It is quite common these days for business men with a bit of spare cash to decide to construct a small number of houses or flats with the intention of selling them while the house prices are high and realising a quick profit. However, now the housing market has slowed down a bit, what happens if you can’t sell all the properties and have to rent some out on short term lets?
Basic VAT position – If you construct new residential property the “first grant of a major interest” (major interest is the freehold sale or the grant of a lease of more than 21 years) in it is zero-rated. This means that you can register for VAT and recover all the VAT on material, professional fees etc. If you can’t sell any or all of the properties and decide to rent them out you are not making a zero-rated supply, but are making an exempt supply. Under normal circumstances you cannot recover the VAT that you incur in making exempt supplies, so you may be faced with the possibility of having to pay back the VAT that you have already claimed.
What HMRC tried - In the early 1990s many developers built residential properties with the intention of selling them and reclaimed the VAT. Due to the collapse of the property market, these businesses found themselves unable to sell their newly built properties and, in order to produce some income, were obliged to let them on a short-term basis, thus making supplies with no right to reclaim VAT.
Since the intended zero-rated taxable supply had been replaced by an actual exempt supply, HMRC tried to apply the ‘clawback’ provision and disallowed all of the input VAT on the construction costs.
But they failed - Two businesses challenged HMRC and took their cases all the way to the High Court. In both of the cases, the High Court held that, because the businesses still had an underlying intention to make a taxable supply, the input tax had to be apportioned to take account of future taxable zero-rated supplies and only a proportion could be disallowed under the ‘clawback’ provisions (Briararch Ltd and Curtis Henderson Ltd v CCE (STC 732 heard together)).
Apportionment – The basis of the apportionment calculation is the 21 years lease of a “major interest”. So, if you construct a house and reclaim £10,000 in VAT and have to rent it out for 9 months until you can sell it your calculation will be:
Input tax on house (£10,000)
252 (21 years x 12 months) x number of months house rented out (9) = £357.14
So, if HMRC had their way, you would have been due to pay them £10,000, using the apportionment approved by the High Court you would only have to pay £357.14 – quite a saving. The actual mechanics would work like this. Every VAT quarter you would repay 3/252 of the input VAT until you sold the house, if you actually sold the house in the first month of your VAT period, then you would only have to repay 1/252 on that return.
VATman keeps trying – Although the case law for this was set in 1992, HMRC still try it on occasionally. In some cases it is poorly trained officers who are unaware of the case law, in some cases it is more experienced officers trying it on and hoping that the taxpayer is unaware of his rights. We came across an example where an officer disallowed all the VAT on the construction of a house in these circumstances and when the taxpayers’ VAT consultant rang the officer and mentioned Curtis Henderson the officer said “I wondered if someone would spot that”!
VAT Tax Tip
Reclaiming the VAT on converting part of your house into an office
Example. The Managing Director of a company, Mr Jones, works from home a lot and is considering having his loft converted into an office to give him more room. The VAT on the work and equipment will come to £3,500, and Mr Jones wonders if the company can recover this.
Classic solution. The normal answer is that the company can recover the VAT on the equipment, they own it and it is for business use, but the VAT on the building work and decorations cannot be recovered because, on the face of it, it is specifically blocked by the VAT legislation (s.24 (3) and (7) of the VAT Act 1994). This states that “where a company purchases, acquires or imports goods or services which are used or to be used in connection with the provision of domestic accommodation by the company for a director, those goods or services are not treated as used or to be used for the companies business and any input VAT is not recoverable”.
Tip. There is a little known (even to HMRC) concession to this rule that allows the recovery of input VAT in certain circumstances. HMRC’s published and internal guidance states that “Where a domestic room or rooms is put to business use HM Revenue & Customs may agree to an apportionment using an objective test to the extent to which the room is put to business use” (VAT Notice 700, para 4.8, C & E Manual V1-13, Chapter 2A, paras 14.7 and 14.7)
This means that if Mr Jones can show HMRC that he intends to use the loft conversion for entirely business purposes, then the company will be able to recover the VAT on the building work and materials. If he can show that the carpets and decorations are for a business purpose as well, then the company will be able to claim that VAT back as well.