Beta This part of GOV.UK is being rebuilt – find out what beta means

HMRC internal manual

VAT Land and Property

Option to tax: input tax and the option to tax: permission options: what is a fair and reasonable attribution of pre-option input tax?

If a person requires written permission to opt, you must refuse permission if you are not satisfied that there would be a fair and reasonable attribution of input tax relating to the supplies of the land that would be taxable if the option has effect.

Before deciding whether to grant permission, you should ensure that the applicant has provided all information requested on form VAT 1614H, familiarise yourself with all the circumstances of the case, and assess the level of input tax that will become recoverable as a result of the option.

It is likely that you will be faced with one of two scenarios.

The first is where the input tax has been incurred in the same period for partial exemption (‘PE’) purposes (including longer period if one applies) as the option is to take effect (information on PE longer periods can be found in PE4100). In this case you can rely on the normal operation of the PE rules and, if the land or building falls to be a capital item, the capital goods scheme (‘CGS’). However, it may be that the existing PE method does not provide for a fair and reasonable recovery of the input tax based on the use and intended use in the longer period. If this is the case the applicant should be invited to submit proposals for a special method before permission is granted to ensure that a fair and reasonable amount of input tax is recovered. It is also important to remember that if the land or building is a capital item, this method will also be used to calculate future adjustments under the CGS and care should be taken that these are adequately catered for.

The second scenario is where the option is granted in a longer period subsequent to that in which the input tax is incurred. In these circumstances there is no legal basis for recovering input tax other than by way of adjustments under the CGS. This is made clear in the High Court decision in the case of R & R Pension Fund (STC 889).

R & R Pension Fund recovered input tax on the construction of a building. On completion they granted a 15 year lease without opting to tax. The exempt use of the building triggered a self-supply charge (no longer applicable) and an input tax restriction of £74,417. The Pension Fund opted to tax and proposed that 99.1% of the input tax should be allowed on the basis of 16 months of exempt use compared to an expected life of 150 years. We said that the CGS should apply and the Pension Fund appealed on the grounds that the CGS did not produce a fair and reasonable result as required by what was then paragraph 28 of Schedule 10. Although the Tribunal found for the Pension Fund, the High Court disagreed and said that if a taxpayer sought to opt to tax, he was bound by the provisions of the CGS.