The freehold sale or grant of a long lease (21 years in England, or 20 years in Scotland) in a new residential property is a zero-rated taxable supply, and the housebuilder can recover all of its associated VAT. However, the renting of a residential property is an exempt supply, and the associated VAT cannot be recovered unless certain conditions are met.
So when the intention changes, from taxable to exempt, what adjustments to previously recovered input tax does the housebuilder have to make? Obviously, HMRC have had so many queries on this subject that they have published a number of VAT Information Sheets and Revenue & Customs Briefs to clarify the position for the beleaguered housebuilders.
The adjustments required to the recovery of input tax in these circumstances was covered by HMRC in VAT Information Sheet 07/08, which gives guidance (and worked examples – see below) on the VAT implications arising when housebuilders temporarily let their new dwellings whilst still trying to sell them.
The VAT Information Sheet was issued in response to recent enquiries from the housebuilding sector, and takes account of the High Court decision in the joined cases of Curtis Henderson and Briararch  STC 732, which took place in the early 1990s. The key points to which the Information Sheet refers are summarised as follows:
• if you temporarily let a dwelling before selling it, you may affect the VAT you can recover on your costs
• many housebuilders who temporarily let a dwelling will not be affected but you need to check this to avoid making VAT mistakes
• there is an easy way to check if you are affected by applying what we describe here as a ‘simple check for de minimis’
If you fail this check, you may have to:
• adjust the VAT previously recovered on your submitted VAT returns
• restrict the VAT to be recovered on your current and future VAT returns
• both adjust your past VAT recovery and restrict your future VAT recovery.
The VAT Information Sheet says that if a business needs to adjust VAT previously recovered, then exceptionally, and if so preferred, it may do so without contacting HMRC.
A housebuilder is required to make a clawback adjustment as soon as the actual or intended use of a property differs from the original plans against which input tax was recovered. A clawback adjustment is a one-off event, and a housebuilder would only make a second adjustment if the building is never let. There is no need to amend the adjustment if the actual period of letting proves to be longer or shorter than anticipated.
Housebuilders that are not already partially exempt must first apply a simple ‘de minimis check’. If they do not fail this, there is no need to make an adjustment, and no need to go on to the second stage. If the check is failed, however, it is then necessary to go on to the second stage to work out the actual clawback adjustment. Where a housebuilder already has a partial exemption method, it will need to apply its partial exemption method to check for de minimis.
The ‘simple check for de minimis’ is carried out by reference to the expected time period the housebuilder will let its building for as a proportion of the economic life of that building, which, for VAT purposes, is 10 years. Provided the total exempt input tax does not exceed £625 per month on average (up to £7,500 per year), and is not more than half of the total input tax, the input tax is ‘de minimis’, and the clawback is not required.
Example of a ‘de minimis’ check taken from Information Sheet 07/08
A fully taxable housebuilder recovered £20,000 input tax on a house that it expected to sell for £300,000. After the end of the tax year, it decides to defer the sale by letting for two years, and so becomes partly exempt.
A simple check for de minimis is:
£20,000 input tax x two-year lease/10-year economic life = £4,000 exempt input tax.
The £4,000 exempt input tax is de minimis because over the tax year, it does not exceed £7,500 or 50% of his total input tax. The builder has no need to adjust the VAT previously recovered on his VAT returns. An important point is to note if the input tax was incurred over more than one tax year, the de minimis test should be applied to the input tax incurred in each of the tax years separately.
If the de minimis test is failed, it will be necessary to make a clawback adjustment based on the
housebuilder’s realistic expectation, judged at the time the original plans were set aside. HMRC may ask for evidence to support this, such as:
• the business plan showing the price originally expected
• reports of estate agents showing this price to be unobtainable, and maybe estimating when a sale will be achievable
• board minutes from the time of the decision to grant short leases, or any other commercial documentation backing up the estimated use
The housebuilder calculates its clawback adjustment by comparing the input tax deducted with the input tax it would have deducted had it held its changed intention all along. If the housebuilder is already partially exempt, it calculates the input tax it would have deducted by using its partial exemption method at the time the costs were incurred.
If it was not already partially exempt, however, it must apply the standard method unless it obtains HMRC approval to apply a special method instead. If the housebuilder so prefers, it can exceptionally base its clawback adjustment on an alternative calculation (and without prior approval), provided that calculation is fair.
A calculation based on the values of supplies is normally fair and straightforward, provided it is based on reasonable estimates and valuations.
Example of a ‘value-based’ fraction taken from Information Sheet 07/08
Estimated eventual sale value
Estimated eventual sale value + estimated short let premiums and rents
A housebuilder expects to sell two houses for £500,000 each. The input tax recovered during the tax year was £50,000. After the end of the tax year, the decision is taken to rent them for a period of three years generating estimated rental income of £200,000. The housebuilder makes no other supplies.
£50,000 input tax incurred x £1,000,000
= £41,667 recoverable input tax
£50,000 input tax previously recovered, so £41,666 = £8,334 to be repaid to HMRC
No adjustment should be made for potential bad debts during the lease period. If it is not possible to fairly estimate the values, a different calculation may be needed. Apportionments based on the expected time period of the rental or short-term let are not recommended, except where used as a quick de minimis check.
A housebuilder that decides to temporarily let before selling will need to apply a partial exemption method if it continues to incur exempt input tax in its current or future VAT periods. The exceptional treatment can only apply for the clawback adjustments. If the housebuilder is not already partially exempt, it must either apply the standard method, or else seek formal HMRC approval to apply a special method.
HMRC have also issued Revenue & Customs Brief 54/08 giving their view on what is acceptable and unacceptable VAT avoidance by housebuilders trying to avoid an adjustment to input tax recovery. The Brief accepts that many housebuilders are finding that they are unable to sell newly built dwellings in the current economic climate, and are, instead, choosing to rent those properties in the short-term.
To avoid the problem of an adjustment to previously recovered input tax, some housebuilders have considered selling dwellings to a connected company to achieve a zero-rated sale. Any exempt supplies are then made by the new owner, thus minimising any VAT recovery restriction for the original builder. HMRC have been asked whether they will challenge such arrangements as avoidance (on the basis that VAT recovery rights cannot be obtained by sales which have no commercial purpose and are undertaken with the sole aim of obtaining a VAT benefit).
The Brief says HMRC do not consider that such a transaction would be unacceptable VAT avoidance in most cases, but goes on to outline the basic criteria in which a sale with the sole aim of preventing VAT costs would be considered abusive (e.g. where repair and maintenance costs are knowingly picked up by the original builder just before the transfer).
This new guidance and the earlier HMRC VAT Information sheet on the consequences of a short let do not deal fully with all situations, and, in particular, does not deal fully with mixed developments. In addition, it makes no comment on the direct tax consequences of selling a property to a connected company.
Finally, in the case of a speculative builder who constructs a house, is then unable to sell it, and then decides to live in it himself, he has a number of options. If the builder operates through a limited company, he can sell it himself personally, and would then have a zero-rated sale. He could rent it himself, and the above adjustment would apply. In the event that the builder is a sole proprietor, and he uses the house as his main residence, he will not have to make any adjustments to the input tax recovered. HMRC Internal Guidance, V1-8A, Section 22.8.2 states:
When a sole proprietor is in the business of constructing property for sale and builds a house on his own land for his own occupation, or by a connected person, he can either:
• recover the VAT through his VAT return in the normal way; or
• claim the VAT through the Refund Scheme.
In these circumstances, he would be entitled to recover the VAT through his own VAT return, so there would be no need to make any adjustments.