VAT charities and property – when can construction be zero-rated

When constructing a property, VAT is charged at the standard rate unless the work falls into a category which justifies zero-rating.  This is an absolute saving for those who cannot recover the input VAT, such as charities, health bodies, educational institutions, housing associations and finance houses.

It is therefore an important step in planning the construction of a property to consider whether the work can (or could with the right planning) be zero-rated.  One category of zero-rating is the building which is intended solely for a relevant charitable purpose (Group 5, Schedule 8, VAT Act 1994).

A typical structure would be to construct and hold the building in a separate entity, and then lease it to the main entity which will use the building.  The letting of the property would not ordinarily be considered to be a relevant charitable purpose, and therefore construction would be at the standard-rate and not recoverable by the charity.  However, one might seek to rely on the principles in the Yarburgh case (Yarburgh Children’s Trust, [2002] STC 207) and argue that the lease of the building is not properly a business activity, and therefore the building is not intended for business use (letting) but for a charitable purpose (i.e. the use by the main entity).

However, a recent case shows that there are limits to this approach.  In the case of French Education Property Trust Ltd v Revenue and Customs Commissioners ([2015] UKFTT 0620 (TC), published on 4 January 2016), the property was constructed by one entity (a charity) and leased to a second entity (also a charity) which operated a fee-paying school.

The Tribunal posed two questions.  First, was the property letting a business?  Second, was the school a business?  If either were a business, the building was not constructed with the intention that it be used solely for a relevant charitable (i.e. non-business) purpose.

In fact, the Tribunal found not only that the property letting was a business, but also that the school was run sufficiently seriously that it constituted a business too.  The case of Lord Fisher (Lord Fisher, [1981] STC 238) was considered, which we reported on 26 September 2012.  As a result, VAT should have been charged on the construction of a building which was not for a relevant charitable purpose and a cost would arise to the charity.

Care must therefore be taken when planning to minimise the VAT costs in constructing, leasing and using property.  There are complex rules governing how VAT should be applied to works and transactions relating to property, and even after navigating through the difficulties posed by the legislation and practices, there are limitations which should be considered such as the Yarburgh, Lord Fisher and French Education Property Trust cases.

For further information on minimising VAT on the construction of property for a charity, please contact the TaxDesk on 0845 4900 509 and ask for Vaughn Chown.