We regularly engage with property developers. Usually, to help them get the most out of their projects from a VAT perspective. Typically, advising on the availability of VAT reliefs to minimise the amount of VAT paid and/or minimise restrictions to the recovery of any VAT payable). Most developers will be aware that the ability to recover VAT on build & professional costs rests on being able to attribute those costs to ‘taxable activities.’
The sale (or long lease) of a new house or apartment is a (zero-rated) taxable activity. Generally, this enables the recovery of any VAT paid on related costs.
If the intention is to rent a new property out on a short term let, this is a VAT exempt activity. Which normally means that the VAT incurred on related costs is irrecoverable (thus becoming a further cost to the project).
So, the VAT position is relatively clear if the intention is taxable (full VAT recovery) or VAT exempt (no VAT recovery).
If you start off with the intention to make taxable supplies (e.g. sale of the houses/apartments you are developing), to fully recover the VAT incurred on build costs. It may mean adverse market conditions mean that you need to defer selling the properties. So, you have to rent them out instead (VAT exempt) at least until such time market conditions are more favourable.
Many developers found themselves in this position in the late 2000s when there was a significant downturn in the housing market. It appears that developers are once again finding themselves in a similar position.
Say a taxpayer fully recovers VAT on the basis that they intended to make taxable supplies. They actually make VAT exempt supplies before their taxable intention is fulfilled. The VAT regulations (regulation 108) call for repayments to HMRC for recovered VAT. Only fully if the taxpayer now only makes VAT exempt supplies; partially if they now make both taxable and exempt supplies.
When developers started to rent out properties 25 years ago they had intended to sell, HMRC started issuing assessments to ‘clawback’ the VAT. The VAT was recovered by the developers (regulation 108 is normally referred to as the ‘clawback’ provisions.)
One of my clients, at the time, is faced with such a predicament and asked if there was anything to be done.
I told them ‘yes’ because there had been two cases a few years earlier (Curtis Henderson and Briararch) that we could use to challenge HMRC’s assessment. The cases are heard together because they deal with the same issue:
The Curtis Henderson/Briararch judgement found that if VAT was recovered on the basis of an intention to make taxable supplies and the intention remained in place, so did the right to recover related VAT costs, although any VAT exempt supplies made would also need to be considered, with the recovery of VAT costs restricted to the extent they are attributable to the VAT exempt supplies.
The principles are set out in the earlier cases, but…
After much negotiation with HMRC we arrived at a simple calculation. The calculation compares the time the property is rented out to the ‘economic life’ of the property. HMRC apply this ratio to the recovered VAT in relation to the development of the properties. We used this calculation to establish whether the value of VAT attributable was below the partial exemption ‘de minimis’ limit (and therefore fully recoverable as being immaterial).
This initial check showed that the VAT costs attributable were above the ‘de minimis’ limit. We then carried out a more detailed calculation using anticipated sale values & rental income values. This shows the expected income it generated from the properties over their 10-year ‘economic life.’ We initially argue that the economic life should be 25 years. However, HMRC insisted that it should be in line with the 10-year Capital Goods Scheme.
Shortly after we conclude the matter, HMRC issue a VAT Information Sheet (07/08) (in September 2008). This confirms methods not too dissimilar to those we agreed with them could be used by any developer. Thankfully, without having to seek approval from HMRC.
We recently used this methodology for a client who had converted a number of industrial buildings into dwellings. To raise some funds for the completion of the project, they rent completed units. HMRC were about to clawback £80k from our client. This was until we submitted a calculation that showed that the value of VAT attributable to the exempt lets. The calculation taking in to account future sales, was below the de minimis limit.
We use similar methodologies for ‘Rent To Buy’ arrangements. These are similar to those described above except the initial rentals are part of a wider agreement with tenants/buyers. A planned exempt rental period should not make a difference. This is, provided there remains an intention to make a taxable sale after the initial rental (whether to the people renting the property or a third party). There are other important factors to consider for Rent to Buy arrangements that may have a VAT impact:
Finally, note that there are other structuring ways for VAT exempt rental activities (including more permanent renting activities). This is so that VAT costs are fully recoverable. But in principle, VAT costs relating to residential rental properties are normally irrecoverable.
As always, if you have any questions, please contact your usual ETC Tax contact.
Check out our next live webinar – Tax Considerations for Property Developers – June 29th – Click here to reserve a space
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