I think that there’s a bit of scaremongering about the possible withdrawal of the reduced rate from conversions and refurbishments. I’ve recently seen a few articles about potential changes to the application of the reduced rate of VAT, following HMRC’s recent R&C Brief 13/2015 (http://tinyurl.com/oc22rth) explaining the ruling by the European Court of Justice about the UK’s application of the reduced rate to the installation of certain energy saving materials.
Some of the articles have suggested that this could lead to changes to the 5% rate for renovations and conversions, as explained in VAT Notice 708: Buildings and construction http://tinyurl.com/pjryxe8.
However, for the reasons I’ve explained below, I don’t think that the 5% rate for renovations and conversions is currently at any risk as a result of the ECJ ruling.
What did the ruling say?
The ruling concerned the application of the reduced rate for the supply and installation of energy saving materials. The ECJ ruled that the UK has applied the reduced rate of 5% too widely as it relates to energy saving materials.
There are two aspects to the ruling:
- the first relates to the status of the customer;
- the second is whether the reduced rate can apply if the supplies are made in isolation, but should only apply if the work is carried out as part of a wider renovation or alteration of the property.
Status of the customer
HMRC’s current policy is explained in VAT Notice 708/6: energy saving materials http://tinyurl.com/q77q4qh. Section 2 of the notice explains that the reduced rate applies to “to the installation of certain specified energy-saving materials (see paragraph 2.5) in, or in the curtilage of residential accommodation (see paragraph 2.16).” Section 3 states that it also applies ” to the grant-funded installation of certain heating appliances, central heating and renewable source systems in the sole or main residence of a qualifying person”.
This means that the reduced rate for energy saving materials applies regardless of the status of the recipient, while the reduced rate for heating appliances, central heating etc is only available if the customer receives a grant towards the cost.
Under EU VAT rules, the reduced rate for such goods and services is supposed to be restricted to supplies made to certain social groups, but under the existing UK rules, there are no restrictions on the customers who are entitled to the reduced rate for energy saving materials . The supplies mentioned in section 3 of Notice 700/6(certain heating appliances, central heating systems etc) can only at the reduced rate if supplied to those who receive a grant towards the cost, which is normally based on income. This restriction based on funding apparently meets the criteria that the reduced rate for such goods should only apply under a social policy.
The ECJ takes the view that the similar restrictions should apply to supplies of energy saving materials. Therefore the fact that any customer can claim reduced rating for energy saving materials doesn’t meet the EU criteria.
HMRC say that they are reviewing the ruling but that any changes to the reduced rate relating to energy saving materials won’t be introduced until the Finance Act 2016 and it doesn’t seem that any such changes will be back-dated, so contractors needn’t worry about assessments for supplies made in the past.
So how does the ruling apply to renovations and conversions?
The second part of the ruling is that the ECJ also stated that the reduced rate for such installations should only apply if the work is done as part of a renovation or alteration. I think that this is the part of HMRC’s Brief that has caused confusion and concern about the application of the 5% to renovations or alterations.
However, I don’t think that HMRC are saying anything about the 5% for renovations and alterations as defined in Notice 708.
As I read it, the ECJ’s ruling relates to the timing of the supply and installation of energy saving materials, heating appliances or other goods mentioned in Notice 700/6.
Timing: when the work is carried out
What does this mean?
Under the current rules in Notice 700/6, the reduced rate applies to energy saving materials and grant-funded heating appliances etc whether or not they are installed as part of a renovation or alteration.
This means that if, for example, you install loft insulation, but there is no other work carried out to the house, then under the current rules, the reduced rate can apply.
The implication of the ECJ ruling is that the reduced rate should only apply if the energy saving materials, central heating systems etc are installed as part of a wider renovation or alteration of the property.
HMRC haven’t expanded on this part of the ruling, so it’s difficult to speculate how this would apply in practice. For example, could you only get reduced rating if you’re only renovating one floor of a house or a couple of rooms? What would qualify as an “alteration” for these purposes?
Too soon to say….
So, a couple of points to end with.
First of all, please remember that this ruling from the ECJ ONLY relates to the supplies of goods and services described in Notice 700/6 and in particular, energy saving materials.
Second, we’re still waiting for HMRC to consider the ruling and issue guidance about how they plan to apply the ruling. I suspect that this will follow discussion with contractors and other suppliers of the energy saving materials etc mentioned in Notice 700/6.
Finally, while we can never know HMRC’s future plans for VAT, I don’t believe that HMRC will use this ruling to remove the 5% rate that currently applies to renovations and alterations (particularly conversions). HMRC is constantly reviewing the law and their policy, particularly when it comes to VAT reliefs such as exemption, zero-rating and the reduced rate.
Of course the VAT cost of construction work is a major factor for any developer, so we always have to watch for potential changes that could affect the property sector. You need to know the liability right from the initial budgeting, so any potential VAT change is always going to be a concern. But at this stage, I would be surprised if there were any significant changes to the rules for renovations and conversions as a result of the ECJ’s recent ruling discussed in this blog.
Marie
August, 2015