Disapplication of an option to tax – seller beware!


Andy Wood

Andy is a practical, creative tax adviser who assists a variety of clients in achieving their personal and commercial objectives in the most tax efficient manner.

Disapplication of an option to tax

We were contacted recently by a new client of ours who had received an email from HMRC, in which HMRC sought to deny the client recovery of input VAT, totaling some £12k, in respect of the costs incurred on the sale of a property by that client some time ago. The reason?  The client had been issued with certificate 1614D by the buyer prior to the sale; the effect of which was to disapply our client’s option to tax.   Unfortunately for the client, they had not been advised at the time of the tax effects of the disapplication and were left feeling slightly aggrieved and somewhat out of pocket.

Options to tax – background

Absent an option to tax, and except in certain circumstances, supplies of commercial land and property are prima facie exempt from VAT (in the same way as supplies of residential property).  An individual or company may choose to ‘opt to tax’ commercial land or property, such that any supplies that they make of that land or property will be subject to VAT. A key driver for this is to enable that person to recover any input VAT they incur in relation to the supplies they make of that land or property. However, in certain specific circumstances, a seller’s option to tax may be disapplied.

Disapplication of the option to tax

A disapplication of the option to tax may apply in circumstances where the property is intended to be designed or adapted, and/or is intended for use as a dwelling or number of dwellings; intended to be used for another residential building i.e care homes or student accommodation, intended for use for a charitable purpose; the sale is to a housing association; it is intended to be used for construction of a building intended for use as a dwelling by an individual; or it is intended to be used as a caravan pitch or houseboat mooring; or finally, by operation of specific anti-avoidance rules (the application of which rules are not always easy to identify).

Effect of a disapplication of the option to tax

Where the buyer intends to use the property in one of the ways outlined above, or the anti-avoidance rules apply, the buyer is able to issue the seller with a certificate to disapply the seller’s option to tax; such that the sale (or lease) by the seller will be exempt for VAT purposes.

Whilst this is helpful for the buyer, who does not have to pay VAT on the transfer; it can be problematic for the seller (or landlord), who will be unable to recover any input VAT they incur in relation to that transaction i.e in respect of legal or estate agents fees; and perhaps more crucially may also face a clawback of VAT they have previously recovered under something called the ‘capital goods scheme’.

When acting for a seller, therefore, it is essential that the seller is made aware of the consequences of selling to such a buyer before committing themselves to the sale. The seller’s tax adviser should also ensure that seller is able to determine whether the certificate they have received is valid.  For example, a buyer is not entitled to certify that the building or part of the building is intended for use as a dwelling or solely for a relevant residential purpose if there is intended to be a period before it is put to such use during which it will be used for other purposes.

Once satisfied that the buyer can legitimately issue the certificate and the certificate is provided, the seller has no choice but to disapply their option to tax. Therefore, for sellers where this causes a real tax issue, sometimes the only real option for the seller is to find a different buyer, who does not intend to issue a certificate.

Whilst another alternative would be for the seller to renegotiate the sale price with the buyer, (perhaps to compensate for the seller’s inability to recover input VAT incurred), again the seller should be aware that a higher purchase price will necessarily mean a larger exempt supply, with a potentially bigger clawback under the capital goods scheme should this be relevant.

Enterprise Tax Centre assists clients with all tax aspects of buying and selling property, so if you or your clients need any further advice in this area, please give us a call and we will be happy to assist.

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