Tax tips: Want to know about tax breaks? Malcolm Nichols from accountant Menzies kicks off a series on organising your finances by charting a way through the maze that is VAT
There is no getting away from it: when it comes to land or property, VAT is a nightmare.
It's a mass of confusing rules that leaves many developers unsure of what's taxed and what isn't, and means they miss out on considerable savings.
For example, there are specific building transactions and works that are zero-rated or exempt from VAT. The immediate cash saving to the developer is that it will not have to pay VAT on the sale proceeds of the property.
The best VAT saving is on the construction of new residential property. The VAT paid on the purchase of building materials that are supplied with labour and services for the construction of new residential property can be reclaimed by the contractor, which can supply the materials and services zero-rated to the developer. As the freehold or long leasehold sale of the newly built property will be zero-rated, any VAT incurred can be reclaimed so that there is no VAT loss to either the contractor or developer.
Savings can also be made on certain types of work carried out on a listed building. Local authority-approved alteration works to listed buildings that are or will become residential dwellings will be zero-rated. The VAT paid on the purchase of any materials used for these alterations can be reclaimed by the contractor. Once again, there is no VAT cost to either the contractor or developer. For the developer to benefit from zero-rating when the residential dwellings are sold, the dwellings must have been "substantially reconstructed". This means more than 60% of the cost of all the reconstruction must relate to the work of approved alterations, or only the external walls remained before reconstruction began.
The confusion starts with VAT on residential refurbishments or conversions. The disposal of an existing dwelling is exempt from VAT. As a basic principle, VAT incurred on any expenses cannot be reclaimed if the disposal is exempt from VAT. If the conversion was from commercial to domestic, however, the situation can be quite different.
To encourage urban regeneration, certain building works have a reduced VAT rate of 5%. This is a valuable, and often overlooked, cash saving for the contractor and the developer.
The 5% rate applies to any work involving the conversion of a commercial property to housing, say, a former warehouse into studio flats.
To encourage urban regeneration, certain works have a VAT rate of 5%. This is an often overlooked cash saving for the contractor and the developer
If the developer sells the freehold, or the leasehold for more than 21 years, and the building had been used for commercial activity for 10 years before the conversion, the sale is zero-rated. This means the VAT paid on materials and labour can be reclaimed.
For example, if the cost of refurbishing a dwelling is £150,000, the VAT is £26,250. In a commercial conversion, however, the VAT is £7500 and if the freehold or long leasehold were granted, that can be reclaimed. Quite often, the freehold-leasehold requirement is missed.
If you are converting or altering residential property, significant VAT savings can also be made. The 5% rate is available on any residential conversions or alterations if:
- The works are to the building fabric
- There is a change in the number of dwellings from those before the conversion
- No part of the building has the same number of dwellings before and after the conversion.
Finally, negotiating a way through the VAT maze is a job for a professional. If you don't want to miss out on relief, get proper advice.
An article in our legal column (13 January 2006, “Having it large”) referred to the case between Shawton Engineering and DGP International. Shawton lost in the High Court and unsuccessfully appealed.
Shawton had placed several contracts with DGP. Although each contract had a completion date, there were variations.
The trial judge accepted that DGP then had to complete the work within a reasonable time. Shawton claimed that DGP had taken longer than reasonable and was entitled to end the contract. The trial judge rejected Shawton’s claim. The Court of Appeal upheld that finding saying: “The judge was right to hold that DGP were not in breach for delay.”
We emphasise that there was never any finding that DGP, which successfully resisted Shawton’s claims, had failed to complete the works in a reasonable time. We apologise for any embarrassment caused to DGP and its directors.
Malcolm Nichols is VAT principal at Menzies Chartered Accountant. Email him at firstname.lastname@example.org