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Option to Tax: Maximising VAT Efficiency in the Commercial Property Sector

Option to tax maximising OTT

When it comes to Value Added Tax (VAT) management, businesses often encounter complex regulations and mechanisms that impact their financial operations. One such crucial aspect is the Option to Tax (OTT), which offers businesses opportunities to optimise VAT recovery in many cases in relation to non-residential property transactions. At The VAT Consultancy, we recognise the importance of understanding and effectively navigating OTT regulations to maximise VAT efficiency for our clients but also to ensure the many pitfalls in this area are understood so that VAT does not form an unnecessary cost.   In this article, we will delve deep into the intricacies of the OTT, providing invaluable insights and strategies to help businesses navigate the complexities in this area.

What is the Option to Tax (OTT)?

The Option to Tax (OTT) (also known as an ‘election to waive exemption’) is a fundamental provision within VAT legislation that allows businesses to elect to charge VAT on the sale or rental of non-residential property provided certain exceptions don’t apply. By exercising this option, businesses can transform what would otherwise be a VAT-exempt transaction into a taxable one, thereby enhancing their ability to recover VAT on associated costs. This strategic move opens up new avenues for VAT recovery, enabling businesses to optimise their financial resources and bolster their bottom line.  There are various considerations however which are set out below.

Example of the Option to Tax (OTT) with a £1 Million Property Valuation

Let’s consider a scenario where a property developer acquires a non-residential property valued at £1 million with the intention of renting it out to generate income. Upon acquisition, assuming the vendor has also opted to tax the building, the Developer is automatically charged standard rate VAT on the purchase price, which amounts to £200,000 (assuming a standard VAT rate of 20%).

If The Developer decides to rent out the property without exercising the Option to Tax (OTT), the rental income would be exempt from VAT. Consequently, The Developer would not be able to reclaim the £200,000 VAT incurred on the property purchase.

However, by opting to tax the property, The Developer can change the VAT treatment of the rental income from exempt to taxable. Let’s explore how this decision impacts VAT recovery and overall financial outcomes:

  1. Opting to Tax (OTT):
    • The Developer decides to exercise the Option to Tax (OTT) on the property.
    • He rents out the property to a commercial tenant for £100,000 per year, plus VAT at the standard rate of 20%.
    • With the OTT in place, The Developer can reclaim the £200,000 VAT incurred on the property purchase as input tax, subject to normal VAT rules.
    • Therefore, The Developer’s VAT position improves, as he can recover VAT on associated costs, including professional fees, maintenance expenses, and future capital investments related to the property.

If the Developer does not opt to tax the property, he is unable to reclaim the VAT he has paid on the purchase of the building so this forms a cost.  It is worth noting however that SDLT is payable on the VAT inclusive value of a property so this will increase if the option to tax has been exercised.


Duration and Implications of OTT

Once a business elects to opt for OTT, the regulations remain in effect for a significant period, typically spanning 20 years. During this period, the business gains the flexibility to charge VAT on relevant transactions, thus maximising VAT recovery opportunities. However, it’s essential to recognise that revoking the OTT option requires careful consideration and adherence to specific conditions. Failure to navigate this process accurately can have far-reaching implications, underscoring the critical importance of seeking specialist VAT advice to ensure VAT compliance and mitigate risks effectively.


The Decision-Making Process

Determining whether to opt for OTT entails a comprehensive evaluation of various factors, tailored to the unique circumstances of each business. At The VAT Consultancy, our team of experts assists businesses in navigating this decision-making process, taking into account factors such as the nature of the property, VAT incurred on costs, potential tenant or purchaser VAT recovery, and implications under the Capital Goods Scheme. By conducting a thorough analysis and providing strategic guidance, we empower businesses to make informed decisions that align with their VAT objectives and financial goals.


Notification and Application Process

Once a decision has been made to opt to tax land/buildings, it is important the correct protocols are followed in determining whether there is a need to simply ‘notify’ HMRC that the business has opted to tax its interest in the building, due to the fact automatic permission is granted due to the fact pattern present (eg no previous exempt income received in relation to the property), or whether it must instead ‘apply’ to opt to tax (in which case HMRC will consider factors relating to income and costs incurred to date in relation to the land/property).  Property transactions can be de-railed and the eleventh hour if the relevant notifications and evidence relating to VAT and the OTT are not available to the solicitors working on the transaction.  It is therefore recommended that this area is considered way in advance of the final stages.


Disapplication of Option to Tax

Complexity can arise when a property that has been opted to tax is sold or leased to a party that will use it for a specific purpose that results in the OTT being disapplied.  This includes the following and specialist VAT advice is recommended to ensure that the VAT cost impact is fully understood so that the sale/lease valuation can be properly determined:

  • Buildings to be converted to dwellings
  • Land to be used to construct a dwelling
  • Buildings to be used for certain charitable purposes
  • Buildings to be used for relevant residential purposes eg as a nursing home


HMRC Acknowledgement Process

Recent changes in HMRC’s acknowledgment process for OTT notifications have introduced additional complexities and considerations for businesses. While acknowledgment no longer serves as a legal requirement, it remains a valuable aspect of property transactions, providing assurance to businesses and stakeholders involved. Our team at The VAT Consultancy stays abreast of these changes and guides businesses through the acknowledgment process, ensuring compliance and minimising potential risks associated with VAT management.


The Importance of Expert Advice

Option to tax or OTT demands expertise and precision. At The VAT Consultancy, we recognise the critical importance of specialist VAT advice in achieving optimal VAT efficiency and compliance. Our comprehensive approach encompasses strategic planning and risk mitigation, ensuring that businesses navigate OTT regulations effectively and maximise VAT recovery opportunities. By partnering with us, businesses can benefit from our deep understanding of VAT regulations and our commitment to delivering tailored solutions that align with their unique needs and objectives.


Summing up OTT

In conclusion, the Option to Tax (OTT) represents a pivotal mechanism for businesses seeking to optimise VAT recovery in non-residential property transactions. At The VAT Consultancy, we are committed to empowering businesses with the knowledge and expertise needed to navigate OTT regulations effectively and maximise VAT efficiency. By leveraging our comprehensive guidance and strategic insights, businesses can navigate the complexities of OTT with confidence, safeguarding their financial interests and ensuring compliance with VAT regulations. Trust us to be your partner in VAT optimisation and compliance, driving sustainable growth and success in non-residential property transactions.


Get in contact

Ready to unlock the full potential of your domestic and commercial property transactions through strategic VAT management? At The VAT Consultancy, we specialise in providing expert guidance and tailored solutions to optimise VAT efficiency and compliance.

Whether you’re a property developer, investor, landlord, or tenant, our team of VAT experts is here to assist you every step of the way. From navigating the complexities of the Option to Tax (OTT) to maximising VAT recovery on property acquisitions, we have the knowledge and experience to meet your needs.

Don’t let VAT regulations hinder your property investment goals. Contact us today to learn how our consultancy services can help you unlock savings, mitigate risks, and achieve your financial objectives.

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