Q&A – Property VAT

Q: My company isn’t VAT registered because all we do is buy, renovate and rent out/sell old residential properties. We pay VAT on the refurbishment costs and this an additional cost because we can’t VAT register to recover it.  There’s not much we can do about it, so there’s not a lot to discuss regarding VAT, is there?

A: In certain circumstances, it is possible to register for VAT, even if you only deal in residential investments.

It is correct that because the rental of residential property is a VAT exempt activity. It is not normally possible to recover VAT incurred on relate costs.

Certain VAT reliefs available…

However, there are certain VAT reliefs available to limit the amount of irrecoverable VAT you will incur.

I.E the 5% reduced rate of VAT can be applied to renovation works in a number of circumstances. Such as, if the property has not been occupied for residential purposes in the two years before the work begins. Or, if the work entails a change to the number of dwellings.

Similar VAT reliefs are also available where a non-residential property coverts into a residential property. Additionally, the long-lease or sale of residential property could mean it will be possible to obtain a VAT registration. This also means the VAT you incur is recoverable.  The same can apply if a residential building that has been unused for more than 10 years undergoes renovation.

Q: 5 years ago in 2018, my Company bought the small office building that it was occupying as a tenant.  The Company bought it from the landlord for £500k plus £100k VAT.  My Company recovered the £100k VAT because it was only using the property for its own (fully taxable) business.

We now need to move into bigger premises so we are selling the office building in March 2023.  We have never opted to tax the property because our accountant told us we didn’t have to. This is because we’ve only used it ourselves for fully taxable purposes, so we could sell it without VAT. We recovered all of the £100k VAT we paid on its purchase and the sale will be VAT exempt because we haven’t opted to tax. However, our accountant told us that HMRC cannot claw back any of the VAT we recovered on the purchase. They said we recovered the VAT more than four years ago, and this was therefore outside the 4 year time limit for assessing VAT.

This sounded reasonable to me, but a friend of mine that I trust said that it didn’t sound right and suggested that I got a second opinion.

HMRC clawing back some of the VAT!

A: You were right to listen to your friend.  Your accountant was right to say that you didn’t need to opt to tax the building to recover the VAT. This is because you were occupying it for fully taxable purposes. However, they were wrong about HMRC not being able to claw back some of the VAT you initially recovered.

Although HMRC cannot make any adjustments to the original recovery because:

• (a) it was correctly recovered at the time
• (b) it’s more than 4 years ago since the VAT was recovered in any case, there is a mechanism that HMRC can use to claw some of it back in a later period if the basis on which the VAT was recovered subsequently changes. This is called the VAT Capital Goods Scheme (the ‘CGS’)

Capital Goods Scheme (CGS)

The CGS applies to land, buildings, or construction works that, when you purchase, are a value of £250k or more. The buildings were also subject to VAT. There is also a version that relates to computers but this is much less common than the property CGS.

In this case, the CGS will apply because the purchase of the building was more than £250k and they can collect VAT.

Under the CGS, the initial recovery (at the time the VAT is first incurred) follows the normal rules. So, it was correct to fully recover the £100k VAT. This is because, at the time, they were using the building d 100% for taxable activities by the Company.

However, they review the ‘taxable use’ of the building in each subsequent year for the next 10 years, and if in any year the extent to which they use property for making taxable supplies is different from how it uses in the year they initially incur the VAT, adjusts must be made.

The amount of VAT that is subject to potential adjusts each year is 10% of the VAT that they initially incur on the CGS item (so in this case, £100k x 10% = £10,000.)

• If taxable use decreases, it will be necessary to pay back some of the VAT originally recovered. 
• If taxable use increases, it will be possible to recover an additional portion of the VAT originally incurred.

Calculation

The first calculate the change in taxable use (as a % increase or decrease) between the year you are making the calculation and the initial period in which you incur the VAT.  This +ve or -ve % applies to the £10,000 (in this case) to arrive at the adjustment required.

If a property sale goes through part-way through the 10-year CGS period, the remaining ‘intervals’ will ‘crystallise’ and only require a single adjustment. They base this on the number of years left in the 10-year CGS period, with the VAT liability of the sale being the ‘use’ to which the property is put when they finally calculate.

So if you sell the property (as VAT exempt) 5 years into the 10-year period, the final adjustment will be 5 x annual adjustments in one.  The total CGS calculation would look like this (£100,000 VAT recovered in year one):

Period                 Taxable Use       Change in taxable use                  CGS adjustment required

(compared to year 2018)                          

Year to 2018       100%                   n/a                                                   n/a

Year 2 (2019)     100%                   0%                                                    £10,000 x 0% = nil

Year 3 (2020)     100%                   0%                                                    £10,000 x 0% = nil

Year 4 (2021)     100%                   0%                                                    £10,000 x 0% = nil

Year 5 (2022)     100%                   0%                                                    £10,000 x 0% = nil

Year 6 (2023)     0%                       -100%                                              £50,000 x -100% =  -£50,000

Conclusion

If you opt to tax the building prior to its sale the recovery % would be 100% (same as when you bought the building). No adjustments are required. Although, you would have to charge VAT on the sale price.

Next steps

Do you have any VAT property questions? do not hesitate to get in touch