You wouldn’t think that such a short little word could cause such a lot of confusion. But there are two different situations where the word has significant VAT implications for property developers.
• The first concerns how much VAT you can claim on materials and expenses.
• The second is whether the property will be “used” for qualifying purposes, which means that you can save VAT on costs and potentially claim more from HMRC.
How much VAT you can claim: VAT recovery rules
In the context of VAT recovery, the principles are the same for all types of business.
In an earlier article, I explained that important difference between “exempt” and “zero-rated” for VAT purposes; i.e. that in principle you can’t claim VAT on your purchases and expenses if you’re making exempt supplies.
“Use” of goods and services
The legislation talks about whether the goods and/or services that a business purchases will be “USED” to make either taxable or exempt supplies. Costs are directly attributed to either taxable or exempt supplies according to whether the goods or services are used for those supplies.
For example a housebuilder who intends to sell new houses will USE goods or services for making zero-rated taxable supplies, while a residential landlord USES goods or services for making exempt supplies of property leases.
Partial exemption recovery rates
We sometimes refer to the partial exemption recovery rate. This usually means the proportion of VAT on overhead costs that can be claimed. This is calculated by using either the partial exemption standard method or a special method. It would apply to office running costs, telephone/internet bills and professional services, e.g. accountancy or legal fees that relate to the business as a whole.
What is a property USED for: commercial or residential?
The second situation applies to VAT and property and concerns the physical end-use of the property.
In everyday language, the most common terms that are used to define properties are commercial, residential or mixed use. However the VAT legislation differentiates the type of property between “qualifying” property and other property.
“Qualifying” properties include properties used as dwellings; for “relevant residential purposes” such as residential homes or student accommodation; and for “relevant charitable purposes” including properties used by charities for non-business purposes and local community properties.
We tend to refer to “qualifying” properties as residential or non-commercial, but remember that these terms don’t accurately reflect what’s in the VAT legislation. It’s an important distinction, because many “relevant residential” properties are actually used for commercial purposes, for example residential homes, so you must remember that there is a distinction for VAT purposes.
How VAT recovery “use” and property “use” work together
The important connection for property developers is that the end USE of the property determines how much VAT you can claim on costs.
This is because different VAT liabilities apply to the sale or rental of the two classes of properties i.e. qualifying and other properties, so this determines whether the vendor/landlord can claim VAT on related costs. I’ve summarized the main differences below.
Qualifying properties
The first freehold or long lease (over 21 years) of a qualifying property by the “person constructing” (usually the developer) is zero-rated, so the developer can claim VAT on related costs.
Other sales or rentals are exempt, which is why residential landlords can’t claim VAT on costs.
Construction of new qualifying buildings is usually zero-rated, while the reduced rate can apply to certain conversions and refurbishments.
Non-qualifying properties, including commercial properties
The freehold sale of any NEW non-qualifying property, e.g. a shopping centre, an office, a factory, is liable to VAT at the standard rate. NEW is normally anytime within 3 years of completion.
However other sales and rental income is normally exempt from VAT except for two specific situations:
• Supplies which are “excluded” from exemption. This includes a range of common types of property use, including car parking, hotel accommodation and holiday lets and the provision of sports facilities or shared office facilities.
• Properties which are subject to the option to tax. This is where the owner/landlord makes an option to tax the property, which means that any sales or rental income is liable to VAT at 20% and not exempt.
Finally, VAT at 20% applies to all work on non-qualifying property, whether new construction, extensions, repairs, conversions or refurbishments.
VAT recovery and when things don’t go to plan
The different VAT liabilities that apply to property sales and rentals means that it can be very difficult for property owners and developers to work out how much VAT they can claim on their costs.
And it can be even more difficult if developers don’t know the VAT liability of the income when expenditure is incurred – for example whether property will be sold or leased – OR when things don’t go to plan. There are special rules to recalculate VAT recovery for these situations, but they are complicated and I’d always recommend taking specialist advice in these situations.
Either way, if you can remember that the word “use” refers to two different VAT rules in the context of VAT recovery and property development, it should help you to understand how the rules work.
Marie