This guide examines the main VAT considerations applicable to residential developers, and sets out the basic VAT position on supplies made to and by them.
In this guide, a residential building means a building designed as a dwelling or a number of dwellings or intended for use solely for a relevant residential purpose. These and other terms used in this guide have particular meanings, which must be considered carefully.
New residential buildings
Once a developer has constructed a residential building, its first grant of a major interest in it – usually a freehold or a lease for more than 21 years – is zero-rated for VAT. This rule extends to a partly-constructed residential building provided it is clearly under construction, i.e. that it has progressed beyond the foundation stage. Zero-rating also applies on the first grant of a major interest where the developer has converted a non-residential building into a residential one.
Where the supply consists of the grant of a lease for more than 21 years, only the premium or first rental payment will be zero-rated. Subsequent payments are exempt from VAT altogether.
The consequence of zero-rating is that developers who make only these types of taxable supplies charge VAT on them at 0%, but are entitled to full recovery of VAT paid on costs that they incur - known as 'input tax'. Central to zero-rating the first grants described above is that the supply must be made by a person constructing or converting the building. In most cases developers will have this status, but it can be enjoyed by more than one person.
Changed intentions: letting instead of selling
When the residential property market suffers a downturn, one option developers have is to let properties in the short-term instead of selling them. They may or may not intend to then sell the property in future when the market improves. However, as residential lettings for less than 21 years are exempt supplies of land, the developer may have to repay some of the input tax it has claimed back on its costs. The developer is likely to have recovered all its related input tax on the basis that it would be making fully taxable supplies of the land by selling it or granting a lease of more than 21 years. Now that the land is not being used in the way that had been originally intended, the developer could have to pay back some of the VAT it had already reclaimed.
HMRC recognises that it is not always worth going through this process where very small sums are concerned and has put in place a process that allows those small repayments to be avoided.
In cases where the developer still intends to sell the property, engages in short-term letting and does not have a partial exemption method in place already, HMRC has devised a simple check sheet to allow developers to calculate whether their input tax is 'de minimis', or such a small amount that it can be easily overlooked. This will prevent VAT from being claimed back in many cases. Where the developer is already partially exempt under an agreed special method, and the exempt input tax is not de minimis, a different comparison must be performed. HMRC is willing to agree new partial exemption methods where the method in place becomes unfair as a result of the exempt lets.
Fortunately these clawback adjustments are one-off events, so no further adjustment will be required if it turns out the developer lets the property for longer than intended. If the developer anticipates having to make exempt supplies of property for some time, it will need to apply a partial exemption method in order to calculate how it can recover VAT going forward.
The developer may decide to let the property on a permanent basis rather than just temporarily, in which case the input tax it has recovered will need to be repaid in full. No simple check for de minimis can be performed in this case.
One way around this problem is for a developer to make the first grant of a major interest in the residential building to a connected party, by selling it to another company in their corporate group which is not a member of the same group of companies for VAT purposes. This will trigger the zero-rated supply rule, and so avoid a clawback adjustment. HMRC has confirmed that this type of arrangement is not considered tax abusive.
However, HMRC has emphasised that although this type of arrangement will be considered in the spirit of the policy that new dwellings should be zero-rated, it will be considered tax abuse where the aim of granting the major interest to a connected company is to recover VAT on costs that would not normally be recoverable in respect of supplying a new residential property, such as repair and maintenance costs.
VAT on costs of construction and conversion
Services supplied in the course of construction of a residential building are zero-rated. The separate supply of services in the course of construction of a residential building by an architect, surveyor or other consultant or supervisor are specifically excluded from zero-rating, and are standard-rated. However, if such services are obtained under a 'design and build' lump sum contract, the liability of the supplies on the design element of the contract follows the liability on the build element. It may therefore be possible to zero-rate them all. Building materials supplied with such construction services and incorporated into the building in question will also be zero-rated, although materials supplied on their own will be standard-rated.
Services supplied in the course of conversion of a non-residential building into a residential building are usually standard-rated. However, such services will be zero-rated when supplied to a relevant housing association.
Other residential conversions can qualify for VAT reduced rating at 5%, such as the supply of 'qualifying services' in the course of residential conversions. Building materials supplied with those services are also reduced rated, although again materials supplied on their own will be standard rated. Residential conversions which benefit from this reduced rating include:
- where the developer is converting commercial property to residential property;
- where there is a change in the number of dwellings, such as a block of flats being converted into one large single residence.
If the developer simply refurbishes and redecorates the building and keeps the same number of dwellings, the services will be standard-rated.
A residential developer must hold a valid certificate when making any zero-rated or reduced-rated supply in connection with a building intended to be used solely for a residential purpose. The certificate will be issued before the supply is made by the recipient of the supply, and the developer must take all reasonable steps to ensure that it is valid. Two certificates are available: one confirms the developer's eligibility to receive zero-rated or reduced-rated building work; the other confirms the developer's eligibility to receive a zero-rated or reduced-rated sale or long lease.
Disapplication of the option to tax
Where the supply is not zero-rated under the provisions described above, a developer may decide to exercise an option to tax over property, so that the onward supply will become a taxable standard-rated supply rather than an exempt supply. This should enable the developer to recover the input tax on its associated costs. However, any option to tax exercised over property which is or is intended to be residential may be disapplied, as explained below. If this happens, the developer will be forced to revert to making an exempt supply.
As well as having an adverse effect on the developer's partial exemption calculation, this disapplication can give rise to problems similar to those discussed above in respect of originally recovered input tax where input tax was recovered on the basis that the developer would be making a taxable supply. This may lead to a clawback adjustment for the developer, and may need to be factored in when it comes to pricing a development.
The option to tax is disapplied where the building is designed or adapted, and is intended for use, as a dwelling or solely for a relevant residential purpose. Where a relevant residential purpose is intended, the option to tax will only be disapplied where the buyer has informed the developer of its intention to use the property for such a purpose and has issued a certificate to that effect. It is therefore possible for the buyer and developer to agree that the buyer will not issue such a certificate, so the developer will be entitled to apply the option to tax. This may be important where the property is in the Capital Goods Scheme and an adjustment would be required if the supply were to be exempt. For more information on the option to tax and the Capital Goods Scheme, please see our separate OUT-LAW Guide to VAT on property transactions.
The option to tax is also disapplied where a buyer acquires commercial property and certifies that the building is intended for use as a dwelling or solely for a relevant residential purpose, provided that the buyer issues a certificate to this effect before the price is legally fixed. The developer also has the discretion to accept this certificate after the price has been fixed where the supplies are made after the certificate has been issued. There is, however, little guidance on what is meant by 'legally fixed': examples can include exchange of contracts, letters or missives or the signing of heads of agreement. If no certificate is provided then the supply will be standard-rated, and the option to tax remains applicable.
Other instances of when the option to tax is disapplied include when the land is supplied to a relevant housing association, provided that the housing association gives a certificate to the developer before the price is legally fixed stating that the land or property will be used as dwellings or solely for a relevant residential purpose. Again, the developer has discretion to accept the certificate after the price has been fixed where the supplies are made after the certificate has been issued.
However, it is possible to zero-rate a sale of development land to a housing association instead, by using a so-called 'golden brick' arrangement. Essentially, this comprises the sale of a partly-constructed residential building, enabling a developer to recover its input VAT while the housing association does not pay any VAT.
This guide is based on an article by Jennie Newton and Alison Kempenaar which was published in The Tax Journal on 3 August 2009.