VAT and the option to tax as a charity landlord
Any charity looking to purchase a property should take appropriate VAT advice at an early stage to ensure there are no unexpected liabilities at a later date.
The charity sector has to contend with some of the most complicated aspects of VAT, and property is one of them. As commercial properties command significant prices, any VAT errors or wrong decisions when considering your option to tax can be crippling.
The option to tax on a charity property
It is important for charities to know that although the rent under a commercial property lease can be exempt from VAT, landlords may choose to waive this exemption and still charge VAT on the rent. This is known as ‘option to tax’.
The reasoning behind this is so that they can recover the VAT they pay on their costs relating to the property. Perhaps the landlord is proposing to redevelop or refurbish the property, in which case the option to tax will allow them to claim back VAT incurred during the building costs. It is therefore good practice to question from the outset if the landlord is intending to charge VAT on the rent.
Unfortunately, when it comes to charity VAT, many smaller charities cannot then recover VAT on the rent they pay as they are not registered for VAT.
However, there are still options available to tackle the VAT on property.
Disapply an option to tax
In this situation, if a charity is intending to use their premises for a relevant charitable purpose (RCP) and not as an office, or more than 5% usage to administrative purposes, they are able to disapply the landlord’s option to tax under the VAT Act 1994.
For more information see HRMC VAT Notice 742A: opting to tax land and buildings, with particular reference to Part 3.5 ‘Buildings to be used solely for a relevant charitable purpose’.
To disapply the option to tax, the charity would need to write to the landlord outlining the relevant charitable use of the property or provide a ‘disapplication notice’. However, it is important to consider that this will then impede on the landlord’s own VAT position and he may then have to pay back VAT that has already been reclaimed or be unable to recover VAT that has already incurred.
He may not wish to proceed with the letting or could command a higher rent to cover his costs. However, it is also worth considering that the landlord may be prepared to reduce the rent but keep it VATable to make your payments more affordable.
Charity VAT reliefs are complex and there is a huge importance in understanding the distinction between business and non-business activity for VAT purposes, so it is recommended that professional advice is sought on what constitutes non-business activity.
The option to tax for charities sharing their property
Increasingly, charities are seeking to work together to create efficiencies, but the issue that VAT can be added where one organisation charges another for services acts as a hindrance to collaborative working.
Charities may be motivated to share their property assets in search of an additional income stream, or perhaps to simply provide space to beneficiaries. But whether a charity shares their property under a sublease or a licence to occupy will depend on the VAT treatment of the arrangement.
A supply of property through a lease or sublease is usually exempt from VAT. Whereas a licence to occupy is likely to be chargeable for VAT at the standard rate.
When you are looking to share or sublease your property, the charity landlord will have the choice to ‘opt to tax’ and may wish to do this to recover associated input tax and to increase tax recovery levels. If a landlord has exercised their option to tax, then it is likely that they will also wish to charge VAT on the sublease.
Always consider the use of your property
Of course, when sharing a property, it is important to be extremely careful that the use of the property does not jeopardise any VAT relief. If a charity were to sublet to an organisation that does not use the property for a ‘relevant charitable purpose’ then HMRC will be entitled to claim some or all the unpaid VAT. Hiring out the building may not automatically fall outside of ‘relevant charitable purposes’ but it requires careful consideration.
In addition to this, if a charity landlord has opted to tax a property and leased to another charity who has also disapplied that option, this will affect your VAT recovery.
HMRC can claim back historically
If a charity constructed a new property for a relevant charitable purpose and were entitled to VAT zero-rating on the construction costs, yet within 10 years the property is no longer used for charitable purposes, the VAT owed can be backdated.
If you are unsure that you are applying the correct and appropriate VAT treatment to your charitable property or would simply like to run a VAT health check to ensure you have the most efficient practices in place, please contact Senior Tax Manager Alan Rolfe on 023 8046 1235 or email firstname.lastname@example.org.