VAT on Property and Construction

The most error-prone area of VAT. The default is exemption, there are three rates in play, and the treatment turns on facts that are frequently not established until after the invoices have gone out, by which time correcting it is expensive and sometimes impossible.

Why Property VAT Goes Wrong

VAT on land and buildings is the most error-prone area of the tax. The default is exemption, but there is a long list of exceptions, three different rates in play, and the treatment depends on facts (the nature of the building, its previous use, its intended use, and who is doing the work) that are frequently not established until after the invoices have been raised.

The consequences of getting it wrong are asymmetric and unpleasant:

• VAT charged when it should not have been is not VAT properly due, so it is not input tax in the customer’s hands. HMRC denies recovery and the customer’s only remedy is against the supplier, worthless if the supplier has been dissolved.
• VAT not charged when it should have been leaves the supplier liable, often on a VAT-inclusive basis if the contract is silent, plus interest and a possible penalty.

The Rates and When They Apply

Zero rating: new dwellings

The construction of a new building designed as a dwelling, or a number of dwellings, is zero-rated, as is the first grant of a major interest in it by the person constructing. The conditions are strict and each has generated litigation:

• the building must be designed as a dwelling, with self-contained living accommodation, no direct internal access to another dwelling, and lawful separate use and disposal;
• statutory planning consent must have been granted and the work carried out in accordance with it;
• the separate use or disposal condition is the one most commonly failed, a planning condition tying an annexe or a new house to an existing dwelling defeats zero rating;
• the demolition and rebuild rules determine when work is a conversion rather than a new build.

The reduced rate

A 5% rate applies to certain qualifying conversions: changing the number of dwellings, converting a non-residential building to residential, and renovating a dwelling that has been empty for the qualifying period. Evidence of the empty period, typically from the local authority, is essential and is routinely not obtained until HMRC asks.

Standard rating and exemption

Most other construction work, and most repairs and alterations, are standard-rated. Sales and lettings of land and buildings are generally exempt, subject to the exceptions and to any option to tax.

The DIY Housebuilders Scheme

A person who builds their own home, or converts a non-residential building into a home, is not in business and cannot register for VAT. The DIY housebuilders scheme allows them to reclaim the VAT they have borne, putting them in broadly the same position as someone who buys a new house from a developer.

Where these claims fail

• The time limit. The claim must be made within the prescribed period following completion. The rules on the deadline and on what constitutes completion have been the subject of change and of substantial litigation, and the safe course is to claim as soon as the building is complete rather than to test the boundary.
• Only one claim. The scheme permits a single claim, so it must be complete when made.
• The separate use or disposal condition, again, a planning restriction tying the new building to an existing one defeats the claim entirely.
• Wrongly charged VAT. Where a contractor should have zero-rated the work and charged 20% instead, that VAT is not recoverable under the scheme. The claimant must go back to the contractor for a credit.
• Ineligible items. Certain fitted goods and services are excluded, and the boundary between building materials incorporated in the building and excluded items is a constant source of dispute.
• Evidence. Invoices addressed to the claimant, planning permission, completion evidence and a full schedule.

The Option to Tax

An option to tax turns an exempt supply of land into a taxable one, allowing recovery of related input tax. Three points cause most difficulty:

• Notification. The option must be notified to HMRC within the prescribed period. HMRC’s change of practice on acknowledgements means the notifying email and any receipt should be preserved as the evidence.
• Disapplication. The anti-avoidance provisions in Schedule 10 VATA 1994 can disapply the option, notably where the land is to be used for a relevant residential or charitable purpose, or where the exempt land grant rules bite. See our guide to option to tax disapplication.
• Revocation. There is a cooling-off period shortly after the option, an automatic lapse where no interest has been held for a long period, and a revocation route after twenty years. None is straightforward and all require care.

The Construction Industry Reverse Charge

For supplies between VAT-registered businesses within the Construction Industry Scheme, the domestic reverse charge shifts accounting for VAT from the supplier to the customer. Errors are common at the boundaries (end users and intermediary suppliers, mixed supplies, and where CIS status changes mid-contract), and they produce assessments on one party and recovery denials on the other.

Practitioner Application

1. Establish the rate before work starts, in writing, and obtain any certificate the legislation requires. Retrospective correction is expensive and sometimes impossible.
2. Check the separate use or disposal condition on every new dwelling and every annexe. It defeats more zero-rating and DIY claims than anything else.
3. Get the empty property evidence early for a 5% conversion claim.
4. For DIY claims, prepare the whole claim before submitting, only one is permitted, and claim promptly after completion rather than testing the deadline.
5. Preserve option to tax notifications and receipts. The absence of an acknowledgement is not the absence of an option, but you have to be able to prove it.
6. Put a VAT clause in the contract dealing expressly with what happens if HMRC later disagrees, with an indemnity and a mechanism for issuing a VAT invoice or credit.
7. Check the CGS position on any capital item: see our guide to partial exemption and the capital goods scheme.

Frequently Asked Questions