Sarah Barron – VAT Specialist
Developers building new homes with the intention of selling them are able to recover the majority of VAT they incur on costs, however anyone building to hold as letting property is not entitled to recover VAT.
In the current climate, we have to anticipate that the housing market will suffer and it may not be possible to sell property in the short term. Developers may decide to let in the short term leading to possible consequences for their VAT recovery. The impact of this can be minimised by taking the decision at the right time to let or by moving the property into a different entity which will do the letting.
What is the VAT trigger?
The trigger which protects the VAT recovery for new homes is the first sale of the freehold or a long leasehold, by the person or entity which has built them. If it will be necessary to let the properties, selling the homes to a separate associated company means that all the VAT already recovered by the developer can be retained. Any future letting undertaken by the associated company will be exempt from VAT, so no VAT on costs incurred by that company will be recoverable, but these should be minimal.
If it is not possible to make that first transfer of the property, then a check on partial exemption will be required. A developer who has completed construction and decides to let for, let’s say, a couple of years, before selling has to check whether any clawback is due to HMRC. If the Developer does not have an existing partial exemption method, the de minimis test can be based on a simple split on the basis of years out of ten, the developer expects to let for. If the VAT on the project is £30,000 and he anticipates letting for two out of the next ten years, the exempt input tax is £6,000. This is below the de minimis threshold of £7,500 and no clawback of VAT already recovered will be required.
If this test is failed a more detailed check will be required. This can be based on the expected future income from the property, so two years’ worth of letting income and the expected ultimate sale price, as follows.
How to calculate the recoverable fraction and the de minimis impact
Total VAT on costs x (Ultimate sale price/Expected letting income plus ultimate sale price)
So on a build which has incurred total VAT of £50,000, expected to sell for £500,000 and two years letting income totalling £40,000. This project has recoverable VAT of £46,297 leaving £3,703 irrecoverable.
Having calculated the amount of VAT which relates to the exempt income, we then check whether this is de minimis. Amounts below £7,500 for a twelve month period ending 31 March, 30 April or 31 May are classed as de minimis and therefore no clawback of the VAT already recovered is due to HMRC.
This method of calculating the irrecoverable VAT is only allowed as an exception at the point when the intended use of the property is changed. If costs are still being incurred then the calculation either has to revert to the standard partial exemption method set out in VAT regulations or you have to agree a special method with HMRC. The standard method looks at the actual income in the period. If this is all VAT exempt letting income, then no VAT on costs in the period can be recovered. It can be time consuming and costly to agree a special method with HMRC, although we would hope that they would take a reasonable approach at this time.
Timing is crucial
In light of the above, the timing of the decision to temporarily let new homes is important. Changing your intention while costs are still being incurred could result in ongoing partial exemption calculations being required and a restriction on recovery. Making that decision once the build is complete, may mean that only one major calculation and possible payment to HMRC is required. The ongoing calculations, once costs are no longer being incurred will be relatively straight forward. However, it should be noted that many developments using that first calculation method, based on estimated future income, on a change of intention may not fall below the de minimis and a payment will need to be made to HMRC.
The decision whether to commit to a period of letting now or hold on until the development is complete will be a matter of judgement based on the costs of the project and estimates of future returns. It should be borne in mind that the whole of the income for the company or trader needs to be taken into account when considering the irrecoverable amount and each VAT registration only gets one de minimis limit per year, so developers need to think about the effects of multiple projects undertaken within a single entity. The example above is based on a number of properties, each costing less than £250,000. Items individually above that value may give rise to adjustments under the capital goods scheme.
Transferring the property into an associated entity will have consequences for other taxes which should be fully understood before any decision is made. This article provides a very brief outline of the issues and potential solutions. As the rules are complex, advice should be taken based on the facts in each case. For specific advice on your situation, contact our Property and Construction sector team.