In the current economic climate, some businesses will take strategic decisions that, whilst done for commercially justifiable reasons, will have a VAT impact.

For instance, consider a business that decides to sub-let part of its building which is excess to requirements:

Valid questions are:

• Does the business have a choice about charging VAT on the letting income?
• Can the business reclaim all input VAT on the costs of the sub-let building?
• Could some of the input VAT on non-direct costs be disallowed because of the sub-let portion?
• If the business sells the building, will the VAT treatment on the sub-letting impact on the sale price?

The Complication Of Partial Exemption:

At a basic level, most transactions (sales and lettings) are exempt from VAT, however there are complexities that need to be considered.

While the letting of a building might be exempt from VAT, this introduces the concept of partial exemption, whereby a VAT registered business makes both taxable supplies (e.g. its normal sales) and exempt supplies (e.g. subletting of the business premises).

If this occurs then the business cannot reclaim VAT on costs directly attributable to the exempt letting business (e.g. agent’s fees). Also, it cannot reclaim a proportion of the input VAT on the non-direct costs (e.g. general overheads).

There are two methods for computing the disallowed amount. This is subject to quarterly and annual de-minimis limits where, should the input tax on the exempt supply be small enough, all the input VAT can be claimed. Needless to say this is not a simple calculation!

In some cases it is possible to avoid partial exemption by making a decision to opt to tax the building in order to get all the input VAT back (by making only taxable supplies).

This is a 20-year election made to HM Revenue & Customs where the business undertakes to charge VAT if it makes any onward supply of the building (e.g. on a sublet or an onward sale). There are strict time limits to opt to tax a building and the business must make a decision on its strategy before it makes any supply (e.g. a property owner must opt to tax the building to get the purchase VAT back before making the first rental supply).

Implications On Sale Of Building:

Some supplies of buildings (e.g. the freehold sale of a commercial building under three years old) must always be standard rated VAT supplies. If a commercial property has been opted to tax then its sale will be subject to VAT as well. This addition of VAT might have an impact on the sale of the building.

For instance, if the business purchasing the building is not eligible to recover VAT (e.g. it is a charity, educational establishment or in the financial services industry) then it may be less willing to take on the building compared to another property with no VAT.

However, if the purchaser is a fully taxable business using the building for its taxable activities, the VAT can be recovered, although adjustments under the Capital Goods Scheme might be required during the following ten years. In this case it is important that a record of the building’s history is maintained. Should the purchaser decide to let or part let the building then it will have to consider the option to tax as explained above.

More Information:

As can be seen, the subject is very complex and this issue of Topical Tips is not meant to be a full summary of the rules. More information can be found here: HMRC VAT Notice 706

Barnes Roffe Topical Tips:

• If you think that some of your supplies might be exempt then you need to double-check your compliance.
• House builders who have been forced to consider renting out their houses rather than selling them need to be especially careful.
• If you are partially exempt then there may be a better method to calculate your disallowed input VAT which might save you VAT.
• New penalty regimes start from 1 April 2009 which will see higher penalties for errors – be sure to review your position before then.

And a final note on another important VAT matter

Due to a recent ruling, claims (known as ‘Fleming Claims’) can be made to reclaim under-recovered input VAT paid before 1 May 1997 and to reclaim overpaid output VAT declared before 4 December 1996.

In some cases, recent court rulings can be used and their impact backdated to make a reclaim. All claims must be submitted before 31 March 2009. In particular charities, car dealers, hot food retailers and members clubs should consider their position. Other more diverse businesses such as bowling alleys, skating rinks, etc. should consider it too. If you think this will benefit your business you must act now!