VAT zero-rating: An internal conflictby
Converting a listed building into luxury flats has highlighted a conflict between the VAT rules for zero-rating and planning and structural requirements to retain key internal features.
The Royal Star and Garter Home is a rather desirable Grade 2 listed estate positioned adjacent to the Richmond Gate entrance to Richmond Park, London.
Originally built to provide nursing facilities for returning WW1 veterans, in 2013 Richmond Hill Developments (Jersey) Ltd (Richmond Hill) purchased and converted the building into 86 residential flats, at a cost of around £95m.
The issue before the first tier tribunal in Richmond Hill Developments (Jersey) Ltd v HMRC  (TC 8232) was whether the sales of the flats were zero-rated – such that the taxpayer could recover input VAT on the conversion – or exempt for VAT purposes.
The sale of residential flats is generally VAT exempt (Group 1, Sch 9 VATA 1994). However, zero-rating can apply to: “The first grant by a person substantially reconstructing a protected building, of a major interest in, or in any part of, the building or its site.” (Item 1 Group 6 of Sch 8 VATA 1994)
Note 4 to Group 6 provides:
“[a] protected building is not to be regarded as substantially reconstructed unless, when the reconstruction is completed, the reconstructed building incorporates no more of the original building (that is to say, the building as it was before the reconstruction began) than the external walls, together with other external features of architectural or historic interest.”
There was no dispute as to the protected status. The issue was the restriction on “substantial reconstruction” in Note 4. The works retained the external walls and roof, but also certain internal features including a marble staircase, floor slabs, a fireplace, and chimney stacks in compliance with the planning consents.
HMRC argued the internal retentions deprived the taxpayer of the zero rate. Richmond Hill contended the retentions were structurally integral and/or de minimis, and that fiscal neutrality and proportionality required a favourable application of Note 4.
The FTT opined that Note 4 merely extended the facades rule (in Note 18 to Group 5 VATA 1994) to the whole exterior for listed buildings.
It was accepted that “external walls” was not so restricted as to exclude foundations and buttresses which were “intimately attached”, and that the floor slabs and steel truss frame had a structural purpose in supporting the walls. However, the floor slabs and truss were “more than mere adjuncts” as they also served another purpose: providing floors. They could not be part of the walls in ordinary language.
In relation to the de minimis argument, the FTT accepted that it applied in principle. The tribunal assessed the works as a whole rather than item-by-item as suggested by Richmond Hill and found that the internal retention was not de minimis, both in terms of significance and area.
On the question of fiscal neutrality, Richmond Hill had obtained correspondence between HMRC and the owner of a listed 1960s tower block whereby HMRC had accepted Note 4 would be satisfied where the size of the building and scale of works warranted the retention of internal elements necessary for structural integrity. However, the FTT opined that the work at that tower block would not have qualified as a “substantial reconstruction” and the taxpayer could not rely on treatment (afforded by HMRC) in contravention of domestic legislation.
Richmond Hill also argued that the UK must ensure that its domestic provisions are proportionate to the attainment of the objectives of the legislation, which included home building and ownership and relieving the financial burden on owners of listed buildings. Note 4 if used to prevent the retention of structurally integral interior features was not proportionate.
Proportionality, HMRC argued, had no effect as member states were allowed a margin of appreciation and, in accordance with Article 109 of the Principal VAT Directive, an objective was the abolishing of non-harmonised exemptions/zero-rating.
The FTT held that the correct application of the principle was to assess whether a provision was unjustifiably broad, not whether it was too narrow. Also, relieving the financial burden on owners of listed buildings was not a readily identifiable object of the legislation. Therefore, the appeal was dismissed.
There has been scant case law on Item 1 and Note 4, Group 6 in its current form. The takeaway is that the zero-rating provision for protected buildings is construed strictly. Only a shell under Group 6 (or demolition under Group 5) will suffice, with little regard to structurally integral internal components.
Muddled aims and outcomes
The rationale behind various zero-ratings is rarely clear when applied. As posited by the FTT in J3 Building Solutions Ltd v HMRC  UKFTT 0318 (TC5087), how does knocking down one building and replacing it with another encourage home ownership? This is especially true given the quirks under Note 18 that extensive basements are permitted but facades are not unless the subject of planning consent.
Unlike Note 18 which somewhat elevates the importance of planning considerations, the limited zero rate for listed buildings per Note 4 is likely to conflict with planning consent. It is extremely rare to find a listed property going through substantial reconstruction without the retention of structurally integral or internal historically important features. Furthermore, those with a better understanding of the reality of construction might argue that the VAT provisions do not sit well with the reality of reconstruction of old buildings which requires a more nuanced understanding of architecture and building work.
For VAT practitioners, however, this decision may be welcomed as a straightforward application of the natural reading of the legislation.
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Max Schofield is a commercial chancery barrister at 3PB Barristers with an interest in VAT liability and rates as well as contractual disputes and commercial injunctions.
Max has been instructed to advise and appear in his own right on a broad range of indirect tax cases concerning a...