VAT on Residential Property

Land and buildings are often the most expensive assets that a business could own and consequently, VAT associated with land and property is also high. As such, it iis important for businesses to ensure it is acting on a sure footing when developing property and making supplies on completion. When considering the development of residential property, it is important to consider;

• The VAT liability of construction and conversion services, which can be zero-rated and reduced-rated respectively, dependent on a number of factors, including whether the properties meet HMRC’s definition of a dwelling;
• The scope of zero/reduced-rating as this applies to qualifying services provided by a contractor and ‘building materials’ provided by a person also providing qualifying services;
• The onward supply of completed properties, which will determine the developers input VAT recovery position.

The VAT People are experts in helping developers understand the main VAT considerations that are applicable to them, while setting out the basic VAT position on supplies made to and by them. If you are supplying services during the construction of a building, or want VAT advice at any stage of the residential development process to maintain compliance throughout, call The VAT People today on 0161 477 6600 or fill out our VAT on new residential buildings

When a residential building has been constructed, the first grant of a major interest in it (usually a freehold sale or a lease of more than 21 years) is zero-rated for VAT. Zero-rating also applies to the first grant of a major interest where the developer has converted a non-residential building into a dwelling.

In cases where the supply constitues the grant of a long lease or a tenancy agreement, only the premium (or first) rental payment will be zero-rated. Subsequent payments are exempt from VAT altogether.

One consequence of this zero rating is that they are entitled to full recovery of VAT paid on costs that they incur, as despite VAT not being due at a positive rate, zero-rated supplies are taxable supplies for VAT purposes and so allow for VAT recovery on associated costs. Despite exempt supplies also not requiring VAT to be accounted for at a positive rate, these are not taxable supplies for VAT purposes and do not allow for recovery of input tax. This is a key distinction between zero-rated and exempt supplies that we often find is misunderstood.

VAT rules of property development on construction and conversion projects

Services supplied during the construction of a qualifying residential property are zero-rated. However, the separate supply of professional services in the course of construction of a residential building - for example, by an architect or surveyor - is specifically excluded and is standard-rated.

It is worth noting that if such services are obtained as part of a ‘design and build’ lump-sum contract, the liability of the supplies on the design element follows the liability on the build portion. Therefore, it may be possible to zero-rate this aspect too.

Building materials that are supplied alongside qualifying construction services and then incorporated into the building will also be zero-rated. However, materials supplied on their own will likley be liable to VAT at the standard rate.

Some residential conversions can qualify for VAT at a reduced rate of 5%, including the supply of ‘qualifying services’ in the course of residential conversions. What’s more, building materials supplied with those services are also reduced rated; although again, materials supplied on their own will likely be standard rated.

Residential conversions that can benefit from this reduced rating include:

• When the developer is converting commercial property to residential property
• Where there is a change in the number of dwellings; for example, a single residence being converted into a block of flats

In cases where the developer has refurbished and redecorated the building, but kept the same number of homes, services will be standard-rated (unless the building has been empty during the entire two-year period prior to commencement of the works).

Whether you’re undertaking a new build or conversion of residential properties, The VAT People can provide you with comprehensive guidance on your liabilities and how you could optimise input VAT recovery.

FAQs about VAT on residential property

What is a major interest in a residential building for VAT purposes?

A major interest in a residential building refers to a freehold sale or the grant of a lease for at least 21 years. The first grant of a major interest is usually zero-rated for VAT purposes, provided specific conditions are met. This essentially means that while the transaction is still within the scope of VAT, it is subject to a rate of 0%. The benefit of a zero-rated onward supply is that the developer can claim back any input VAT incurred on associated costs.

What does zero-rating mean and when does it apply?

Zero-rated supplies are taxable supplies, where VAT is applied at 0%, so VAT is not charged to the customer at a positive rate, but the supplier can still recover input VAT on associated costs.

With respect to residential property, zero-rating typically applies to the first grant of a major interest in a newly constructed residential property. This includes the sale or long lease of a newly built house or flat. The same treatment extends to the first sale or long lease of a new dwelling which has been converted from a commercial property.

