For VAT registered businesses, without taking any action subletting your office space to another business is VAT exempt.
This means that the rental income and associated costs will be exempt from VAT for invoicing purposes. That is, you will not add VAT on top of the rent charge that you have agreed (in your accounting software, the VAT rate to select is ‘Exempt Income’).
However, there is a complication to consider. If all of your sales usually have VAT included at the standard rate of 20%, or one of the reduced rates then at the moment you claim back all of your VAT on your purchase invoices. There is a risk that you may not be able to do so due to the rental income being exempt for VAT. This is called partial exemption. There is a level at which you are able to ignore this if the impact is not material.
If you already issue some or more invoices that are exempt for VAT purposes then there will be two exempt income streams. It would therefore be prudent to carry out a review to assess whether there is a material impact and therefore whether you are only able to reclaim some of your VAT on purchases.
Depending on the outcome of this review, you may wish to consider making an application to HMRC to opt to tax the subletting of the office. If approved you will charge VAT on your rental income and be able to reclaim all of the VAT on your purchases.
The only issue to consider when opting to tax the office is the VAT status of the business you are subletting to. If they are VAT registered they will be able to reclaim the VAT you charge them, but if they are not VAT registered then by opting to tax the rents you will be imposing a 20% increase on the rents, which may not be palatable for them
If you need help with this, or with other advice, then please get in touch with our accounting team.