applying for an option to tax via email. If you apply by any other means, you will not receive a confirmation from HMRC. It is therefore recommended you keep a copy of the automated confirmation email from HMRC for your records to provide as part of any sales or lease pack.
If you are looking to sell or lease a property, please contact our Real Estate team who would be happy to assist.
