Option to Tax and the Capital Goods Scheme on Law Firm Premises

The Default: Land and Buildings Are VAT-Exempt

The starting point for any premises decision is that a supply of an interest in land or buildings is normally VAT-exempt. Selling or letting commercial property is an exempt supply, which means the owner charges no VAT, but, crucially, also cannot recover the input VAT it incurs on related costs: the purchase price VAT, the VAT on a refurbishment or fit-out, agent and professional fees, and running costs of the property.

For a law firm buying or fitting out an office, that default can mean a large block of unrecoverable VAT. A substantial refurbishment carries 20% VAT, and if the firm cannot recover it, that VAT is simply an added cost of the project. The lever that changes this is the option to tax, which turns the exempt supply into a standard-rated one and unlocks recovery. But the option is a long commitment, and once VAT has been recovered on a high-value building, the Capital Goods Scheme keeps watch over that recovery for a decade, re-adjusting it as the firm's circumstances change. The two regimes are best understood together, and they connect back to the firm's partial-exemption position.

What the Option to Tax Does (VATA 1994 Schedule 10)

The legal anchor is Schedule 10 to the Value Added Tax Act 1994 (paragraphs 23 to 29), with VAT Notice 742A as the accessible HMRC guidance. The effect is straightforward: once an owner has opted to tax, all the supplies it makes of its interest in the land or building will normally be standard-rated, and it will normally be able to recover any VAT it incurs in making those supplies.

The single most important practical point is who opts. It is the owner or landlord, over their own interest in the property. A tenant firm does not opt to tax its landlord's building; only the owner of the relevant interest can opt over that interest. So a firm that merely occupies leased premises has no option to make over the landlord's building. What a firm can do is opt to tax where it (or a connected entity) owns the relevant interest: a firm that owns its own premises, or holds them through a connected property company or a SIPP or SSAS pension scheme, can opt to tax that interest. The owner of the interest is the opter, never the tenant.

Why a Firm or Landlord Opts to Tax

The reason to opt is to recover input VAT on a purchase or a substantial refurbishment or fit-out. The logic is mechanical: VAT on premises costs is recoverable only if the onward supply (the rent the owner charges, or a later sale) is taxable, and that requires the option. Without the option, the onward supply is exempt and the input VAT is stranded.

The trade-off is real and long-lasting. Once opted, the owner must charge 20% VAT on rent or on a later sale of the property. That is fine where the recipient can recover the VAT (a fully taxable tenant or buyer), but it is a genuine cost where the future tenant or buyer is VAT-exempt or partly exempt and cannot recover it, for example another professional firm with exempt income, a bank, an insurer or a charity. Opting can therefore make the property less attractive to a category of future occupiers or purchasers, which is part of why the decision must be modelled rather than taken reflexively.

The arithmetic of the decision is usually a comparison of two numbers over time. On one side sits the input VAT the option unlocks now: 20% of the purchase price, or 20% of the refurbishment spend, recovered up front (subject to the firm's recovery rate). On the other side sits the VAT the owner must charge on future supplies of the property, the present value of which depends on how long the property is held, whether it is let or owner-occupied, and crucially whether the eventual recipient of the supply can recover the VAT. Where the firm occupies its own building and never lets it, the "VAT on rent" cost largely disappears (a firm does not charge itself rent in a way that creates an irrecoverable VAT cost in the simple owner-occupier case), and the live exposure is the VAT on an eventual sale. Where the property is held to let, the VAT on rent is an ongoing feature for the whole option period. These are the variables a proper model weighs; the option is rarely either obviously right or obviously wrong in the abstract.

How to Opt: The Decision and the Notification

Opting to tax happens in two stages. First the owner makes the decision to opt. Then the owner notifies HMRC, normally within 30 days of the decision, on form VAT1614A. The notification is what gives the option its administrative effect, so the 30-day window matters.

HMRC's practice on acknowledging options to tax has been reduced in recent years, so the firm should not rely on receiving a confirmation and should instead keep its own clear, dated record of the decision and the notification. That record is important if the option is ever questioned, on a future sale, for example, when a buyer's solicitor will want evidence that the option was validly made and notified.

The 6-Month Cooling-Off Period

An option to tax is not entirely irreversible at the outset. Within a window of less than 6 months from the day the option took effect, and provided the conditions are met (broadly, no tax has yet been recovered or charged under the option in a way that prevents revocation, and no relevant supplies have been made), the option can be revoked without HMRC's permission, notified on form VAT1614C.

This cooling-off period is the main safety valve for a change of mind. A firm that opts to tax in anticipation of a transaction that then falls through, or that reconsiders the commercial position quickly, can step back within the window. Once the 6 months pass, that easy exit closes and the long-term commitment described next takes over.

