Surrender of an option to buy land - exempt or taxable supply?

The taxpayer agreed an option with L giving it the right to purchase some of its land in the future at an agreed price. It was described as an option 1 agreement. The taxpayer obtained planning permission to develop the land in July 2016 but instead of taking up the option to buy the land it received a fee of £1.425m from L in December 2016 in return for surrendering the option. This allowed L to sell the land on the open market.

The taxpayer treated the payment received as exempt from VAT as a land supply. Neither party made an option to tax election. HMRC used to accept exemption in this situation but has recently changed its interpretation of the law and how UK law interacts with EU legislation. It considered the payment received by the taxpayer to be standard rated on the basis that the...