UPPER TRIBUNAL DECISION REGARDING VAT TREATMENT OF NEW DWELLINGS WHERE A PART OF THE BUILDING IS RETAINED

Following on from our last blog post the outcome of HMRC’s appeal to the Upper Tribunal in JS Building Solutions (J3BS) was published in June 2017. The decision has not been subject to any further appeal.

As outlined in the blog post below, J3BS carried out a building project that resulted in an enlarged dwelling incorporating three walls of the existing dwelling on the site. The First-tier Tribunal held that this was the construction of a new dwelling and zero rating could be applied to the works. The First-tier tribunal did not see the works as amounting to the alteration of an existing building preferring to characterise the works as the construction of a new building.

The Upper Tribunal rejected the approach of the First-tier stating that in almost all cases a project that does not satisfy the façade retention rule will be seen as an existing building and works will not be able to be described in VAT terms as the construction of a new building. The façade retention rule allows a single façade or double façade on a corner site where it is retained as a condition or requirement of statutory planning consent or similar permission  to be ignored for the purposes of determining whether a project can be a zero rated new build dwelling.

If as was the case here more of the pre-existing building is retained than the requisite single or double façade then the works to those retained parts would be an alteration of an existing building and excluded from the zero rating provisions.  

The Upper Tribunal decision distinguished itself from the earlier Astral decision which allowed the zero rating of a large extension to an existing church to form a care home.  

CONTINUING SAGA OF WHETHER A NEW BUILD IS A NEW BUILD OR NOT

Yet another case about the scope of zero rating in the context of new build dwellings has been heard before the First-tier tribunal (FTT) .  

A new dwelling can be constructed free of VAT where an entirely new building is constructed or all that remains of the existing building is a single façade or a double façade on a corner site which are retainedas a condition or requirement of planning consent.

The VAT law also states that the construction of a building does not include—

(a) the conversion, reconstruction or alteration of an existing building; or

(b) any enlargement of, or extension to, an existing building except to the extent the enlargement or extension creates an additional dwelling or dwellings; or

(c) ...... the construction of an annexe to an existing building.

The recent legal developments that have muddled the above rules is the concept that the retained façade rules are not the only instance where a qualifying new building can incorporate parts of the pre-existing building and still be zero rated. It has been held (in the Upper Tribunal (UT) decision case of Astral Construction) that zero rating can apply where works can be best described as the construction of a building and not fall into any of the exclusions listed above (eg conversion, reconstruction, enlargement etc) then zero rating can still apply even though the retained part amount to more than a single or double facade. This approach which is resisted by HMRC introduces an element of uncertainty into the task of establishing the whether a project is zero rated or not .

In the tribunal decision of J3 Building Solutions Ltd (released May 2016) the building contractor and his representative argued that the works amounted to the construction of a new building and were zero rated despite the fact that some parts of the pre-existing dwelling were retained, namely two walls on a corner the building that eventually formed the outer skin of the new building in that part of the site. They also contended that if the works did not amount to a new build then the retained walls were either not part of the new dwelling or if they were facades forming part of the dwelling then they were a double facade on a corner site and retained as a condition or requirement of planning consent and therefore zero rating applied to the works.

 SITE PLAN SHOWING RETAINED ELEMENTS IN J3 BUILDING SOLUTIONS CASE

SITE PLAN SHOWING RETAINED ELEMENTS IN J3 BUILDING SOLUTIONS CASE

HMRC argued that the VAT provisions which specifically exclude the reconstruction or alteration of an existing building from the zero rating were applicable due to the retention of parts of the pre-existing building and that the retained facades were not part of a corner site nor retained as condition or requirement of planning consent.

The FTT found that as a matter of fact and degree that the works amounted to the construction of a new building and were zero rated despite the fact that some parts of the pre-existing dwelling were retained, namely the two boundary walls which visually formed a corner of the new dwelling and parts of a further external wall. The tribunal said that what was done could not possibly be described as alteration of an existing building stating  “Demolition is not alteration, and the only parts not demolished were not altered.

 This decision has been appealed by HMRC to the Upper Tribunal who are understood to be relying on the Upper Tribunal decision in Boxmoor Construction Ltd – a case HMRC won where a house was largely demolished and replaced – the key difference between Boxmoor and J3 is that in Boxmoor the Upper Tribunal stated that the First Tier Tribunal would have classified the works as alteration works to an existing building if they had been asked to determine the nature of the works and therefore the works could not be zero rated. In J3 the tribunal was very clear that they thought the works were of a new building based on the facts. It will be interesting to see how the case is argued when it eventually comes to court in 2017.  

CUSTOMER DUE DILIGENCE - WHY DO LANDMARK PT NEED TO DO THIS?

As tax practitioners Landmark PT are required to consider and abide by UK anti-money laundering legislation.  

