VAT for construction has always been governed by rules that allowed accounting for VAT only when money was received. The change would have imposed VAT on any money outstanding 18 months after the completion of work.
Specialist traders and small builders have usually collected all their money 18 months after the end of a project, but this is not true of civil engineering contractors and major contractors. These firms will be frequently subject to substantial retentions, and will have claims that have not been fully quantified 18 months after the completion of work. The change in law sent construction tax specialists into a complete spin. Their view was that the change would bankrupt substantial numbers of contractors.
A solution for both sides
Faced with the weight of opposition from construction, Customs relented and has been eager to produce new legislation that will relieve the problem for both sides – because Customs, too, has a problem.
Its initial legislation did not arise from a malicious desire to make lives in construction awkward. It was faced with serious tax avoidance by the property industry.
Many financial institutions are not supposed to recover the VAT they incur on the purchase of buildings – they are exempt businesses. But some accountants had found ways of inventing companies that acted as construction companies in contractual terms, but belonged either to the firm that wanted the building or even to its accountant.
These artificial companies would commission a building using ordinary construction contracts. They would then sell it on to the final user of the building on what appeared to be construction contracts, but which provided for payment over very long periods, frequently more than 40 years. The result was that some consumers in the financial industry did not pay VAT on their buildings for 40 years, if at all.
It was to stop this avoidance of VAT that Customs acted.
Negotiation has resulted in a great leap forward – construction has been offered a choice of ways out of the horrific situation it feared
After an initial panic from construction and a lot of righteous indignation from Customs, what has emerged has been a period of serious negotiation in a complicated area, and some genuine goodwill between the parties. The result of this was the consultative document called A VAT MiniGeneral Anti-avoidance Rule in Construction Services (GAAR). Despite this incomprehensible title, it represents a great leap forward. Construction has been offered a choice of ways out of the horrific situation it feared.
Really, a GAAR is a law that says you must not avoid VAT – and if you do, you will be asked to pay the VAT you would have paid if you had not tried to avoid it. The trouble with such a blanket statement is two-fold – what does Customs mean by tax avoidance? And what tax would you have paid if you had not done what you did do? Many fear Customs might view tax avoidance as any arrangement that reduces the VAT payable by as much as £1.
If a housebuilder negotiates with a housing association and builds houses to designs it knows the association approves, then sells the freeholds to the association, is it engaged in tax avoidance? After all, it can zero-rate the sale and recover all the building costs. If it had sold the land to the association, which then commissioned the houses itself, the housebuilder would have to sell the land in an exempt sale and zero-rate only the building costs. The first course may well lead to less tax being paid than the second – so does that make it tax avoidance? The trouble with a GAAR is that there is no certainty. There is always the fear that transactions entered into innocently for commercial motives may be misconstrued as avoidance devices. That said, a GAAR is simple, and once taxpayers know it is there, it may, by its very existence, prevent a lot of mean-spirited tax avoidance.
An unappealing alternative
The alternative offered by the consultative document is a piece of legislation so complicated that even tax specialists wrap a wet towel around their heads before beginning to work with it. But the trouble with tax avoidance is that it is complicated and, in order to prevent it, it is often necessary to use thousands of words.
But the drawback to the precisely worded legislation is not only its complexity. By targeting its attack, Customs often finds the tax avoidance industry simply moves its attentions to a related but unprotected area. Precisely targeted legislation becomes a game of cat-and-mouse where the cat is driven to more and more eccentric behaviour – and is constantly left without a dinner, because the mouse is always one step ahead.
Liz Bridge is director of taxation at the Construction Confederation.