VAT: New HMRC view of zero-rated buildings
HMRC has adjusted the criteria for deciding whether construction services should be zero-rated. Marie Stein explains why this has happened, and how three tax cases influenced its change of approach.
Zero-rated construction services
The construction of certain new residential and charity buildings can be zero-rated if certain criteria are met. To qualify as new construction, the property must be "designed for use as a dwelling" or "intended for use solely for a relevant residential or relevant charitable purpose".
One of the main criteria is that any previous building on the same site must be demolished to ground level unless there is a statutory requirement to retain a facade of an existing property (or two if the property is on a corner).
Otherwise, the retention of any other parts of a property, however small, means that the zero-rate cannot apply. In most cases, this means that the work will be liable to VAT at 20% if replacing, altering, extending or enlarging an existing property, although the 5% rate may be available if the work qualifies as conversion of a commercial property or a renovation of an existing dwelling.
The same criteria that apply for zero-rated construction services must be met in order for the sale of the property by a developer to be zero-rated, or to qualify for a VAT refund under the DIY scheme for a private individual.
HMRC response to cases
VAT Information Sheet 07/17: Construction services and zero-rated relief discusses the application of the zero-rate following the decisions of the upper tribunal (UT) in the following cases:
- Astral Construction Ltd (Astral)
- Boxmoor Construction Ltd (Boxmoor)
- J3 Building Solutions Ltd (J3BS)
In all three cases, the UT considered whether construction could be zero-rated if any part of the existing building is retained.
Incorporating existing buildings
In Astral, the UT ruled that the construction of a nursing home which incorporated an existing church qualified for the zero-rate because the size and nature of the new property meant that it could not be regarded as alteration, extension or enlargement.
HMRC has accepted the ruling and states that "where the size of the addition to the existing building greatly exceeds the original building and the function changes HMRC is prepared to accept that such works are entitled to be zero-rated".
However, HMRC's policy seems to be subjective and the VAT Information Sheet 7/17 doesn't comment on how the Astral decision could apply to different types of development. For example, what if a builder incorporated an existing commercial garage into a significantly larger new dwelling - would the same principles apply? I suspect that HMRC wouldn't accept this argument although the work would almost certainly be regarded as a conversion and therefore eligible for the 5% rate.
Incorporating parts of existing properties
In Boxmoor, the UT decided that the retention of part of a facade that did not form part of the planning requirements, consisting of brickwork under a ground floor bay window, was sufficient to prevent zero-rating.
Finally, in J3BS, the UT ruled that the work did not qualify for the zero-rate primarily because the work involved the retention of additional exterior walls to meet the zero-rate criteria, as I described in my article on this case last year.
The HMRC responses to the decisions in Boxmoor and J3BS deal with very specific situations where portions of an existing dwelling are retained. Commenting on Boxmoor, HMRC: "now accepts that a very minor part of a building may be retained above ground level if it's small enough to be ignored as ‘de-minimis’" while pointing out that the retention of brickwork under a ground floor bay window was NOT held to be ‘de-minimis’. Unfortunately, there is no definition of the term ‘de-minimis’ in this context.
Commenting on J3BS, HMRC discussed the meaning of the word ‘facade', confirming that in its view not all external walls can be treated as facades. However, there is some relaxation about whether the requirement for facades to be retained must be part of the formal planning requirements.
Where does this leave us?
As is often the case with HMRC's responses to tribunal or higher court decisions, there are more questions than answers. I suspect there will be some interesting tribunal cases over the next few years testing HMRC's revised policies.
In the meantime, if you believe that a client has either paid too much VAT on construction work, has not claimed VAT relating to a potentially zero-rated sale, or has had a DIY claim dismissed that could be affected by these changes in policy, then get the claims process started as soon as possible.