The requirements of the UK anti-money laundering regime are mainly set out in the Proceeds of Crime Act 2002 (POCA) (as amended) and the Money Laundering Regulations 2007. This legislation has been interpreted in a document released by the Consultative Committee of Accountancy Bodies (CCAB) entitled Anti-Money Laundering Guidance for the Accountancy Section and includes supplementary guidance for tax practitioners. HM Treasury has approved this guidance and the courts must consider the content of this guidance when determining whether a tax advisor’s conduct gives rise to an offence under the legislation referred to above.

SUPERVISED BY A SUPERVISORY AUTHORITY

One key element of the anti-money laundering legislation and the associated guidance is that a tax advisor should be supervised by a supervisory authority who will assess an advisor’s compliance with money laundering legislation and if necessary take appropriate action to ensure compliance by the advisor concerned. In the case of Landmark PT we are supervised by the Chartered Institute of Taxation.

CUSTOMER DUE DILIGENCE

Another important cornerstone of the legislation and our obligations relates to the need for tax advisors to carry out effective ‘customer due diligence’ when establishing a business relationship with all clients. This involves the tax advisors being able to demonstrate to their supervisory body that they have identified and verified the identity of clients using documents or information from reliable and independent sources. In certain circumstances this process includes identifying the beneficial owner of a client and understanding the ownership and control structure in place behind the client entity.  

HMRC UNDER PRESSURE OVER NEW PENALTY REGIME FOR DIY BUILDERS

The UK VAT rules include a special VAT refund scheme for people who build or commission the construction of a new dwelling or convert a non-residential building to form a dwelling for their private occupation.  The scheme puts DIY builders in a broadly similar position to a developer selling a zero-rated property. If claimed, HMRC must refund any VAT chargeable on the supply, acquisition or importation of goods used by the self-builder in connection with the construction of a new, qualifying, dwelling as well as the 5% VAT in relation to conversions.


Historically HMRC have not issued penalties to DIY builders in cases where they perceive a claimant has been careless or has completed the claim form inaccurately. However at some stage in 2014 there was a change in HMRC policy and HMRC started to issue penalties based on a percentage of the Potential Loss Revenue (PLR). Three instances where penalties were raised made their way to the First-tier Tax Tribunal and three times HMRC were held to have incorrectly raised the penalties.

In the first case the claimant built some flats for resale and tried to use the DIY scheme to reclaim the VAT incurred in building them. The claimant filled in the form and answered all questions on the form truthfully and correctly including advising HMRC that the flats were intended for sale. HMRC took the view that the inaccuracy was in submitting the form at all. In dismissing HMRC’s case the Tribunal commented as follows:

‘HMRC's argument produces the logical absurdity that the [claimant’s] accuracy in the completion of a form designed to check eligibility under the Scheme gives rise to a penalty for inaccuracy.’


The claimants subsequently registered for VAT and reclaimed the VAT through the normal VAT accounting system.

In the second case a similar situation arose where a couple submitted a DIY claim for VAT incurred in the renovation of a farmhouse that had not been lived in for ten years. Unfortunately the claimants after submitting the claim form and dealing with HMRC queries could not prove to a sufficient degree that that property had been unoccupied so the claim was withdrawn by the couple. HMRC raised a penalty on the basis that the lack of evidence was an inaccuracy. Once again the Tribunal held the penalty was invalid on the basis that HMRC’s reason for the penalty (i.e. the lack of evidence) did not amount to an inaccuracy and so no penalty should have been raised.

In the third case the accountants of a DIY builder sent in error an overstated claim to HMRC. The tribunal held that the DIY builder had not been careless as he had employed professional accountants to prepare his claim and as such it was reasonable to assume that the claim would be accurate and therefore the HMRC penalty was not valid. 

Retained wall denied zero rating

Both the construction and sale of a new building designed as a dwelling is largely zero rated for VAT purposes. Generally any pre-existing building needs to cease to exist with the only exception in the VAT legislation being the retention of a single façade, or double façade on a corner site, the retention of which is a condition or requirement of statutory planning consent.  

Because the sale is taxable albeit at a zero rate of VAT this means the developer can register for, and recover VAT on related expenditure. If the new dwelling is not a new building then the sale is likely to be VAT exempt which does not give the right to VAT recovery.

In the recent tax tribunal decision of M Lennon & Co Ltd, a property developer redeveloped an existing end of terrace dwelling for resale. Due to structural problems the building was demolished all but part of the front façade which was retained to provide support to the party wall with the adjoining building. No planning permission was required for the rebuilding of the house therefore the retained façade could not be said to be retained as a condition or requirement of planning consent.

The tribunal dismissed the appeal on the basis there was no condition or requirement to keep the façade. Unfortunately, the recent reported Astral Construction decision was not referred to. Using the Astral principles in this case may have led to a conclusion that there was a new building on the site as a matter of fact, degree and impression irrespective of the retained section.  So perhaps there was a missed opportunity here.

