VAT & charity

[Asvsix]

IML Ltd a nursery school purchased a commercial property, opted to tax and registered for VAT. The whole of the top floor of the property has been let to ABB Ltd a charity (religious) and who have moved in. The space will be used for meetings and conferences and at weekends the space will be used for religious activities.
The ground floor, smaller floor space, will be used by the owner to run a nursery (a new company IMB Ltd has been incorporated). IML Ltd director is a trustee in ABB Ltd. IML Ltd currently charge VAT to ABB Ltd and will do the same when IMB Ltd starts running the nursery.

IML Ltd is trying to claim the VAT it incurred on the purchase of the commercial property through the quarterly VAT returns. The VAT office has suspended the returns saying the above transaction is not a taxable supply quoting Notice 742a sections 13 and 3.5 see below.
What is the best way forward?

[spidersong]

The best way is to engage a specialist to see what can be salvaged.

The following is of course an immediate reaction to the information as presented without knowing the full ins and outs of each business and the agreements between them which would be needed to form a full opinion and which are no doubt too detailed to attempt in a forum setting, anyway:

So at the moment a business which is likely fully exempt in its general trade occupies the building and lets it to an associated business which has a mix of non-business use and unless they opt their interest in the building as well exempt use in letting rooms for meetings and conferences, or potentially exempt education.

If the businesses were unrelated everyone would have fairly significant restrictions on their recovery anyway (the nursery wouldn't get any in relation to the floor it has, and the religious charity wouldn't get much of the VAT charged by the other company back). As they are related they seem to fall quite squarely under the anti-avoidance rules, and so the option will have no effect, even if it did have effect it would be disapplied by the prohibition on opting buildings for charitable use, the VAT incurred will not be recoverable, it will be debateable whether the nursery can even be registered for VAT, and everyone will be regretting not bottoming out these issues before buying a building with VAT applicable to it.

A experienced advisor/specialist may be able to salvage something but there is still going to be significant restriction on recovery whatever happens from the limited information available.