Contractors and the 5% rate: I’ve been blogging recently about the VAT reliefs for residential property development and why it’s important that contractors don’t overcharge VAT. It’s over 10 years since the government introduced the 5% rate for certain conversions and refurbishments, yet over the past year, I’ve seen a number of situations where both commercial developers and private clients are having problems convincing contractors that they can charge 5% VAT on certain conversion work, and I wonder why it’s such a problem.
Contractors are generally confident about applying the zero-rate to new residential construction, but seem reluctant to charge 5% for conversions. HMRC normally refuse to give “rulings” to requests from contractors about the issue because they say – correctly – that the subject is dealt with in Notice 708 and they only give rulings, never mind clearances, when there is genuine uncertainty about the way that the law applies to certain transactions.
Why does the 5% rate exist??
It might help to understand the reason that the 5% rate was introduced. It isn’t any kind of scam or potential avoidance. It was introduced by the last Labour government as part of a series of measures to deal with the shortage of housing in the UK. The idea was to encourage developers – both commercial and DIY developers – to buy old commercial properties and convert them into usable housing. EC law prevented the government from re-introducing the zero-rate for such conversions, so the government did the next best thing and introduced the lowest rate of VAT. And yet contractors seem to be nervous about using it.
Perhaps I’m going to ruffle a few feathers here…
but I think perhaps it’s time to be a bit blunt with contractors who always charge 20% to cover their backsides. YOU NEED TO DO A BIT OF HOMEWORK AND READ VAT NOTICE 708, SECTIONS 7 AND 8 WHICH CLEARLY EXPLAIN WHEN THE REDUCED RATE APPLIES.
You don’t need to be an expert on VAT to sit down and spend half an hour reading a few pages of HMRC’s guidance. You DO need to be certain that your client’s development meets ALL of the criteria to qualify for the reduced rate, but if you sit down with your client and the notice and go through the guidance carefully, you should be able to work out which parts of the work you’re doing qualify for the reduced rate. And as long as you can identify the value of the reduced rated work separately on your invoice, you need only charge 5% on that value of the invoice.
One reason contractors are nervous is that even though the guidance given in the VAT Notice seems to be clear, they are concerned that they might not properly understand the terminology – for example that the property falls within the precise definitions explained in the notice, including the definition of “single household dwelling” or other residential property as explained in section 14 of Notice 708. Also the 5% rate doesn’t apply unless you’re changing the number of single household dwellings in each part of the property, not just the property as a whole. This rule is a bit difficult, but HMRC give some helpful examples in section 7 of Notice 708.
So yes, you’ve got to understand the details. But if you’re confused about it, you can ask HMRC’s VAT helpline for advice – or – and here’s a radical idea – why not spend a little bit of money on professional advice from a VAT consultant to go through the rules in detail so that you understand them properly. You don’ t have to do this for every development, but if you invest a bit of time and money in learning how the rules apply, then you’ll be confident about identifying when you can charge the 5% rate for future qualifying contracts.
And if you can charge 5% instead of 20%, this has surely got to help you win more work!
You can also work with your client and your solicitor to include some clauses in the contract that enable you to charge additional VAT if HMRC dispute the application of the 5%, or how to deal with disputes about the liability in the event that neither party agrees with HMRC’s rulings.
HMRC’s VAT Notice 708 “Buildings and construction” is the best place to start for the main rules. And my new book is a good place to find out how the rules work in practice and more information about the subject. Chapters 9 and 10 of my book explain in more detail how the rules work There’s also chapter about dealing with such VAT related issues in contracts.
The 5% rate was introduced for a good social and economic reasons. Now it’s up to contractors to take advantage of it.
Marie
Marie 2014