Property developers, VAT and COVID 19
As if there’s not enough to think about at the moment, property developers need to be extra careful with short term lets of new or newly converted domestic properties. Or they could end up with unexpected VAT bills.
The property market has been badly affected by the current COVID 19 situation. Residential sales and lettings particularly, because of the strict social distancing rules over the past couple of months. In the short term, developers are turning to the short-term rental market to generate some income.
This isn’t a new practice; property developers often let new properties on short term lets when the market is slow. But the current situation is more extreme than normal.
And this means that it could affect the overall cost of new and, particularly, newly converted dwellings for a lot of developers. I won’t go into a lot of technical detail here, other than referring you to specific sections in VAT Notice 708, which explain the rules in depth. But make sure you read and understand this article and do the research if you think it applies.
Developers and short leases
Chances are that if you’re a property developer and have either built new dwellings (see Notice 708, para 3 and 4 https://tinyurl.com/v39xe7m); or you’ve converted non-residential to residential (Notice 708, para 5 https://tinyurl.com/v39xe7m); you’ll be hoping to sell the freehold or grant a long lease (over 21 years) in the completed property. You will have claimed VAT on the cost of goods, materials, professional services and; in the course of conversions, contractors’ invoices; on the basis that your sales will be zero-rated.
If, however, you grant short lets; e.g. for 6 months, then this income would be VAT exempt. Under normal VAT rules, you can NORMALLY claim VAT on costs relating to exempt leases (“exempt input tax”). This mean that you may have to repay some of the VAT you’ve claimed to HMRC.
And this applies even if you are still planning to sell the freehold/long leases as soon as you’re able to do so once the short leases have expired.
Property developers, VAT and COVID 19: Partial exemption
The VAT rule that applies in this situation is the “change of use or intention” rule, which is explained in detail in VAT Notice 706; para 13 https://tinyurl.com/v2oyjnz. it applies when businesses don’t use the goods and services to make the type of supply originally envisaged and use them for a different type of business. That’s sounds like real VAT speak, but our property developer changing the use from a zero-rated sale to an exempt lease is a very common example.
In principle it means that you have to carry out a calculation to work out how the new “use” of the properties affects how much VAT you’ve claimed on your costs is exempt input tax and whether you need to repay any of this to HMRC. The calculation is based on partial exemption principles and is both tedious and fiddly. But you have to it.
It is possible that your newly calculated exempt input tax will be within the partial exemption “de minimis” limit so you don’t have to repay the VAT to HMRC. But you MUST do the calculation; otherwise in principle you are required to repay ALL of the VAT claimed on the new construction/conversion.
The main alternative is to sell the freehold/long lease to an associated and separately registered business; e.g. an associated company, which grants the short-term leases. That way the developer doesn’t have to repay any VAT because it’s all attributalable to the initial freehold/long long lease. Page Break
This can be a very tidy and practical solution, but you must ensure that any long lease falls within the specific rules in VAT Notice 708, paras 3-5 https://tinyurl.com/v39xe7m. For example, that the and lease doesn’t contain any break-clauses/reversion clauses that would return the lease to the developer, as this could affect the zero-rating of the developer’s sale. In the circumstances, it’s sensible to take advice about this situation to make sure that the arrangements don’t cause unexpected VAT problems.
Of course, like any business situation, the VAT issues will differ depending on the unique facts of the business concerned.
But you already know that VAT on property development is a difficult subject. COVID 19 simply adds a further level of complexity to a subject that already costs a lot of developers unexpected VAT bills. Don’t get caught out.