If you want to avoid mistakes and unexpected VAT bills, you need to do the VAT planning for your development as part of the initial financial planning for the project.
It might seem obvious that the VAT cost of a development is the difference between the VAT you pay on costs and the VAT you claim from HMRC. But do you know how to work out the VAT on your costs and the VAT you can claim from HMRC?
What would you do if your building contractor added an extra 10% to their bill, or the bank asked for an extra 5% interest? Of course, this shouldn’t happen when you plan things in advance, with your solicitors drawing up contracts, your financial advisors deal with the bank and other investors. And the accountants deal with tax, VAT cashflow and other financial stuff. It’s simple business common sense: make sure you understand how much money you need for ALL of your costs right from the start.
So what do you do when HMRC tells you that you’ve got the VAT wrong and end up having to fund an extra 20% VAT on costs?
You probably expect your accountant to sort it out. But that’s not really being fair to your accountants. Expecting an accountant who is NOT a VAT specialist to deal with VAT on property development is a bit like expecting your GP to do brain surgery. And yes, I apologise to any accountants who feel slighted by this comment; but you have enough stuff to do for your clients to be experts in the more complex areas of VAT. But I think that a big part of the problem is simply that developers and their accountants simply don’t realise that the subject is so complex; one of those situations where you don’t know what you need to know.
Knowing how to work out the VAT on costs and how much VAT you can claim is not as simple as it looks. It’s one thing to read HMRC’s VAT Notice 708: Buildings and construction, to find out whether the contractor’s services qualify for the zero-rate or the reduced rate. But working out the overall net VAT cost of a development means that you not only need to understand several different sets of VAT rules, but, more importantly, how they all work together.
And It’s difficult. I’ve worked in VAT since the 1980s and have written books about the subject, and I still double check the rules and take time to make sure I’ve considered everything.
If you invest a lot of time finding the right land/property to develop, arranging finance and meeting with potential architects, builders and other suppliers, why don’t you invest the same attention to detail correctly establishing the VAT cost of your development?
Here’s a very important fact: the default position for property developments is that the sale or rental is VAT exempt. This means that in principle, you have to pay 20% VAT on ALL your costs and can’t claim any of it.
Getting the VAT wrong could increase your costs by anything up to 20%! What effect would that have on your planned ROI?
I think that many developers – and their accountants – simply don’t understand the subject fully and can make very basic mistakes even when they think that they have covered the subject correctly.
But getting it wrong can really mess things up. Whether it’s because of not understanding the rules, or – more likely – that you simply don’t know what you need to know.
And we all know that ignorance is not accepted by HMRC as an excuse for making mistakes.
It’s the wrong sort of conversion!
Earlier this year, I was contacted by a developer who had overclaimed over £100,000. It was because of a simple error: they didn’t know that there are two definitions of the word “conversion” and they’d used the wrong one. Their carefully budgeted development overnight became a potential loss, as they had to repay the £100k to HMRC and can’t claim VAT on any future costs.
Which form to get 5% rate on renovations?
.More recently, a developer asked which form was needed to claim the difference between the 20% VAT paid to the contractors and the 5% rate on renovations. I had to explain that there’s no such form. It doesn’t work like that. You have to ask your contractor to charge the 5% from the start of the project. That’s how you get the 5% rate.
I see situations like this, involving everything from simple property flips to office conversions, new construction and many mixed developments, from first time flippers to multi million pound developers all the time.
Many developers don’t know which questions to ask. So to get you started, here are some of the difficult things about VAT and property development:
- VAT is a transaction tax and any single transaction – income or expenditure – can affect the overall VAT cost of a development.
- There are A LOT of transactions in any property development scenario. You need to consider the implications of each one in the context of the whole development.
- You need to understand detailed rules about at least three different subjects: VAT on income, expenditure and claiming VAT. Each one of those is a complex and detailed subject in its own account.
- And then there are special rules if things don’t go to plan and you have to recalculate your VAT claims.
However, the REALLY difficult bit is understanding how all of the rules work together.
I spent a long time writing my book “VAT for residential property developers and contractors”, which you can buy from Amazon or from our shop. It explains the important rules – in everyday English where possible, with lots of practical information – along with my 3 step process for managing the VAT process through the development and beyond. The book is a very good resource. But like any good resourse, you need to take the time to read it properly and learn how the rules apply to your situation.
But the real VAT cost of a property development also includes the time and hassle of dealing with HMRC’s queries, the cashflow costs of delayed claims, unexpected professional costs; to say nothing of the stress and sleepless nights, when you realise that instead of the anticipated profit from your long planned development, chances are the unexpected VAT costs will change the profit into a loss. And that doesn’t even take into account any penalties or interest that you may have to pay HMRC in addition to overclaimed or underpaid VAT.
It’s a simple business decision: make sure that you fully understand the VAT rules and how they apply to your development as part of your financial planning. Otherwise, you may be caught out with unexpected VAT costs, that have a serious effect on your development’s financial success.