Residential Renovations and Conversions
Current Issues | VAT | 3rd November 2017
VAT as it applies to property is one of the more complex parts of the VAT system and to cover every aspect of the relevant legislation would require an entire book. This article is, therefore, only looking at two specific situations:
- Renovating a property that has been empty for some time
- Residential conversions
VAT is often overlooked when budgets and costings are being put together as there is a tendency to assume that it is a side issue that can be safely ignored – something for the book-keeper to sort out!
However, any project that involves property should have a consideration of the VAT treatment factored in at an early stage to ensure that costly mistakes do not arise.
This is particularly important when dealing with residential property as VAT incurred on expenditure is rarely recoverable which means that project costs can end up being 20% higher than budgeted.
The inability to recover VAT on costs arises because the architects of the VAT system thought that it would be a good idea to relieve domestic accommodation from VAT. However, the quid pro quo for not having to account for VAT on income is denial of VAT recovery on costs.
As many of the costs incurred by a landlord or developer will be subject to VAT the exemption is a one sided relief because the VAT will not be recoverable.
The UK VAT system also, rather confusingly, includes some situations where VAT does not apply to income but does allow VAT to be recovered on underlying costs. These are projects where zero rating rather than exemption applies.
Zero rating generally applies to new-build developments but a full explanations is outside the scope of this article so readers are recommended to seek advice from a VAT specialist.
A good example of when VAT can be an issue is a renovation project. For example, a developer buys a run-down flat and refurbishes it with a view to making an onward sale or perhaps retaining it so as to earn rental income.
The income from sale or letting will be exempt from VAT and as a result VAT incurred on related expenditure will not be recoverable.
In most cases the VAT charged by suppliers will be at the full rate of 20% but that may not always be appropriate in every situation.
Obviously for a small project it might be possible to use contractors that are not VAT registered which would confine the VAT cost to the 20% attaching to materials, equipment hire, professional fees etc. but is there another possibility?
For some projects the answer is yes – there is another possibility.
If the run-down flat has been empty for more than two years any works of renovation or alteration should be subject to VAT at 5% rather than the full 20%.
The contractor will be able to fully recover VAT incurred on building materials, equipment hire and so on but will only charge VAT at 5% on his invoices to the property owner.
It will be necessary to have documentary evidence confirming that the property has not been lived in for at least two years.
So although the developer is not able to recover VAT the amount at stake is considerably reduced.
Another situation where the 5% rate can arise is where a property is altered so as to increase or decrease the number of residential units.
Again the contractor recovers VAT at 20% on materials, sub-contractors etc. and only charges VAT at 5% when billing the developer or landlord.
Care has to be taken to ensure that the increase or decrease in the number of residential units fits inside HMRC’s definition which can be quite complex and will require expert advice.
Where the project involves conversion from commercial to residential there is an additional VAT advantage available.
If the newly created residential units are to be sold rather than let, the sale proceeds will be zero rated rather than exempt.
N.B. Zero rating only applies to the first sale after conversion with all subsequent sales being exempt.
As noted above zero rating allows VAT to be recovered on costs so it is a worthwhile aim but what if you want to retain the properties and let them?
Depending on the ownership structure it may be possible to sell the properties to an associated entity in order to benefit from zero rating thereby preserving the VAT recovery rights. The associated entity then conducts the exempt letting activity.
Two final points to bear in mind for both renovation and conversion projects:
- It is the supplier’s responsibility to charge VAT at the correct rate. If they fail to do so the customer’s only recourse is to go back to the supplier and ask for the relevant invoices to be reissued showing the correct VAT rate. There is no facility enabling customers to seek reimbursement from HMRC.
- When seeking reimbursement of overcharged VAT from a supplier it is essential to bear in mind the four year cap that applies to VAT corrections. Any attempt by a supplier to seek reimbursement from HMRC of VAT overpaid more than four years ago will be rejected which means that the supplier will, in turn, be unable to make reimbursement to his clients
VAT can often be an unwelcome cost for property developers and landlords and a trap for the unwary. Fortunately there are some situations where the extra cost can be minimised but the legislation is complex and ever changing so expert advice is a must
Specific advice should be obtained before taking action, or refraining from taking action, on any of the subjects covered above. If you would like advice or further information, please speak to your usual Shipleys contact.