You have reviewed your business premises and realise that you have surplus space that could potentially be sub-let to another business. But what are the VAT issues that need to be considered before you make this decision? Kevin Ferguson takes a closer look.
LIABILITY OF RENTAL INCOME
The starting point is that income you receive from letting out a specific area of land on your premises is exempt from VAT and therefore not subject to output tax. This is good news if your potential tenant cannot claim input tax on their own expenses, for example if they are a small business which is trading below the registration threshold.
It is important to be clear about the difference between a land supply and giving another business the right to trade from your premises. A land supply means that your tenants will occupy their own area of land which is available for their exclusive use.
Example: Jane is VAT registered as a hairdresser and has agreed that Mary can rent a chair and desk in her salon for her beautician business. The fees paid by Mary will be standard-rated because the arrangement is giving her a right to trade in the salon rather than a clearly defined area of land.
INPUT TAX CHALLENGE
If you earn exempt rental income, this means that you are partially exempt with an input tax restriction on your expenditure.
Wholly linked to exempt use
You will be input tax blocked on any expense that directly relates to your subletting activity, e.g. advertising expenses incurred in trying to find a tenant.
Partly linked to exempt use
These can be either mixed costs or general overheads. If, for example, you rent the premises from a landlord who charges you VAT, this input tax will be partly blocked if you are sub-letting some of the premises.
The VAT on your mixed costs and overheads will be apportioned using the standard method of calculation, which is based on the proportion of your exempt and Vatable income for a period. However, it might be worth writing to HMRC and asking for a special method of calculation, e.g. a method based on floor space or employee numbers.
DE MINIMIS LIMITS
You might have a winning outcome if your sub-letting activity means that your exempt input tax falls within the partial exemption de minimis limits. There are separate de minimis tests but the main test is to check if your exempt input tax is less than:
£625 per month on average, i.e. £1,875 in a VAT quarter
Less than 50% of your total input tax
But don’t forget that the exempt input tax figure also includes the proportion of input tax you don’t claim on your overheads and mixed costs.
OPTION TO TAX
If you cannot recover some input tax as a result of your partial exemption calculations, you could make an option to tax election with HMRC for the premises in question. You will then charge 20% VAT on your sub-letting income and can therefore claim input tax on your related costs.
However, once you make a tax election, be aware that it cannot be revoked for 20 years. This will apply to all of your income from the building (subject to some overrides), including any future sale.
Review any arrangement with a prospective tenant to see if it gives them their own area of land or just gives them the right to trade from your premises. Check whether you can fully claim input tax through the partial exemption de minimis limits. If not, consider if making an option to tax election with HMRC might be worthwhile.
As you will see, this is not quite as straightforward as would first appear and it is worthwhile taking professional advice before making any decisions, please contact me or one of the team at JRW who will be happy to help.