Are new dwellings zero rated for VAT? Not exactly, explains Kevin Hall in Taxation Magazine.
It is a truth universally acknowledged, that a new dwelling constructed and sold, must be zero rated. Jane Austen probably chose not to write this sentence because it is not true.
A variety of cases have demonstrated that the VAT rules relating to property are opaque, and the judge in one case was roundly condemnatory: ‘With the greatest reluctance … we are accordingly forced by an absurd (and perhaps none too carefully drafted) law into an absurd decision, which flies in the face of common sense, of equity and of the ‘social purpose’ which is supposed to underlie and inform zero rating.’
Calam Vale Ltd had converted a pub into two new residential dwellings and sold them. The taxpayer thought these sales would entitle it to recover the VAT paid on its costs, but HMRC rejected the claim and the tribunal upheld that decision. The issue was a subtle one, but the outcome was financially serious and illustrates the level of care required of those working in the property sector.
Given the current short supply of housing provision, together with the rise of online retail at the expense of ‘bricks and mortar’ shops, conversion works are a growing area. This article will explore relevant VAT rules and highlight some of the issues to be addressed.
It is well-known to property developers, constructors and their advisers that the construction and supply of a new dwelling can be zero rated, but that there are a number of tests to meet.
These are set out in VATA 1994, Sch 8 group 5, with note (2) requiring that:
- the dwelling consists of self-contained living accommodation;
- there is no provision for direct internal access from the dwelling to any other dwelling or part of a dwelling;
- the separate use, or disposal of the dwelling is not prohibited by the term of any covenant, statutory planning consent or similar provision; and
- statutory planning consent has been granted in respect of that dwelling and its construction or conversion has been carried out in accordance with that consent.
Some of the ambiguities in group 5 have been explored in the courts and tribunals, where it is always taxpayers challenging the opinion of HMRC. The legislation also contains other notes, which impose further tests.
As a result, many additional requirements now exist which prevent supplies being zero rated, such as: if any existing building is not demolished to ground level; if planning consent does not specify any retained façade; or if work commences before planning permission is granted, even if this is granted with retrospective effect. This last point was stated in 2021 by the First-tier Tribunal in the case of CMJ (Aberdeen) Ltd (TC8140).
Conversions often result in a mix of VAT rates. For example, the zero rate might apply to the sale of qualifying new dwellings after conversion, but the conversion works themselves will either be reduced rated or standard rated. It will be important for the clients of constructors that the reduced rate is applied wherever possible in case the client cannot recover all the VAT charged to them.
The rules governing the application of the reduced rate to conversion works are set out in VATA 1994, Sch 7A group 6, but determining the appropriate rate of VAT is a complex process. Primarily, attention is required to what existed before the works began and again to what is created after the conversion. However, there are many additional details to consider before determining the correct rate of VAT. Care should be taken over factors as varied as whether the new domestic reverse charge applies, the status of different parts of a site, and whether materials incorporated qualify for the reduced rate.
As for zero-rating sales, there are also requirements that any statutory planning consent and (additionally for conversions) any statutory building controls are in place from the outset (VATA 1994, Sch 7A group 6 para 10).
Non-recovery of VAT
Reducing or eliminating the VAT on purchases is important for the constructor’s client, and therefore also for the constructor, in particular if the VAT cannot be fully recovered by the client and will become an additional cost.
Purchases often include, among other things, the purchase of the property itself, construction work, sales agents and professional fees, eg planning consultants, legal advisers, architects, and so on. Multiple planning points should be considered at the earliest opportunity to reduce the VAT.
For example, in order to remove VAT on the purchase of a property, the purchaser can act unilaterally to disapply it, but they are required to meet certain deadlines, and discussion with the vendor is encouraged as the implications of doing so are not straightforward. When considering professional fees, significant VAT savings can be achieved if the project is structured appropriately from the outset.
Charging the reduced rate of VAT is important even if the client expects to recover the VAT charged in full, as property projects frequently change direction with the VAT becoming unrecoverable. There are a number of scenarios where this might happen. One example is if a developer later rents out the new dwellings, which is an exempt supply requiring VAT on attributable purchases to be unrecoverable. This is often seen when new dwellings cannot be sold straightaway, and intentions change.
An ‘absurd’ example is highlighted by the case of Calam Vale.
Calam Vale (VTD 16869) had argued that its constructor’s conversion works had created two new dwellings in a building where previously there had been commercial premises on the ground floor and a flat on the first floor. It might be thought that the sale of each new house should be zero rated on the grounds that, where there was now a new dwelling, no complete dwelling existed prior to the conversion works.
However, there is an asymmetry in the legislation at this point.
This reasoning holds for conversion works to qualify for the reduced rate as a new dwelling was created where previously there was none, or only a part of one. Paragraph 3(3) of VATA 1994, Sch 7A group 6 – conversion to a new dwelling – set outs this condition.
‘3(3) The second condition is that there is no part of the premises being converted that is a part that after the conversion contains the same number of single household dwellings (whether zero, one or two or more) as before the conversion.’
The same reasoning does not hold for the creation of the same new dwelling when it comes to selling it. Note (9) of VATA 1994, Sch 8 group 5 – sale of a new dwelling – prevents the zero rating.
‘Note (9) The conversion, other than to a building designed for a relevant residential purpose, of a non-residential part of a building which already contains a residential part is not included within items 1(b) or 3 unless the result of that conversion is to create an additional dwelling or dwellings.’
Calam Vale’s sales were exempt and so could not recover VAT on all its costs.
The ‘absurd’ result is that the creation of a new dwelling incurs an unrecoverable VAT cost where there should be none. More absurdly, this VAT cost only arises because Calam Vale had divided the properties vertically, dividing the pub and flat in two. Had the conversion instead occurred horizontally, the sale of the new dwelling on the ground floor would have qualified for zero rating and the VAT on all attributable costs would have been recoverable in full; although the works to the first floor would not have qualified for the reduced rate and the sale would still be exempt.
The judge highlighted the inconsistency of the law by noting that if an office building, with a caretaker’s flat on the top floor, was converted vertically into four townhouses, the sale of each new house would be exempt because each would have contained part of the caretaker’s residential accommodation. If, on the other hand, the same building was converted into flats, dividing it horizontally, only the top floor flat would be exempt. The remaining flats, having been converted from entirely non-residential space, would have been zero rated.
Calam Vale, although now an old case, is a timely illustration of how varied and subtle the VAT rules are. It is easy to overlook an opportunity or unexpectedly incur a large VAT liability.
As the market for new housing developments picks up, it will be important for constructors, developers and their advisers to undertake early and careful VAT planning in order to avoid converting profits into losses.
- Key points
New dwellings that are constructed and sold are not always zero rated for VAT. In order for a new dwelling to be zero rated, there are a number of tests to be met – these are set out in VATA 1994, Sch 8 group 5.
- Conversions often result in a mix in VAT rates – the rules are set out in VATA 1994, Sch 7A group 6, but determining the appropriate rate of VAT is a complex process.
- Ensuring the reduced rate of VAT is charged correctly wherever possible by the constructor is important, in case the VAT becomes unrecoverable for the developer. The 2001 case of Calam Vale is one example to pay attention to.
Originally written for Taxation Magazine.