VAT building project challenge
Neil Warren considers some of the key VAT issues for a developer who has bought a detached house and plans to convert it into six flats.
The starting point for any project of this nature is to always be clear about the VAT liability of sales you will earn at the end of it.
In the case of converting a house into six flats, the income will be exempt from VAT, irrespective of whether the flats are rented out or sold by the developer when they are completed.
Sales of dwellings are only zero-rated if they are newly built on bare land or are converted from a non-residential building into dwellings and then sold, such as an office block converted into flats.
VAT registration and input tax
As the sales of the flats are exempt from VAT, there is no scope for developers to register for VAT and claim input tax. If a developer is already registered because of making taxable sales from other projects, they will be partially exempt with an input tax restriction on all costs that directly relate to the conversion project, plus a proportion of VAT on overheads using the standard method based on sales (VAT Notice 706, para 5). Any VAT charged by suppliers will be a project cost because input tax cannot be claimed.
Liability of building services
Here is some good news: the change in the number of residential units between the start and the end of the project (from one to six) means that builder services will be subject to 5% VAT. This rate extends to materials provided by the builder as part of their work.
Note: the 5% VAT rate also applies to a project which results in a reduced number of dwellings eg converting two semi-detached houses into a single, detached house. It is the change in number that is the relevant issue.
The 5% rate of VAT also extends to subcontractors working for other builders on the project ie it applies to all construction services. It is important that builders apply the correct rate, otherwise, HMRC might disallow input tax on future compliance visits.
Eric the Electrician has charged £10,500 + 20% VAT of £2,100 to Contractor Clive for electrical works on the conversion project instead of 5% VAT at a total cost of £12,600. Contractor Clive can only claim input tax of £600 as if the payment included 5% VAT ie £12,600 x 5/105. He should ask Eric for a VAT credit of £1,575 ie £2,100 less £525 so that the correct VAT of £525 has been charged. Clive will then reduce his input tax by £75 when the credit is received ie from £600 to £525.
The standard rate of VAT always applies to professional fees relevant to UK buildings, and there are no exceptions to this outcome ie surveyors, architects, estate agents, project managers and lawyers.
The only potential VAT saver is for a developer to engage a building contractor on a “design and build” basis, ie where the architects and surveyors work for the contractor. They will charge the contractor 20% VAT, which the contractor will claim as input tax, and their onward supply to the developer is all subject to 5% VAT ie the design fee follows the same VAT liability as the building work.
Option to tax
An option to tax election can be made by a developer on any UK land or building but it is overridden in relation to supplies involving residential property.
So, an option to tax on a building that consists of a ground floor shop and first floor flat would only apply to the rent and sale of the shop – income earned from the flat is still exempt from VAT.
An option to tax would therefore not be worthwhile for a developer looking to make a conversion of the sort discussed in this article.