A result of the economic downturn is that many residential developers are looking at temporarily letting new houses rather than selling. HM Revenue & Customs (HMRC) takes the view that if this course of action is taken it may result in claw back of VAT on the grounds that an exempt rather than zero-rated supply has been made.

An HMRC Information Sheet was released on 16 September setting out guidance on the potential calculations required. It runs to eight pages and it is likely that businesses will want to take specialist advice on its application, as the contents are far from straightforward.

It is the view of HMRC that these provisions should not affect many developers on the grounds that the input tax to be restricted would fall within de minimis limits (currently £7,500 pa).  Developers who are fully taxable are able to carry out a simple de minimis check. This requires the business to ascertain the input tax incurred on building a new property (not an easy task in itself for many companies), and how long the property will be let. You may be surprised to know that HMRC considers the economic life of a property to be 10 years. If, for example, the property is to be let for two years, it would expect a restriction of 1/5 of the input tax, unless that amount was less than £7,500. If input tax is incurred spanning more than one year, separate calculations are required.

For those developers already partly exempt, a claw-back adjustment is required. HMRC strongly discourages an adjustment based on the number of years it is to be let. It suggests the following calculation:

                           Estimated eventual sale value
Estimated eventual sale value + estimated short let premiums and rents

Businesses should be prepared to provide evidence of how they arrived at estimates – for example with business plans, estate agents’ reports or other commercial documentation.

Recovery will also be restricted on current and future VAT incurred and calculated using a partial exemption method.

Whilst this is not a new requirement, it is further bad news for a sector that is already struggling. It may also come as a surprise to those developers who were not in business in the early 1990’s when circumstances were similar. Space does not allow a full discussion of the consequences but there are opportunities to mitigate and in some cases completely avoid the adjustment altogether. We would be delighted to discuss this with you.

Jackie Richmond is VAT Director at Menzies. She can be contacted at jrichmond@menzies.co.uk