Mark Withers | 1st June 2021

Disapplication of option to tax on land

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Mark Withers | 1st June 2021

Disapplication of option to tax on land


Paragraphs 12 to 17 of Part 1 of Schedule 10 to the Value Added Tax Act 1994 hang as something akin to a sword of Damocles over any party who has opted to tax for VAT in relation to land and subsequently disposes of an interest in it.

When can a disapplication of option to tax be made?

Paragraph 12 was designed to prevent avoidance schemes which allowed exempt (or partly exempt) occupiers to recover VAT on property expenditure. By way of an example, if a dentist (the provision of dental services being exempt from VAT) constructed or carried out significant works to a building, it could grant a lease to a vatable third party and take a leaseback. There would be VAT payable by the dentist on the rent but the VAT on the capital expenditure would be recovered.

Paragraph 12 of Schedule 10 of the VAT Act 1994 provides that if the Capital Goods Scheme (“CGS”) applies i.e. construction expenditure in excess of £250,000 had been incurred and during the CGS adjustment (i.e. whilst the VAT was potentially repayable) the property was occupied by the party which had incurred the capital expenditure or a party connected with it and was used (or it was expected it would be used) for less than 80% vatable purposes, the option to tax (put in place to enable VAT on the capital expenditure to be reclaimed) will be disapplied and the VAT reclaimed (or part of it) would be irrecoverable.

The introduction of this provision caused much concern in the mid 1990’s and it led to some frantic drafting to try to avoid options to tax being unwittingly disapplied.

Paragraph 12 was considered recently by the Court of Session in the case of Moulsdale Properties -v- HMRC. The case is fascinating both in terms of the application of paragraph 12 and how easily a property owner might fall foul of it.

In this instance, the owner of a property opted for tax and rented it to a connected party who provided exempt services. Some years later the owner of the property sold it subject to a lease and didn’t charge VAT on the sale, having taken the view that paragraph 12 applied to render the option to tax of no effect.

Owing to the passage of time, the CGS adjustment period had expired and since the buyer wasn’t registered for VAT, the seller couldn’t have expected that the property would become a capital item in the hands of the buyer. The Court therefore considered the option to tax wasn’t disapplied and VAT was due on the sale. The buyer (unregistered for VAT) would then have found itself paying 20% more for the property than it intended and the seller will have been left scrabbling to demand VAT post completion

The case very much rests on its facts but the point to glean from it is the importance of a seller having a clear understanding of its VAT position and how any dealings may impact upon it. It isn’t surprising the government continues to look to simplify the operation of VAT in relation to land and the landscape will no doubt continue to evolve.

If you have any queries around the topic of disapplication of option to tax on land or any issues raised in this blog, please contact Mark Withers.

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