The important role of solicitors in construction contracts

The important role of solicitors in construction contracts. I’m currently working with a couple of developers who are appointing contractors to do various construction work. One is a commercial developer, the other is converting a property into his family home. In both cases, some of the work is eligible for the reduced rate of VAT, but the contractors want some sort of guarantee that the developer will pay any additional VAT should HMRC issue assessments for 20% VAT in the future.

Most construction contracts contain some sort of guarantee clause to deal with such situations. If the solicitor has used a pro-forma document as the basis for the contract, the VAT clauses may be adequate, but it’s important to make sure that the clauses cover all of the VAT issues that may be specific to your development. That’s why it’s important to work with your solicitor from the planning stage.

I’m not a solicitor and of course you should always be guided by your solicitor about what is and what isn’t included in contracts. But I’ve often dealt with situations where disputes about relatively simple VAT issues end up costing a huge amount of time, money and stress for all parties involved simply because the contract doesn’t provide any framework for dealing with such issues. Some contracts don’t even mention VAT or even stipulate whether the costs are VAT inclusive or VAT exclusive. Sometimes the situation becomes adversarial because the contract doesn’t allow for any other way of dealing with the issue even though the amounts of VAT involved are relatively small.

Ideally we’d ask HMRC to rule about the VAT liabilty of such work in advance so we know for sure whether they accept that the zero-rate or the reduced rate applies. However HMRC won’t provide rulings about the VAT liability of construction services unless the liability is unclear or isn’t covered in HMRC’s published guidance. And because the contractor is ultimately liable to pay the correct amount of VAT to HMRC, many contractors charge VAT at 20% unless the client specifically asks that the reduced rate applies, as I discussed in one of my recent blogs.

Identifying the main issues

This means that it’s important to identify the main VAT issues and make sure that there is a framework within the contract for dealing with VAT issues and in particular the VAT liability of the construction work. Even if the developer can recover VAT on the contractors’ services, they can only charge VAT that is “correctly charged” so it’s essential that the correct rate and amount of VAT is charged and the parties agree the liability between them. You might decide to ask a VAT consultant for advice about the liability and agree to split the cost of their services to clarify any issues where you don’t agree.

It’s equally important that contracts aren’t over-complicated and provide a bit of flexibility for dealing with VAT issues. You don’t want to end up with pages of VAT clauses in an attempt to cover every potential VAT issue. Over the years, I’ve worked with some very good solicitors and we’ve dealt with VAT by identifying the potential problems and agreeing on clauses that provide a framework for dealing with VAT issues. For example, whether the contractor and developer should dispute HMRC’s rulings, practical issues such as VAT invoices and payment of under-charged VAT – or credit notes if VAT has been over-charged – and how to proceed if one party wants to appeal HMRC’s ruling and the other doesn’t.

I’ve written more about dealing with VAT in construction contracts in my “Guide to VAT and residential property developments”. But the most important thing is to work with your solicitor to identify the key VAT issues and ensure that your contractor doesn’t charge any more VAT than necessary and avoid the cost and hassle of lengthy disputes. You’ll be glad that you took the time should disputes about VAT arise during the course of your development.

Marie
March, 2014