28 June 2017

VAT on commercial construction projects

When constructing property, it is important you consider your VAT position at the planning stage and incorporate it into any budgets or cash flow models.

When it comes to the VAT status of building projects, there are a number of basic rules to follow. If these rules are considered and confirmed at the planning stage of a project, the final VAT position will be clearer and the associated budgets more reliable. Remember that if the intended or initial use of a building changes, there may be a requirement to repay the VAT recovered or an opportunity to recover more.

Constructing new commercial buildings

The first basic rule is that you should expect the construction of all new commercial buildings to be liable to the standard rate of VAT. There are exceptions to this, for example, the construction of a new village hall, care home or a relevant charitable purpose building could be zero-rated.

With a 20% standard rate of VAT, this can result in a significant additional cost. For every £100,000 spent, an additional £20,000 of VAT will be incurred. As long as the VAT incurred can be recovered in full by the developer of the property, there should be no additional VAT cost. However, if the property is used for non-business (free of charge) or exempt activities, the VAT incurred on construction costs could be blocked or restricted from recovery, which would lead to an additional cost.

The sale of new commercial buildings is always liable to the standard rate of VAT. As a result, when a developer constructs and sells a new commercial property, there should be no irrecoverable VAT cost. Equally, when a developer commissions the construction of a new building and occupies and uses the property itself, as long as it can recover all the VAT it incurs, the VAT on the construction of the building should be recoverable in full. Once again, there will be no irrecoverable VAT cost.

Renting out constructed buildings

If a property is constructed as an investment and rented out to third parties, the rental income is exempt from VAT. This would preclude or restrict the recovery of VAT incurred on any construction and ongoing costs. Property owners or developers that find themselves in this position can elect to charge VAT on the rent (commonly known as the option to tax). By opting to tax, the developer or owner will have to charge standard rate VAT on the rental income it receives. However, this will normally allow the developer or owner to recover the VAT it has, and will, incur on costs related to that particular property.

Developers should be aware that, in some cases, the election to charge VAT can be blocked by their tenant. This commonly occurs if the tenant is a charity that is using the property for non-business or free of charge activities (other than office space). This can also apply if, under anti-avoidance rules, the tenant is unable to recover all of the VAT it incurs and is connected with the developer or another party that has provided funding to the developer for that particular building.

Capital goods scheme

The recovery of VAT on any construction project valued in excess of £250,000 must be monitored for a period of 10 years under a scheme known as the capital goods scheme. Under this scheme, if the property is used for a purpose that has a different VAT liability, there will be a requirement to review and potentially adjust the VAT incurred on its construction. This procedure is intended to ensure the recovery of VAT incurred on the construction or renovation of a building reflects its true use. If the VAT incurred on the construction of a building is not recovered and the property is used for standard-rated activities, an element of the VAT can be recovered each year for the remainder of the 10 year period. Conversely, if VAT has been recovered and the building is used for an exempt or non-business purpose, an element of the recovered VAT should be repaid to HMRC.

Given the money involved in property construction projects, it is important that the VAT position is considered at the planning stage and incorporated into any budgets or cash flow models. Steps can be taken to simplify and improve the VAT position of projects that are unduly complicated or result in additional VAT cost. Professional advice or guidance should be taken at the planning stage of every significant construction project, and we are always on hand to help.

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