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HMRC internal manual

VAT Land and Property

Option to tax - anti-avoidance test: what is the aim of the anti-avoidance test?

The anti avoidance test is intended to prevent businesses that would not normally be entitled to fully recover VAT (such as those in the finance, education, private health care and leisure sectors) from using the option to tax to recover more input tax on the acquisition, construction or refurbishment of buildings than they would ordinarily be entitled to.

Before the test was introduced, some exempt businesses had used ‘sale and leaseback’ (or ‘lease and leaseback’) schemes to avoid upfront VAT costs. Typically, a business wishing to construct a building would have arranged for a subsidiary company to construct the building and lease it back to the exempt business, having opted to tax. The subsidiary, as a result of its option to tax, would be able to recover the input tax on construction costs in full - the actual VAT cost of the building being drip fed via the taxable rental payments incurred by the exempt business. Such an arrangement could provide a significant cash flow advantage.

The anti-avoidance test was introduced in 1997 to combat this type of arrangement. The test has the effect of disapplying the option to tax in situations such as the above, where the grant has certain features which are commonly found in tax avoidance arrangements.

It is not the aim of the legislation to upset normal commercial property transactions, such as the construction of a building by a property developer who will then lease it out to third party tenants. However, the test is a mechanistic one. There does not have to be an intention to avoid tax for the test to be triggered. Therefore, some arms length commercial arrangements are caught by it.