Property developers, contractors and over-charged VAT: Whenever I do presentations about VAT and property, one of the most common questions is “why does it matter how much VAT my contractor charges if I can claim it back from HMRC?”.
The reason is because of one of the most important principles of VAT, which is that you can’t recover VAT which has been over-charged. This applies even if you’ve paid the VAT to the contractor and the contractor has included the VAT on his VAT return and paid it to HMRC. So when a VAT officer visits a property developer, they can have a profitable time by issuing assessments for VAT claimed in error on contractors’ invoices.
I agree that this is a ridiculous situation, but that’s the way the law works. VAT which has been charged incorrectly isn’t input tax and can’t be claimed, whether you’re a commercial property developer or a DIY housebuilder or converter.
I’m guessing that there are a lot of developers out there who have claimed such VAT on their VAT returns in the past and assume that it doesn’t really matter. Unfortunately, it does. If you’ve included incorrectly charged VAT on your VAT return, the return is in error and you must notify HMRC under the disclosure procedure. Main contractors who’ve paid too much VAT on invoices from subcontractors could also have claimed such VAT in error.
It means that property developers have to understand the VAT liability rules for construction services in as much detail as their contractors
The VAT liability of any “supply” of goods or services is the responsibility of the supplier – in this case the contractor. The contractor has to charge the correct amount of VAT on his sales and pay the right amount to HMRC. A lot of VAT registered contractors take a very conservative approach and charge VAT on anything that isn’t obviously zero-rated new construction so that they don’t end up with unexpected VAT bills from HMRC in the future. And if they have charged VAT incorrectly – e.g. 20% instead of 5% – the only way that the developer can claim back the VAT is if the contractor issues a credit note for the incorrect invoice and issues a new invoice showing the correct rate and amount of VAT.
The only way developers can avoid such problems is to understand when the zero-rate or reduced rate applies to construction work and negotiate the VAT liability with their contractors, preferably before signing the contract.
But I know it’s not as easy as it sounds. I was recently helping a client work out the VAT liability of work on a property conversion. I explained that certain parts of the construction services would qualify for the reduced rate of 5%. The client was surprised, explaining that the surveyor had told him that there was no way that any of the work qualified for the reduced rate, in spite of the fact that the VAT liability of the specific work was mentioned in VAT Notice 708, Property and construction.
Unfortunately this is quite a common situation. Contractors, surveyors, architects and others involved in the construction side of development often err on the side of caution, but all they’re doing is adding to their client’s costs. And when it’s the difference between 5% VAT and 20% VAT, that’s a lot of money to add to the cost of any development, especially if the developer can’t recover VAT on his costs because his income from from the sale or rental of the properties is VAT exempt. Major conversion contracts for single properties can easily cost £200k to £300k, which means that developers could end up paying tens of thousands of pounds unnecessary VAT. This is not pocket change.
What about asking HMRC for rulings?
Contractors can ask HMRC for rulings about the VAT liability of construction work. However, HMRC’s responses to requests for such rulings are often very general and refer the business to the relevant section of Notice 708 so that they can work out the liability themselves. And if a developer asks HMRC to confirm that the contractor is charging the correct amount of VAT, HMRC’s usual practice is to tell the developer that they do not reply to such requests from the customer.
So for the most part, contractors and developers have to sort out the VAT liability between them. And unfortunately, there’s no easy short-cut to dealing with this issue. You either have to learn the rules yourself or take specialist advice each time you are planning a development. The guidance in VAT Notice 708 is comprehensive and includes many practical examples to help you decide whether construction services are zero-rated, reduced rated or standard rated.
Sort it out at the planning stage and in the contract
For either party, the best way of protecting your position is to ensure that the VAT liability of any construction work is agreed when the contract for the construction work is being drawn up. Contractors and developers can take a lot of time and effort to agree detailed costings for contracts, but pay relatively little attention to the VAT which I find very strange because THE DIFFERENCE BETWEEN THE STANDARD RATE OF 20% AND THE REDUCED RATE OF 5% IS A WHOPPING 15% OF THE VALUE OF THE CONTRACT! I’ve seen situations where developers and contractors are in dispute over the cost of small parts of a contract, which is only 2-3% of the value of the total development. Why spend weeks or months arguing the price of construction work when one of the easiest ways to save up to 15% is to see if the reduced VAT rate could apply?
I’m often surprised that there is still so much confusion about the rules. The VAT reliefs for new construction, certain conversions and refurbishments have been available for a long time now and I’d expect residential contractors to understand the rules so that they can incorporate the potential savings when quoting for contracts. I know that there are some contractors who take a lot of time and effort to work with their clients to take advantage of the VAT reliefs. But time and time again I see situations where VAT is overcharged and neither the developer nor the contractor seems to have little more than a passing awareness of the VAT reliefs.
Of course you should always defer to your solicitor’s advice when it comes to the contents of any contract or other legal document, but solicitors who deal with contracts and/or land and property should be familiar with basic VAT liability issues and be able to include suitable VAT related clauses. Another good idea is to include some procedure for dealing with VAT related disputes – for example what to do if HMRC disagrees with the VAT liability and both parties want to appeal against this decision.
Either way, you can’t claim VAT that has been charged incorrectly and that’s why you MUST agree the VAT liability of any construction work with your contractor at the planning stage and agreed in the contract.
It’s your money so make sure that you’re not paying more VAT than you have to, whether or not you can claim the VAT from HMRC.
Marie
March 2014
I’ve discussed this subject in more detail in my new ebook “Guide to VAT and residential property development”.