The 20-Year Commitment and Later Revocation

An option to tax generally lasts 20 years. Outside the 6-month cooling-off period, revocation is available only in limited circumstances. It can be revoked where more than 20 years have elapsed since it first had effect (on form VAT1614J, subject to conditions). Separately, the option is automatically revoked where the opter has not held an interest in the opted building or land for a continuous period of 6 years beginning at any time after the option had effect.

The practical message is sober: outside the 6-month window and the 6-year-no-interest rule, the owner is committed for two decades. Every future rent invoice will carry VAT, and any sale within that period will be a standard-rated supply. That is why opting is a strategic decision about the property's whole future, not just a way to recover VAT on today's refurbishment.

The Capital Goods Scheme: What It Is and the Thresholds

The second regime is the Capital Goods Scheme (CGS), set out in the VAT Regulations 1995 (SI 1995/2518), regulations 112 to 116, with VAT Notice 706/2 as the accessible guidance. For high-value capital assets, the CGS spreads and re-adjusts input VAT recovery over a fixed number of intervals, reflecting changes in the asset's taxable versus exempt use across the adjustment period.

The thresholds and intervals are exact and are measured VAT-exclusive:

• Land, a building or part of a building, civil engineering works, and refurbishment or construction costing £250,000 or more (excluding VAT): a 10-interval adjustment period. This is the threshold most relevant to a law firm buying or substantially refurbishing premises.
• A single computer or item of computer equipment costing £50,000 or more (excluding VAT): a 5-interval adjustment period. Note this is a single item at £50,000 or more, not aggregated everyday IT spend, so it catches a large server or system rather than a batch of laptops.

One caution on terminology: an interval is not always a full calendar year. The first interval can be a part-period, so it is more accurate to speak of intervals than of years. Aircraft, ships and boats are also 10-interval items, but they are out of scope for a law firm.

It is also worth being clear about what counts towards the £250,000 threshold on a refurbishment, because this is where firms misjudge whether the scheme applies. The scheme bites on capital expenditure on the building (construction, reconstruction, extension, refurbishment or fitting out), measured VAT-exclusive, where it reaches £250,000 or more. Routine repairs and maintenance, which are revenue rather than capital, do not bring an asset into the scheme. A single large fit-out project will commonly clear the threshold; a series of small, unconnected repairs will not. Where a firm is unsure whether a project is capital expenditure on the building of the required scale, that is a question to settle before assuming the CGS does or does not apply, because the answer drives a decade of monitoring obligations.

For most law firms, the practical reality is that the premises (a purchase or a major refurbishment) is the only CGS asset they will ever hold. The £50,000 single-computer threshold occasionally catches a substantial server installation or practice-management system bought as one item, but the bulk of a firm's IT spend (laptops, screens, smaller licences) falls well below it and is recovered in the ordinary way. So the centre of gravity of this scheme, for a firm, is almost always the building.

How the CGS Re-Adjusts Recovery Each Interval

At the end of each interval the firm compares its taxable-use percentage for that interval against the baseline recovery (the recovery position set at the end of the first interval) and adjusts. The adjustment formula is: total input VAT on the capital item, divided by the number of intervals in the adjustment period, multiplied by the adjustment percentage, where the adjustment percentage is the difference between the interval's recovery percentage and the baseline.

The direction of the adjustment follows the change in use. If taxable use falls in a later interval (for example because the firm has become partially exempt), the firm repays part of the VAT it originally recovered for that interval. If taxable use rises, the firm recovers more. So the recovery on a building is not locked in at purchase: it is monitored across the full 10-interval period (or 5 intervals for a qualifying computer), and a final adjustment crystallises on a sale of the asset or on deregistration.

Two features of the mechanism are worth drawing out, because they shape the practical burden. First, the baseline is fixed once, at the end of the first interval, and every later interval is measured against it. That makes record-keeping for the first interval especially important: the firm needs to be confident the first-interval recovery rate is right, because it anchors the next decade. Second, the adjustment in each interval is only a tenth of the total VAT at stake (a fifth for a computer), so a single bad year produces a modest, bounded clawback, not a wholesale loss of the recovery. The scheme is designed to track use fairly over time, not to penalise a one-off fluctuation, which is why a firm that drifts in and out of partial exemption across the period sees the adjustments net out rather than compound.

A sale of the building part-way through the adjustment period triggers a final adjustment for the remaining intervals, treating the disposal as either fully taxable or fully exempt use for that balance depending on how the sale is treated for VAT (which is itself affected by whether the option to tax is in place and whether the sale qualifies as a transfer of a going concern). Deregistration similarly crystallises a final adjustment. These end-of-life events are where a CGS schedule that has been kept properly over the years earns its keep, because the figures needed to compute the final adjustment are exactly the ones the firm should have been recording interval by interval.

