Revenue and Customs Brief 3 (2024): VAT on Cladding Remediation Work

This insight authored by Jimmy Davies and Bradley Gibney, aims to clarify HMRC’s policy on the deduction of VAT incurred on cladding remediation works performed on existing residential buildings. Revenue and Customs Brief 3 (2024) (RCB3/24) provides a useful summary of HMRC’s policy.

Background:

Following the events of Grenfell Tower where 72 people lost their lives due to highly flammable, non-compliant cladding, remediation works became an area of political significance.

Many other residential blocks of flats were found to have serious historical fire safety defects associated with cladding installed in their original construction or subsequent refurbishment. As this posed a serious risk to life, Michael Gove, the Secretary of State for levelling up, housing and communities, announced a commitment in 2022 to make companies which installed unsafe cladding pay for its replacement.

The government has previously rejected calls for specific VAT relief on remediation costs. Developers performing remediation works incur VAT on their costs. Subsequently, the deductibility of this VAT has become a hot topic.

History of HMRC’s position on input tax deductibility

In October 2023, HMRC finally gave their views on input tax deductibility for developers on a ‘Construction Working Group’ call. On this call, HMRC implied that VAT incurred on costs of remediation work does not have a ‘temporal link’ to the initial construction by the developers (except in very limited circumstances where the developer is undertaking snagging – see below).

HMRC went on to imply that VAT can only be deducted by developers when remediation costs have a direct and immediate link to general business activity. The conclusion from HMRC’s approach is that VAT incurred on remediation costs which have a link to general business activity should be considered a business overhead, and input VAT deducted in line with the developers’ partial exemption method.

HMRC believed that this meant only remediation works performed by developers undertaking statutory remediation works within sections 126-129 of the Building Safety Act 2022 - known as the ‘Responsible Actors Scheme’ - had a link to general business activity. Many VAT advisors and those within the construction industry believed HMRC’s position to be overly restrictive.

On this call, HMRC went even further and suggested that they believed VAT could not be deducted on costs incurred for remediation works outside the scope of the Responsible Actors Scheme – i.e., developers who had voluntarily carried out remediation would suffer VAT.

This was controversial as many developers had voluntarily undertaken remediation works prior to or regardless of statutory obligations so to protect their reputation.

HMRC’s updated policy

Since taking this position in late 2023, HMRC have rowed back. RCB3/24 summarises their current policy.

HMRC policy is now that VAT on developers’ remediation costs can be deducted if it is:

• Directly and immediately linked to the initial construction, because it is snagging; or
• Directly and immediately linked to the general activities of the business

For remedial work to be considered snagging, it must be connected to the original construction via a retention clause in a contract to perform damages work, within the original contract for construction, and works must be performed by the person who undertook the initial construction.

Any remediation works which are not considered snagging may have a link to general business activity. RCB3/24 says that HMRC consider this to mean that the remediation work is a cost component of future taxable supplies by the developer – meaning the developer intends to continue to undertake developments or other taxable activities. VAT on these costs is deductible in line with the developer’s partial exemption method.

What has changed

HMRC now recognises that developers will be able to treat VAT incurred on cladding remediation works as a cost component of future business activity. VAT is deductible in line with the normal overhead VAT recovery.

HMRC no longer see it as a requirement that work is carried out under the statutory provisions of the Responsible Actors Scheme.