VAT & Option to Tax
The option to tax is a well-established mechanism that allows a business to convert what would otherwise be an exempt supply of land or property into a taxable one, thereby recovering input VAT on associated costs. A recent First-tier Tribunal decision is a useful illustration of how the anti-avoidance provisions can strip that option away entirely - with significant financial consequences.
In Nissi N Nissi Limited v HMRC, the company had opted to tax a property at Tower Bridge Road in London and claimed input VAT totalling £606,164 across a series of quarterly returns. HMRC issued assessments to recover those repayments, arguing that the option to tax should be disapplied under the anti-avoidance provisions in Schedule 10 of the VAT Act. The Tribunal agreed, and the appeal was dismissed in full.
The anti-avoidance provisions are designed to prevent the option to tax being used to generate input VAT recovery where the economic reality of the transaction does not support it. In broad terms, they apply where the property is a "Capital Item" (a VAT specific definition), the grant is made to a connected party or a development financier, and the occupant of the property would not be able to recover at least 80% of the VAT charged on the supply. Where those conditions are met, the option to tax is disapplied and the supply reverts to exempt, regardless of the election that is in place.
In this case, the property was supplied to a connected party intending to operate a children's nursery - an exempt activity carrying minimal VAT recovery. The conditions were met, the option was disapplied, and with no taxable supplies being made the company had no entitlement to the £606,164 in input tax it had claimed. The Tribunal did not need to address HMRC's alternative argument, which was that the invoices underlying the input tax claims had been falsified - a point the company had largely conceded in its own submissions.
The practical message is that opting to tax does not guarantee input tax recovery. Where a developer grants an interest in a property to a connected party or financier, and the intended occupier's business is wholly or largely exempt, the anti-avoidance provisions are likely to bite. The VAT position should be assessed at the outset, before the transaction completes and before input tax is claimed.
VITA has extensive experience advising on land and property VAT, including option to tax elections, disapplication risks, and associated input tax recovery. If you are involved in a property transaction where VAT recovery is a consideration, please get in touch.
