The majority of farms and estates will be registered for VAT. As with any form of taxation, on the surface VAT can seem simple; however, it has many complexities in particular opting to tax land and buildings
What is opting to tax (OTT) on land and buildings?
The supply of land and buildings, such as the sale, leasing or renting of freehold land and buildings, is normally exempt from VAT. This means that no VAT is charged, and the entity making the supply cannot normally recover any of the input VAT incurred on costs relating to the exempt supply.
Due to the nature of activities undertaken by many farms and estates, they are classed as partially exempt for VAT purpose. This means they generate both taxable (e.g. sale of crops and livestock) and exempt supplies (e.g. land and building rental). Under the partial exemption rules, a business can only recover the input VAT relating to exempt supplies provided that the amount of such input VAT does not exceed both, £7,500 and 50% of the total input VAT incurred in VAT year (year ending March, April or May depending upon which of those dates is the end of a VAT period).
Once an OTT election has been made, VAT will be charged on the rent at the standard VAT rate. The landlord is then able to recover all the VAT that has been incurred in making the supply. However, even after an OTT has been granted, residential income will always be exempt from VAT.
Letting of commercial buildings
The letting of a commercial building (if not solely for storage) is generally seen as an exempt supply for VAT. If the building costs or repair costs are likely to exceed the partial exemption threshold, businesses should consider opting to tax the property to allow for the full VAT on costs to be recovered.
When repairing an existing building which has previously been used for trading activities, but is now about to be let out, an OTT should be made prior to any subsequent supplies of the building being made. The option cannot be materially backdated, and HMRC should be notified within 30 days of the decision.
If the building is new, and no other activity has been operated from it, an OTT made at any point prior to its first use will ensure full input tax recovery. This can be particularly useful if building costs are higher than expected or exceed the partial exemption threshold in a particular year.
Once the land or building has been opted to tax, any future supplies will be subject to VAT. If the tenant is not VAT registered, they will have the added cost of covering the irrecoverable VAT.
If the building is sold within 20 years of the effective date of the option, VAT will need to be charged on a sale of the building (unless transfer of going concern rules apply). It is, therefore, important to consider the long-term plans for the building before making an OTT.
Promotion agreements
A promotion agreement relies on a developer or land promoter gaining planning permission on land on behalf of a landowner, who then sells the land. As the sale of land is generally exempt for VAT purposes, no VAT can be recovered by the landowner on costs associated with the sale.
The promoter acts as a principal in his own right, securing planning permission for the landowner for which he charges a fee. This fee will be subject to VAT and will almost certainly exceed the partial exemption threshold. Therefore, the only way for the landowner to recover the input VAT is by making an OTT election on the land.
If the land is personally owned, rather than by a business, it will be necessary for the landowner to register for VAT and OTT the land to enable VAT on the promoter’s fee and other costs to be recoverable.
Communication
When letting or selling land or commercial buildings, it is essential for all parties and their professional advisors to understand the VAT treatment, this will enable any contract to include the appropriate VAT clauses. This is crucial to ensuring the ability to be able to charge VAT and to recover VAT on associated input costs.
The timing of the OTT should be carefully considered and made only when there is certainty of selling, letting or of considerable improvement or repair work taking place. This should avoid the landowner being left with land or buildings on which they will have to charge VAT for no actual benefit. As mentioned above, generally once made the OTT election lasts for at least 20 years, however, there is the possibility of revoking the option to tax within six months, subject to certain conditions being met.
Summary
Careful consideration of if, and when an OTT should be made is key to ensuring the most beneficial VAT treatment. Opting can open the door to recovering VAT on costs that would otherwise be irrecoverable. However, by opting too early, you could be stuck with having to charge VAT on a sale or rent where the purchaser or tenant is not able in a position to reclaim. This could result in a lower rent, or sale proceeds being achieved.
If you would like to discuss options to tax, please contact one of our VAT team, or your usual Hazlewoods contact.