On 31 January 2014, HMRC issued Brief 04/14 and Information Sheet 02/14 regarding the correct rate of VAT for the construction of certain buildings. This new guidance will be relevant for contractors who construct buildings and the customers (developers) who engage them.
The default position is that construction work is subject to VAT at the standard rate. However, the construction of certain kinds of building can be zero rated. One example is where the new building is to be used solely for a “relevant residential purpose” (Note 4, Group 5, Schedule 8, VAT Act 1994).
What is a relevant residential purpose?
In Notice 708, HMRC interprets a relevant residential purpose to mean that the building is to be used as:
- a home or other institution providing residential accommodation for children,
- a home or other institution providing residential accommodation with personal care for persons in need of personal care by reason of old age, disablement, past or present dependence on alcohol or drugs or past or present mental disorder,
- a hospice,
- residential accommodation for students or school pupils,
- residential accommodation for members of any of the armed forces,
- a monastery, nunnery or similar establishment, or
- an institution which is the sole or main residence of at least 90% of its residents.
It is important to note that HMRC specifically excludes the following from buildings used for relevant residential purposes:
- hospital or similar institution,
- prison or similar institution, or
- hotel, inn or similar establishment.
Certification of relevant residential purpose
There are a number of conditions to be met before construction work can qualify for zero-rating when constructing such a building. One condition is that the contractor must receive a certificate from their customer (the developer) confirming the intention to use the building solely for a relevant residential purpose.
Another pitfall is that HMRC considers buildings to have useful economic lives of ten years for VAT purposes. The importance of this is that the building could cease to be used for a relevant residential purpose (including sale) within ten years of practical completion. If that happened, the developer would suffer a VAT charge which effectively hands back to HMRC a portion of the VAT which would have been charged by the contractor if the building had not been used solely for relevant residential purposes.
Designed as a dwelling, intended to be used solely for a relevant residential purpose
Taxpayers who suffer a change of use VAT charge should consider whether this could be minimised.
The construction of certain buildings can be zero-rated under a number of alternative provisions. HMRC has now confirmed that, if the relevant residential purpose provision no longer applies, an alternative provision could be applied to maintain the zero-rating claimed for the original construction costs.
A building is constructed which is certified for use solely for relevant residential purposes. The contractor zero-rates their supplies to the developer in accordance with Note 4, Group 5, Schedule 8, VAT Act 1994. The developer puts the building to a non-qualifying use within ten years. Before paying a change of use VAT charge, the developer determines that the building’s design as a dwelling qualifies for zero-rating under Note 2, Group 5, Schedule 8, VAT Act 1994 and avoids the change of use VAT charge.
It is important to note that the two different zero-rating provisions do not always apply to the same buildings.
A building might be designed as a qualifying dwelling and certificated as intended for use solely for a relevant residential purpose. However a separate dining hall, which was constructed at the same time as a student block and which qualified for zero-rating under the relevant residential purpose provision, would not qualify for zero-rating under the provisions for buildings designed as dwellings. A VAT charge would therefore apply to any change in use of the dining hall, but the student block might continue to qualify as zero-rated.
It is a welcome announcement from HMRC that taxpayers can apply an alternative zero-rating provision when a certificated building is put to a different use. Practitioners and their clients should consider this option to reduce their VAT liability before paying any change of use VAT charge.