Contributed by Hilary Bevan FCCA CTA AIIT, Bevan VAT Consultancy Ltd.
I often get questions from accountants whose clients have purchased a property which they intend to renovate/convert. This is a case study of one of those questions.
Mr Bishop has bought a property on Ramsey Street. It comprises a shop on the ground floor, and a flat on the first floor. He intends to renovate it and wants to know what the VAT implications are.
That sounds like one question, but there are actually two key things that need to be considered:
(1) the VAT liability of the renovation/conversion costs he will incur; and
(2) whether or not that VAT is recoverable.
VAT liability of the conversion/renovation costs
The answer always starts with more questions. We need to know what the property is at present, and what it will be after the work takes place.
Ground floor
Mr Bishop advises us that the ground floor is currently a shop. Some work is needed to renovate it, but he intends that it will still be a shop after the work is carried out.
There are no VAT reliefs in connection with work to commercial premises and so all of this work will be subject to VAT at 20%.
First floor
We are told that the first floor has previously been used as a flat, but it has not been occupied for at least two years.
Mr Bishop is going to renovate the flat so it can be lived in again.
VATA 1994, Sch. 7A, Grp. 7 allows the reduced rate of VAT to be applied to qualifying services in the course of the renovation or alteration of dwellings which have not been lived in for the last two years.
That could include building work, plastering, plumbing, joinery, etc.
It also applies to building materials where they are supplied and incorporated by the person carrying out a qualifying service.
Building materials bought by Mr Bishop directly would be subject to VAT at 20%, as would professional fees such as architects and consultants.
Measuring the two-year period
In order for the reduced rate to apply, the dwelling must not have been lived in for the period of two years ending when the renovation works start.
The difficulty in these cases can often be how to prove how long the property was empty. Mr Bishop should consider asking the seller, and could also contact his local council’s empty property officer, if they have one.
Shared costs
In a building such as this, there are likely to be some costs which relate to both the residential and the commercial parts. For example, repairs to the roof would be for the building as a whole, not just one particular part.
Where that is the case, the costs can be apportioned.
Recoverability of VAT
It is a fundamental principle of VAT that VAT on costs can only be recovered to the extent that it is incurred to generate VATable income.
It is crucial, therefore, that we establish what Mr Bishop is going to do with the property once the work has been carried out.
Ground floor
Mr Bishop intends to keep the property and rent out the shop to a third party to operate.
The default position for rental of a commercial property is that the rental income is exempt from VAT ( VATA 1994, Sch. 9, Grp. 1, Item 1 ).
That would mean that no VAT was chargeable on the rent but that consequentially, none of the VAT on the renovation work could be recovered.
Opting to tax
Mr Bishop could make the decision to opt to tax the property.
An option to tax changes the VAT liability of the rental income and makes it standard rated. That would mean VAT would be charged on the rent at 20%, but also that VAT could then be recovered on all of the associated costs.
Once made, an option to tax applies to almost all future sales or leases of the shop for at least the next 20 years, so it is not to be entered into lightly.
Mr Bishop would need to consider what his future use of the property is likely to be and whether any buyers or tenants are likely to be VAT registered. That would need to be weighed up against the amount of VAT at stake.
An option to tax applies to commercial premises only, and so would have no impact on the upstairs flat.
First floor
As is often the case with property development projects, Mr Bishop has not made a final decision on what will be done with the upstairs flat.
In an ideal world, he’d like to grant a 99-year lease to someone who would want to live there long term.
He realises though, that interest rates are high, and so now might be a difficult time to find a lessee. If he can’t find someone who wants a long lease, he is prepared to offer it on a six-month assured shorthold tenancy, or would even consider using it as a holiday let, as it is in a desirable area on a quiet cul-de-sac.
Granting a long lease
The VAT treatment of this option will depend on how long the flat was unoccupied.
The grant of the first major interest in a renovated dwelling which was not lived in in the ten years before the renovation took place is zero rated ( VATA 1994, Sch. 8, Grp. 5, Item 1(b) ).
As such, no VAT is chargeable on the lease premium, but the zero-rated supply means that the VAT can be recovered on all of the renovation costs.
If the flat has been lived in within the previous ten years, the lease premium will be exempt from VAT. As such, the VAT on the costs would not be recoverable.
As with the two-year period for the reduced rate to apply to the renovation work, the difficulty can often be in establishing categorically when the property was last lived in.
Residential letting
Letting the property under a six-month AST is exempt from VAT ( VATA 1994, Sch. 9, Grp. 1, Item 1 ). That means that no VAT is recoverable on the renovation costs.
Holiday lets
Holiday letting is standard rated ( VATA 1994, Sch. 9, Grp. 1, Item 1(e) ). As such, Mr Bishop would charge VAT at 20% on the letting income, and would also be able to recover all of the VAT on the renovation costs.
Change in intention
Initial VAT recovery is based on the intention at the time the costs are incurred.
Most small-scale developers like Mr Bishop have pretty fixed intentions, and we don’t have the word count to review changes of intention in detail but if they did change he would need to consider whether input tax claims needed adjustment.
Finally
As can be seen from the above, what at first sounds like one simple question from a client, can often lead to various potential scenarios. If you ever find yourself in this position, the first three questions you ask should be:
(1) What is the property now?
(2) What will it be after the work has been carried out?
(3) What income is it going to generate, e.g. rent, sale, trade?
It is always best to establish the position before any costs are incurred.
Useful links
For commentary on land, property and construction, see Quick Overview from ¶70000.
If you have any comments on this article, please e-mail the editorial team at tax-weekly@croneri.co.uk.
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