With margins being squeezed in the current economic climate, developers cannot afford to ignore valuable tax breaks. But, Jackie Richmond asks, what are they and where do you find them?

With a challenging economic climate, developers are more likely to hold on to stock for longer, or sell stock on to other developers to ease cashflow. But these can have VAT implications: poor planning can result in paying VAT unnecessarily, or unexpected VAT costs that are irrecoverable.

The provisions regarding the transfer of a going concern (TOGC) – that allow for the sale price to be treated as outside the scope of VAT when a business is transferred – are useful where sites are sold before or during development.

Residential developments

A developer that has purchased existing houses in order to demolish them for new-build homes will recover VAT on costs on the basis that the new homes sold will be zero-rated for VAT purposes. But if planning permission is obtained, and the site is sold on before any work is done, VAT incurred becomes irrecoverable, as it is not possible to elect to charge VAT on residential property.

The VAT costs in this scenario can be avoided by treating the sale as a TOGC. This is possible where planning permission for development has been obtained and it is clear that the seller intends to redevelop the site. In this instance, VAT already incurred in relation to the site will be recoverable in full if no other exempt supplies are made.

There will be VAT cost if redevelopment is delayed, existing houses are let out, or if, after redevelopment, new houses are let out short term with a view to waiting for the market to recover. These supplies are exempt for VAT purposes and while HM Revenue & Customs (HMRC) will generally prevent recovery of VAT on the expenditure incurred, developers should consult professional advisers on partial exemption rules, which do allow an apportionment of development costs.

Commercial developments

It is advisable to seek professional advice as prior planning can ease cashflow and enable VAT to be factored into negotiations

There are provisions relating to VAT and the purchase of commercial property. The main benefit of using them, thus avoiding VAT being charged, is to get away from the additional funding cost of paying over the VAT, together with the cashflow cost of paying over VAT to the seller and not being able to reclaim it for up to four months.

If the property purchased is a mixture of commercial and residential (for example, a shop with flats above), and the seller has opted to tax, VAT can only be charged on the commercial element. HMRC expects the seller to make a reasonable apportionment; for example, one based on floor space if the elements have not been valued separately.

If the commercial property has been opted to tax and is to be converted into dwellings, the seller is unable to charge VAT on the sale price unless both parties have agreed in writing prior to the sale taking place. This provision can only be agreed if the buyer intends to sell the freehold or grant a long lease (in excess of 21 years) of the subsequently converted property. Clearly, in these circumstances, it is hard to see why a buyer would agree to allow VAT to be charged and the seller may wish to factor any irrecoverable VAT into the purchase price.

Where the seller is holding commercial property with planning permission for redevelopment, TOGC provisions are useful.

Finally, for developers in business before 1997, a recent case, Condé Nast, may provide an opportunity for a VAT reclaim stretching back to 1973. In the case, the House of Lords ruled that HMRC’s attempt to impose a three-year cap on VAT reclaims was ineffective retrospectively. The opportunity for developers arises from a previous decision in the case of Rialto Homes, where it was found that HMRC’s policy of not allowing zero-rating on soft landscaping for new developments (planting of trees and shrubs) was wrong. At the time, the three-year cap was in place, but Condé Nast now provides an opportunity to recover VAT incurred on soft landscaping prior to 1997. A claim will depend on the records available, and while it may prove difficult to obtain necessary evidence to substantiate a claim, HMRC is willing to agree to reasonable estimations.

VAT is a complicated area of tax, particularly in relation to property, and one that is often misunderstood. It is advisable to seek professional advice as prior planning can ease cashflow and enable any VAT costs to be factored into price negotiations.