Mitigate VAT on your construction projects
Construction businesses are always looking to handle their finances in smarter ways and never more so than in the present economic climate. One field which is frequently ignored is VAT on building projects.
Gemma McCaldon-Gower explains the importance of reviewing current and future projects and how this could lead to improved cash flow or a VAT refund depending on the developer’s VAT status.
For some developers the arrangement is straightforward – they simply pay VAT to the contractor then reclaim it from HMRC. The downside of this is that the VAT outlay must be financed for up to four months before it is reclaimed via the VAT return which increases the cost of borrowing. Also, VAT repayment claims are subject to scrutiny by HMRC who will take any opportunity to disallow input tax if there is any reason to do so.
Some developers are unable to recover VAT on construction costs and professional fees depending on the property being developed and its intended future use. In these cases, the VAT becomes an absolute bottom line cost although with careful planning there are ways to mitigate this.
What are the rules and how can the VAT be ‘mitigated’ more effectively?
The rules are broadly that:
- New residential dwellings are covered by legislation for the construction services to be VAT zero-rated (0%).
- A conversion from commercial to residential use is covered by legislation which allows the reduced-rate (5%) to apply.
- Contractors must apportion their VAT charge if they are working on a new build development of new commercial and new dwellings. Otherwise if the values are not apportioned, the whole supply should be treated as standard-rated (20%).
- Zero-rate on construction also applies to the construction of buildings being used for Relevant Residential Purposes (RRP) and Relevant Charitable Purposes (RCP).
- The reduced-rate applies to renovations where a dwelling has not been lived in for two years previously or where a conversion results in a different number of dwellings in a building for example where a house is converted into flats.
Developers and contractors are not always aware of all the VAT reliefs available and so fail to use them to their best effect.
Understanding and applying the correct reliefs at the outset is the best way to mitigate VAT or even remove it completely.
Don’t just take the easy option
Some construction companies and contractors are knowledgeable in this area, but many are not and simply take what they perceive to be the easiest option by simply applying VAT at 20% so they have less risk of an issue with HMRC. Others don’t want the hassle of having to consider applying VAT at different rates and many are simply unaware that VAT does not always have to be applied at 20%.
We have reviewed many construction projects to ascertain whether or not part of or all the work qualifies for VAT relief through either zero-rating or reduced-rating and have worked with contractors and developers to ensure that VAT is charged correctly going forwards. Some projects may have a mixture of two or even all three VAT rates.
What about completed projects?
The VAT position for completed construction projects can also be reviewed to ensure that VAT was correctly charged. This is especially useful for developers who have constructed property where VAT couldn’t be recovered, such as dwellings constructed as portfolio stock for residential lettings.
If a project has been incorrectly billed with VAT in the last four years, there is scope to have the contractor issue a credit note and a VAT refund and again this is an area where we have successfully helped clients.
Examples of where we have helped
We recently assisted a local charity who had built a sports pavilion and football pitches. VAT had been charged by the contractor on the whole of the contract sum and due to the VAT status of the charity, none of the VAT had been reclaimed. Although the building was completed in 2017 (and therefore within the 4 year period to correct VAT errors), we reviewed the project and concluded that certain elements of the construction services qualified for VAT zero-rating. Following lengthy correspondence and discussions with HMRC and the contractor, it was agreed that the charity had overpaid VAT in the sum of £140,000 and this was refunded to the charity. There was no cost to the contractor as they simply adjusted the VAT in their VAT returns and claimed it back from HMRC.
Another client had taken over a partly completed conversion of a commercial property into apartments for rental. Therefore the client was not VAT registered and not able to recover VAT charged on the development costs. They engaged a new builder who treated the construction services as standard-rated. Before the project completed we were asked to review the VAT treatment and advised that the construction services should have been charged at 5% and 0% as the project was part conversion and part new build. The outcome was a refund to the developer of the VAT overcharged totalling £100k.
Get in touch
If you have been engaged in previous development projects, have an ongoing project or are planning a project we can review the VAT position. This could improve your cash flow, save VAT or even result in a VAT refund.
Where there is scope to ask the contractor for a credit note and a refund of VAT overcharged, this is only possible if the contractor is still trading. Therefore don’t delay. Contact Gemma at Gemma.Mcaldonemail@example.com
The information was correct at time of publishing but may now be out of date.