Are new dwellings always zero rated? VAT specialist explains

Are new dwellings always zero rated? VAT specialist explains

Kevin Hall, a VAT specialist at law firm Wright Hassall, poses the question whether new dwellings are always zero rated? Well, not exactly – as he explains.

Thanks to a variety of cases, property developers have become aware that the new dwellings they build and sell risk not being zero rated, leaving large unanticipated bills for VAT. Given the increase in residential conversions, a round-up of risks would be a timely reminder.

The boundaries
The construction and supply of a new dwelling can be zero-rated as long as certain conditions are met, including:

  1. a) the dwelling comprises self-contained living accommodation
  2. b) there is no direct internal access from the dwelling to any other, or part of a dwelling
  3. c) the separate use, or disposal of the dwelling is not prohibited by any covenant, statutory planning consent or similar provision; and
  4. d) statutory planning consent has been granted for the dwelling and its construction or conversion has been carried out accordingly.

The relevant legislation also contains further tests, which can prevent supplies being zero-rated, such as any existing buildings not being demolished to ground level; planning consent not specifying retained façades; or works started before planning permission is granted.

If any single test is not met, the construction will be standard-rated and the sale will be either standard-rated or exempt with no recovery of VAT on costs.

Repurposing buildings set to rise

When buildings are repurposed, from office block to houses, for example, it can involve a mix of VAT rates. Sales of new dwellings after conversion might be zero-rated, but the conversion works themselves will be reduced rated or standard rated.

When clients cannot recover the VAT charged to them, they may seek a provider permitted to charge a lower rate of VAT. Alternatively, if the price is a market rate, the lower the rate of VAT, the higher the profit margin, which makes the VAT rate very important to smart property professionals.

However, if a low rate is charged inappropriately, the supplier is responsible for the VAT and HMRC will pursue the supplier for the missing VAT and impose penalties and interest. Determining the correct VAT rate can be tricky, requiring what existed before the works began and what is created afterwards to be carefully considered.

Care should be taken over factors as varied as whether the new domestic reverse charge applies, the status of different parts of a site and whether materials used qualify for the reduced rate. There are also requirements that any statutory planning consent and (additionally for conversions) any statutory building controls are in place from the outset.

Non-recovery of VAT

Purchases typically include the purchase of the property itself, construction work, planning agents, legal fees, architects’ services, sales agents and the materials. The VAT paid on costs can be significant and steps should be taken at the outset to minimise the VAT.

For example, to remove VAT on the property purchase, the purchaser can often act unilaterally to disapply it, but they must meet certain deadlines. Discussion with the vendor is encouraged, as the implications of disapplication can be financially serious for the vendor. When considering professional fees, significant VAT savings can be achieved if the project is structured appropriately from the outset.

Charging the reduced rate of VAT makes sense, even if the client expects to recover it in full. Property projects often change direction, which can render the VAT unrecoverable, such as the developer later renting out the new dwellings, which is an exempt supply requiring VAT on attributable purchases to be unrecoverable.

The absurdity of VAT rates

Consider the scenario, a constructor creates new town houses from a three-storey office building with a top floor penthouse flat. Having created new dwellings where there were none previously, the developer believes the sale of each new town house will be zero-rated.

The conversion works will indeed qualify for the reduced rate, but this is not true when it comes to selling the new houses. If each of the new houses contains a part of the original penthouse, their sales will be exempt and VAT on costs cannot be recovered.

This VAT cost can be the difference between a profitable and a loss-making project, and it only arises because the property had been divided vertically. If the conversion had been horizontal in approach, the sales of the new dwellings on the first three floors would have qualified for zero rating and the VAT on all attributable costs would have been recoverable in full. The works to the top floor penthouse would not have qualified for the reduced rate and the sale would still be exempt.

This example illustrates how varied the VAT rules are and how easy it is to overlook an opportunity or unexpectedly incur a large VAT liability. Given the UK housing shortage, there is a real likelihood that the conversion of commercial property to residential use will increase and it will be important for constructors and developers to carefully consider VAT at the earliest opportunity, to avoid converting profits into losses.

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