'Occupation' of a building for purposes of disapplying option to tax

Under certain circumstances, an option to tax is disapplied if the person occupying the relevant property does not intend to use it predominantly for taxable purposes.

This condition usually means that any standard rated supply under the option to tax reverts to being exempt where the user is unable to reclaim more than 80 per cent of its input tax, and thus affects the supplier’s right to recover input tax.

Following the House of Lords judgment in The Principal and Fellows of Newnham College in the University of Cambridge, HMRC have revised their policy in deciding when a person is ‘in occupation’ for the purposes of the disapplication provisions.

HMRC have now made it clear that the usual factor determining occupation i.e. physical presence alone, is not the only test. In addition to phsyical presence, the person must have a right to occupy it to the exclusion of others.

In other words, that person must have actual possession of the land along with a degree of permanence and control. They add that occupation can also exist without formal, written agreements and that day-to-day reality can differ from the terms of a contract.

Therefore, the substance and reality of any situation should dictate whether or not a person occupies a building. For example, a person could be occupying a building even if an agreement allows for joint occupation or if a person does not use all the land all the time.

Perhaps most significantly, HMRC state that a person with an ‘inferior’ interest in land or buildings will not be considered ‘in occupation’ until that interest expires. They give the example of a situation preventing a person from having rights of occupation for the time being.

However, the danger might be in failing to consider future intentions. As ever, it is the intention or intended use at the time of a supply that dictates the correct VAT treatment and here, if a person is not in occupation at the time of the relevant supply but fully intends to be at some stage before the end of the 10-year adjustment period for the Capital Goods Scheme, that person must still consider whether they will be using the land or buildings predominantly for taxable purposes (as described in the first paragraph above).

If input tax recovery would be less than the usual 80 per cent, then the option to tax would still be disapplied, despite the initial inferior interest. Occupation just in order to arrange to let or re-let a property would be ignored.

Business that have lost input tax through HMRC’s incorrect interpretation of the disapplication provisions, or more specifically, their incorrect definition of ‘in occupation’ may now claim a refund, subject to the usual capping provisions, but must also calculate output tax due on supplies of the building, which as a result revert to being standard rated.