Zero-rating can also apply to buildings intended for a relevant residential purpose, such as student accommodation and care homes, provided specific conditions are met. This treatment allows developers to reclaim any VAT incurred on construction and related expenses, which can improve cash flow and project viability.

When does a reduced VAT rate of 5% apply?

A reduced VAT rate of 5% may apply to certain qualifying services involved in converting a commercial building into a residential unit. This rate also applies to building materials supplied alongside those services. The reduced rate can be especially advantageous for developers as it reduced the amount of VAT incurred, thus providing a cost advantage where this cannot be linked to an onward taxable supply and is therefore irrecoverable.

What is a valid certificate and why is it important?

A valid certificate must be held by the developer when making any zero-rated or reduced-rated supply in connection with a building that is intended for a relevant residential purpose. The certificate is issued by HMRC before the supply is made, and the developer should take all steps to ensure it is valid.

Two types of certificates are available - one that confirms the developer’s eligibility to receive zero-rated or reduced-rated building work, while the second confirms their eligibility to receive a zero-rated or reduced-rated sale, or long lease.

How does the Capital Goods Scheme impact VAT recovery for developers?

The Capital Goods Scheme applies to capital expenditure relating to land and buildings with a net value of more than £250,000, such as the purchase of properties themselves and high value capital works (refurbishments, etc).

Where VAT is incurred on such expenditure, initial recovery of the VAT follows the normal rules. However, 10 annual adjustments will have to be made at the end of each financial year to reflect the actual use of the premises, i.e. where the property is used to make exempt supplies, a proportion of the VAT recovered will have to be paid back. For each adjustment, 10% of the total VAT recovered on the construction will be at stake.

These apportionment calculations will have to be repeated for each financial year using figures collated throughout the year, detailing the amount of non-business use and taxable and exempt supplies made in relation to the property, and then the apportionment percentage calculated will reflect actual use.

Should the use of the building be fully taxable, then no adjustment will be required. However, if exempt supplies are made or the property is used for non-business purposes, VAT initially recovered will need to be adjusted and repaid in accordance with the adjustment calculations.

What are common VAT traps for residential property developers?

Residential property developers often face avoidable VAT pitfalls that can have financial consequences. Common issues include:

• Failing to plan budgets accordingly: inadequate VAT planning can lead to unexpected costs where supplies, services or developments have been misclassified. This may increase overall project expenditure.
• Not keeping sufficient records: failing to maintain accurate VAT records, including invoices and supporting documentation can result in lost recovery opportunities, compliance breaches and HMRC enquiries. Good record-keeping is essential to demonstrate the VAT treatment applied throughout the project lifecycle.
• Misclassifying purchases and VAT recovery: incorrectly categorising supplies made on completion of a development may cause errors in VAT recovery. This often occurs where mixed-use developments or different property types are involved, leading to partial exemption complexities and disallowed claims.

What are the risks involved in not complying with VAT rules?

Failure to comply with VAT rules exposes property developers to a range of risks that can escalate quickly if not addressed. Penalties can be substantial, often increasing where HMRC considers errors to be careless or deliberate, and interest charges on unpaid VAT can add further pressure to cash flow over time.

HMRC will take the view that a developer is responsible for ensuring VAT is applied correctly in relation to business activities, and even unintentional mistakes can still result in fines. There is an expectation that businesses will take reasonable steps to apply the correct VAT treatment, and ignorance of the rules is rarely accepted as a defence.

In more serious cases, consistent non-compliance or any fraudulent activity may lead to criminal prosecution, damaging a business’s reputation and potentially restricting its ability to trade in the future.

Applying the wrong VAT rate or recovering VAT incorrectly can also have a direct impact on profitability, eroding margins and creating financial uncertainty, especially on large-scale projects where VAT liabilities can be considerable.

For guidance on managing your VAT obligations effectively, The VAT People can provide tailored support to help you comply with legislation and protect your business.