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: input tax incurred in anticipation of an option to tax

Before input tax can be deducted the taxpayer must have a clear intention to use the costs that the input tax is incurred on in making taxable supplies.

A taxpayer will normally be expected to make and notify an option to tax prior to recovering input tax in relation to future supplies of a property if those supplies would only become taxable by virtue of an option to tax. An option to tax is considered to be the clearest evidence that the taxpayer intends his supplies to be taxable, though it should be remembered that an option to tax is disapplied in respect of certain types of supply and so will not always be sufficient evidence of intention. See Notice 742A Opting to tax land and buildings for further details. Where, despite an option to tax, there is evidence that a taxpayer intends to enter into transactions where the option will disapply, input tax claims should not be allowed.

Following the tribunal decisions in Trustees of Park Avenue Methodist Church (VTD 17443) and Beaverbank Properties Ltd (VTD 18099) we now accept that objective evidence, other than an option to tax, can be used by taxpayers to demonstrate an intention to make taxable supplies. In the first of the above decisions, the tribunal found that:

‘The making of an election means that a future supply will be taxable. But the making of an election is not, as we see it, essential to establishing an intention to make a taxable supply even where a supply will only be taxable if an election is made. Other objective evidence of intention may be available’.

A similar conclusion was reached by the tribunal in Beaverbank. Beaverbank was a property development company which incurred costs in relation to the planning of a mixed retail/leisure development project in Ayr. The VAT on the costs amounted to approximately £15,000 and this was recovered by Beaverbank on the basis that it related exclusively to their intended taxable supplies (the sales or leases of the retail/leisure units).

Beaverbank did not opt to tax at this initial stage of the project, as it was the usual practice to delay the option until planning permission was secured. As it turned out the planning authority refused the planning application and the project was aborted. The Commissioner’s assessed Beaverbank for the input tax recovered, claiming that, in the absence of an option to tax, this could only have related to intended exempt supplies.

The Tribunal, however, was of the view that other evidence should be considered, such as a financial appraisal of the project which showed that the overall viability depended on VAT being charged. Beaverbank also produced copies of its planning application, which showed that the proposed buildings (cinemas, shops, fast food restaurants, etc) were likely to be sold or leased to VAT registered entities. The Tribunal was of the view that the evidence showed beyond reasonable doubt that had the project gone ahead, Beaverbank intended to make taxable supplies.

HMRC accept that it can be onerous for taxpayers to opt every site that they are considering and then withdraw options on sites that are rejected. If it is inevitable that an option will be made prior to the making of any supplies then a taxable intention can exist prior to the making of an option.

If you find that a taxpayer who intends to make supplies of commercial properties has claimed input tax prior to the effective date of an option to tax you should consider all available evidence of the trader’s intention.

Some examples of the types of evidence that a trader might retain are contained in section 9 of Notice 742A Opting to tax land and buildings. No individual document is likely to be determinative and you should try to satisfy yourself that all the evidence leads to the same conclusion. You should also consider whether the building is designed and planned to suit taxable occupants. As in Beaverbank, the planning documents may also be helpful in confirming the type of development envisaged.

If the evidence is not clear then you should assume that the taxpayer was keeping his options open and thus did not have a clear intention to make taxable supplies.

In no circumstances should input tax claims made prior to an option to tax be allowed where there is evidence that had the trader opted the option would have been disapplied.

An assessment should be issued where a trader has recovered input tax and cannot produce appropriate contemporaneous evidence that he intended to make taxable supplies. However, where a developer has incurred costs in the course of investigating potential projects, the input tax treatment will depend on his intentions at the time the input tax is incurred. Where the developer:

  • has a clear intention regarding the supplies he intends to make, he must attribute the input tax incurred to the liability of the intended supply;
  • has no clear intention about the supplies he intends to make, the input tax must be treated as residual and apportioned according to the trader’s partial exemption method.

Such costs are normally referred to as speculative costs. For further information see section 9 of Notice 742A Opting to tax land and buildings. It is particularly important to establish a trader’s intention where projects are subsequently aborted. In such cases a trader may never make an option to tax and the entitlement to input tax will depend solely on their intentions at the time the input tax was incurred. You should also consider whether at any stage there has been a change of intention and whether Clawback/Payback procedures should have been applied - see Notice 706 Partial exemption for further details.