Harlow Property Ltd - option to tax, partial exemption and a nursery tenant
Harlow Property Ltd has been VAT-registered for twelve years. In the year to 31 March 2025 it makes these supplies: rent from a retail unit let to a VAT-registered high-street retailer, £60,000 a year, with no option to tax exercised; rent from a dental surgery let to a partnership of dentists, £40,000 a year, on which Harlow exercised an option to tax five years ago; and the sale of two newly built houses for £250,000 each. Input tax is £20,000 a year on general overheads, £8,000 on costs directly attributable to the retail unit, and nothing directly attributable to the dental surgery. Harlow is considering exercising an option to tax on the retail unit. It has also been approached by a children's nursery that wants to rent a vacant third unit for £45,000 a year.
1. Should Harlow exercise an option to tax on the retail unit? Quantify the partial exemption position and advise.
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Current position
Taxable supplies (standard-rated dental rent £40,000 plus zero-rated new houses £500,000) = £540,000. Exempt supplies (retail rent) = £60,000. Total = £600,000, so the recoverable proportion under the standard method is 90%.
Input tax: £28,000 total.
- Directly attributable to the retail unit: £8,000 - irrecoverable.
- Residual: £20,000 × 90% = £18,000 recoverable.
- Recoverable total: £18,000; irrecoverable £10,000.
De minimis? Exempt input tax is £8,000 + (£20,000 × 10%) = £10,000. The £625-per-month test (£7,500 a year) is failed, so the business cannot reclaim everything. Harlow is genuinely partially exempt.
Effect of opting to tax
The retail rent becomes standard-rated and all supplies become taxable, so the whole £28,000 is recoverable - a saving of £10,000 a year. The tenant is a VAT-registered retailer making standard-rated sales, so it recovers the VAT and the rent is commercially neutral to it.
Points before opting
- The option is irrevocable (broadly, no revocation for 20 years) once VAT has been charged; the cooling-off period only helps if no VAT has yet been invoiced.
- The lease must permit VAT to be added to the rent - check whether the rent is stated as exclusive of VAT.
- The option binds any future sale of the property: the buyer must opt for a transfer of a going concern, or 20% VAT of £240,000 would arise.
Recommendation: opt to tax, subject to confirming the lease wording and the tenant's recoverability.
2. Advise on the proposed letting to the children's nursery and whether Harlow should opt to tax the third unit.
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The tenant's position
A nursery provides education and childcare, which is exempt. It therefore cannot recover VAT on rent. Any VAT Harlow charges is a real 20% cost to the tenant - an extra £9,000 a year on £45,000 - which the nursery will resist, either by negotiating the rent down to £37,500 net or by going elsewhere.
Harlow's position if it does not opt
Exempt income rises by £45,000. Assuming the retail unit has been opted, supplies are: taxable £600,000 (retail £60,000 + dental £40,000 + houses £500,000) and exempt £45,000, total £645,000. Exempt fraction = 6.98%.
- Residual input tax attributable to exempt supplies: £20,000 × 6.98% ≈ £1,396.
- Add any direct exempt input tax on the nursery unit, say £1,000 of fit-out costs.
- Exempt input tax ≈ £2,396, which is below £7,500 a year and well below 50% of total input tax.
So the de minimis test is met and Harlow recovers all its input tax. The nursery letting costs nothing in VAT recovery terms.
Alternative
If the retail unit is not opted, exempt supplies become £105,000 out of £645,000 - 16.3% - and exempt input tax would be around £8,000 + £3,260 = £11,260, comfortably outside de minimis, permanently losing recovery.
Recommendation: do not opt on the nursery unit; keep the rent VAT-free and let the de minimis rules absorb the exempt input tax. Confirm in writing that the rent is inclusive of any VAT.
3. Harlow is offered £1,200,000 for the retail unit and the dental surgery by an investor who will continue letting both. Explain the VAT consequences and the conditions Harlow must satisfy.
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Default treatment
The sale of an interest in land is exempt unless an option to tax has been exercised. Both units are (or will be) opted, so the sale is standard-rated at 20% - £240,000 - unless it qualifies as a transfer of a going concern.
TOGC conditions
- The buyer must be a taxable person, or become one as a result of the transfer (it must be VAT-registered before completion).
- The property must be let, or available for letting, and the buyer must intend to continue letting it in the same way. The two units are let to a retailer and a dental partnership, so this is satisfied.
- The buyer must opt to tax the properties before the date of transfer. An option exercised after completion is too late and the sale becomes standard-rated.
- The seller must charge no VAT, and the contract must be drafted as a TOGC - price exclusive of VAT, with a TOGC clause and a warranty that the buyer will opt.
If the conditions are met
The supply is outside the scope of VAT. No £240,000 output tax arises, no SDLT is paid on a VAT element, and Harlow's partial exemption position ends cleanly. If they are not met, the buyer must find £240,000 up front and recover it through its own partial exemption calculation - often only partly - so the deal could easily fall through on price.
Practical points
- Confirm the buyer's VAT registration number and obtain its completed option to tax before exchange.
- Keep the option to tax documentation for both units; HMRC can ask for it on enquiry.
- Do not include any standard-rated chattels or services in the same invoice without apportioning the price.