The Interaction With Partial Exemption

This is the join that a firm most needs to understand, because it links the premises decision to the firm's wider VAT position. The CGS adjustment percentage is the firm's partial-exemption recovery rate for the interval. A fully taxable firm has a recovery rate of 100% and stays there interval after interval, so no clawback arises and the building VAT recovered at the outset simply stands.

But if the firm later becomes partially exempt, its recovery rate drops below 100%, and the CGS makes it repay a slice of the originally recovered building VAT for each affected interval. The most relevant trigger for a law firm is exempt income that breaches the de minimis limits, most commonly material, non-incidental interest, including retained client-account interest. Our guide to partial exemption and client account interest explains when that actually happens (for most firms the interest is incidental and there is no restriction). The point here is the consequence: where a firm does tip into partial exemption, the effect is not confined to that year's overheads, it reaches back across the CGS intervals and re-adjusts the recovery on the building too. Conversely, opting to tax can itself improve a firm's recovery on premises costs. Premises VAT decisions and partial-exemption status are linked over a 10-year horizon, and should be managed together.

Worked Example: A CGS Interval Adjustment

The following is an illustrative sketch to show the mechanics, not advice, and the figures are invented.

A firm owns its office (or holds it through a connected property company) and spends £400,000 plus VAT on a major refurbishment, comfortably over the £250,000 (VAT-exclusive) land-and-buildings threshold. The input VAT is £80,000 (20% of £400,000). The owner opts to tax the interest, notifying on form VAT1614A within 30 days, so the refurbishment input VAT becomes recoverable. The refurbishment is a 10-interval CGS item, so the annual slice for adjustment purposes is £80,000 divided by 10, which is £8,000 per interval.

In the first interval the firm is fully taxable, so its recovery rate is 100% and it recovers the full £80,000. That 100% becomes the baseline. Suppose that, two intervals later, the firm becomes partially exempt because materially large, actively managed retained client-account interest has breached the de minimis limits, and its partial-exemption recovery rate for that interval falls to, say, 90%. The adjustment for that interval is the slice (£8,000) multiplied by the adjustment percentage (the 10-point fall from 100% to 90%), which is £8,000 multiplied by 10%, equal to £800. The firm repays £800 of the originally recovered VAT for that interval.

If the reduced recovery rate persists, a similar adjustment can arise in each later interval for which taxable use remains below the baseline. If the firm returns to full taxable use, the adjustment falls away for subsequent intervals. The lesson: the £80,000 recovered up front is not locked in; a later change in the firm's taxable-use percentage re-adjusts it, interval by interval, over the 10-year period.

Practical Decision Points and Cautions

• Check whether the landlord has opted before taking a lease. It determines whether your rent carries 20% VAT and therefore your own recovery position.
• Model the option before committing. Weigh the up-front VAT recovery against the 20-year lock and the effect on a future sale or letting to a VAT-exempt or partly exempt party.
• Notify on time. Form VAT1614A normally within 30 days of the decision, and keep your own dated record given HMRC's reduced acknowledgement practice.
• Track CGS items and intervals. Maintain a schedule for each capital item over its 10 intervals (or 5 for a qualifying computer), recording the baseline and each interval's taxable-use percentage.
• Coordinate with partial-exemption monitoring. Because the CGS adjustment percentage is the partial-exemption recovery rate, the two reviews should be run together.
• Note the TOGC interaction. A sale of premises as part of a going-concern business transfer can, where the conditions are met, be a transfer of a going concern outside the scope of VAT, which interacts with an option to tax; this is a point to take advice on at the time of any sale.

The same fit-out spend that drives these VAT decisions usually also carries capital allowances, and the recovery rate discussed in our guide to partial exemption and client account interest is the very figure that feeds the CGS adjustment. For the timing of output VAT on your own fees, see our guide to the VAT tax point and time of supply for law-firm billing, and for the wider framework our guides to VAT on legal services, solicitor VAT accounting and VAT registration for solicitors.

Speak to a Specialist

Premises VAT is one of the highest-value VAT decisions a law firm makes, and it is also one of the easiest to get wrong, because the option to tax binds the property for 20 years and the Capital Goods Scheme keeps the recovery in play for a decade. The right answer depends entirely on the numbers, on whether the firm is and will remain fully taxable, and on what the firm intends to do with the property in future. Before opting to tax a purchase or refurbishment, or when reviewing recovery on premises the firm already owns, speak to a legal-sector-specialist accountant who can model the option, set up the CGS tracking, and coordinate it with your partial-exemption position.