A potential VAT trap when temporarily letting unsold dwellings

Background

During the recession from 2008 to 2009, many housebuilders could not sell their completed dwellings and were forced to let some properties temporarily generate cashflow until the property market recovered.  It is possible that this could happen again in the current economic uncertainty.  We expect that HMRC will be paying close attention to the sector with a view to raising VAT assessments for overclaimed input tax.  Letting new residential properties creates a potential VAT problem which is explained below.

Zero-rating

Sales of new dwellings built from scratch are zero-rated provided the sale is of either the freehold or a long lease exceeding 21 years (or 20 years in Scotland).  Zero-rating also applies to supplies by builders or developers of buildings converted from non-residential to residential use, for example, a barn conversion.  Where the intention is to make a zero-rated taxable sale, input tax on building materials, professional fees and equipment hire etc may be recovered in full.  Construction services supplied by a builder and materials provided by the builder which is incorporated into the dwellings by him will be zero-rated.

Exempt

Rental income from dwellings is VAT exempt apart from holiday accommodation (including holiday lets and short-term serviced accommodation).  Under the partial exemption rules, an input tax block applies on the construction costs if the property is let out other than as holiday lets.

Whilst there is a clear intention to make zero-rated taxable supplies, input tax is reclaimable, subject to holding the correct evidence to support the claim.  

So, what does it mean when a builder or developer is forced to change his plans and let out some or all of the new homes on a temporary basis?

Payback and clawback rules

The input tax treatment depends on the first supply that is relevant to an expense.

• If a business claims input tax as there is an intention to make a taxable supply, but then the intention changes and an actual exempt sale is made, input tax claimed in the previous six years must be repaid to HMRC in the VAT period when the change in intention takes place.
• If a business does not claim input tax because the intention is to make an exempt supply, but then the intention changes and an actual taxable sale is made, input tax unclaimed in the previous six years can be claimed in the VAT period when the change in intention takes place.

2008 guidance

In 2008, HMRC addressed the VAT position and published guidance to housebuilders on the implications of letting unsold residential properties for VAT purposes.  The guidance has not been updated and remains in place today.

The guidance explained that in many cases builders could temporarily rent out new dwellings without any loss of input tax.  It essentially relaxes the normal partial exemption principles and often provides a better result than applying partial exemption calculations.  HMRC will exceptionally allow builders who do not currently operate a partial exemption method, to instead adopt a “simple check for de minimis”.  This simple check is based on the expected time period a builder will let his building as a proportion of the economic life of that building, which HMRC have said is ten years.  The exempt input tax is calculated by applying the proportion to the total input tax.  Provided the exempt input tax is less than £7,500 per annum and less than half of the total input tax, the exempt input tax is de minimis and can be recovered in full.

If the simple check cannot be applied, HMRC prefers calculations based on values and expected values of the various transactions.

Further opportunity

If the amounts of VAT involved are significant and breach the partial exemption de minimis threshold, a taxable supply can still be achieved (and irrecoverable VAT avoided) by transferring the completed houses to a connected person that is not a member of the same VAT group as the housebuilder.  This would mean that the letting of the houses would not affect the developer’s fully taxable VAT status.  HMRC has confirmed that it does not consider this practice abusive since it does not produce a result contrary to the purpose of the VAT legislation.

Conclusion

There is a genuine prospect that HMRC will see this as an opportunity to raise assessments and therefore care should be taken to deal with the VAT correctly and take specialist advice when required.  We are working with a number of our property clients who are considering temporarily letting their dwellings, providing advice and helping them with the VAT calculations.  If you require certainty and don’t want the prospect of a large VAT bill, our best advice is not to wait until HMRC come knocking but instead to be proactive and assess the position ahead of making any exempt lettings.