The tribunal also commented on the need for planning consent to be granted for a new dwelling to be zero rated concluding that a property specific consent might not be necessary if the planning regime allowed the works under some general planning consent such as permitted development rights or local development orders.

ZERO RATED NEW BUILD OR STANDARD RATED EXTENSION

In the case of Astral Construction Ltd the Upper Tribunal held that works provided in the course of constructing a large nursing home attached to an existing church could be treated as zero rated construction works despite the fact it was attached to and incorporated the church as an entrance foyer and other facilities for the site. HMRC were originally arguing that the works failed the VAT requirements to be a new building and should be 5% rated as a conversion.

 EXISTING CHURCH WITH NEW BUILDING WRAPPED AROUND IT 

EXISTING CHURCH WITH NEW BUILDING WRAPPED AROUND IT 

The VAT legislation says that certain services provided in the course of constructing certain residential and charitable use buildings can be zero rated. The notes in the legislation then provide more detail on the borderline between when a building is new and zero rated or when it is is not new and potentially 20% rated (assuming the 5% VAT rate is not due).

In particular the law says the construction of a building does not include the ‘conversion, reconstruction or alteration of an existing building’. Nor does it include ‘any enlargement of or extension to an existing building’. This note has long been interpreted as suggesting that any pre-existing building must be totally demolished (other than retained facades as referred to below).

The law also goes on to say a building ‘only ceases to be an existing building when: demolished completely to ground level; or the part remaining above ground level consists of no more than a single façade or where a corner site, a double façade [subject to further conditions related to planning]

What the Astral decision confirmed is that if works to an existing building as a matter of fact and impression do not amount to a conversion, reconstruction or alteration to an existing building or an enlargement or extension to that building then perhaps they could be seen as the construction of a new zero rated building even though parts of the existing building are retained.

The separate provision regarding total demolition or retained facades only confirms where an existing building ceases to exist so this does not affect the Astral scenario.

HMRC have not released any revised guidance in the light of this decision yet although they are likely to in the next couple of months. Whatever the content of the HMRC guidance this decision does mean that where major redevelopments are occurring there is another pathway to consider by which zero rating may be achieved. 

CHOICE OF PROCUREMENT ROUTE CAUSES VAT HEADACHE

The recent tribunal decision of Alan Johnson highlighted the issues that arise when a housebuilder expects common sense to have any application in interpreting the intricacies of the VAT legislation.  

This decision relates to a VAT reclaim made to HMRC by a private individual in relation to the construction of a dwelling. Whilst construction services to construct the new dwelling are zero rated the separate supply of building materials and other items are VAT standard rated. Where the new dwelling is being commissioned by a person for private occupation the VAT on some of these standard rated items can be reclaimed by the self-builder by way of a DIY builder VAT reclaim application to HMRC at the conclusion of the project.

In this case VAT incurred on the separate purchase of building materials was allowed however HMRC rejected the reclaim of VAT on items that were hired by the self-builder including scaffolding hire, skip hire, digger hire stating that the DIY builders VAT scheme was only applicable to VAT on building materials and not the VAT on hire services.

HMRC made the point that where the hire of an item and its use on site were by two distinct legal entities  then the hire on its own could not be treated as zero rated services nor could the VAT be reclaimed as being VAT incurred on ‘building materials’. HMRC stated that the hire of the digger with an operator could be zero rated as construction services and the claimant would need to ask the supplier to adjust their invoicing accordingly from the 20% VAT rate to the zero rate.

The claimant argues that ‘building materials’ often included an element of services. HMRC accepted that where the cost formed an inherent and inseparable part of the cost of the materials then the VAT on this part would be treated as part of the cost of the building materials (e.g. haulage costs of stone to site charged by the stone supplier) and this VAT would be capable of reclaim.

 This case highlights the importance of considering project procurement at the outset of a scheme if VAT costs are to be minimised. 

Back to basics: Introduction to the option to tax

Income from the sale or letting of property is generally exempt from VAT. There are however three exceptions where VAT is chargeable at 20%

1)      The freehold sale of new or partly completed commercial buildings  (‘new’ means a building less than three years old)

2)      Subject to various conditions certain classes of commercial property including hotel accommodation, holiday accommodations, storage buildings etc

3)      The sale or letting of commercial property over which the owner has made a valid option to tax (residential property is not affected by the option to tax)

This article focuses on the basic concepts in relation to making an option to tax. 

So why would someone opt to tax?

The option to tax means the owner has to charge VAT on rental or sale of the property. The main advantages are

1)      The main reason for opting to tax is that VAT on costs e.g. a refurbishment can be recovered whereas without an option the VAT would not be recoverable

2)      Avoiding VAT on a going concern purchase – if a person steps into the shoes of an existing commercial landlord who charges VAT on rental income then as long as certain conditions are met including the incoming purchaser making an option to tax on the property then no VAT is chargeable on the disposal price (this can reduce SDLT costs)

The main disadvantage is that VAT must be charged on the sale or rental of an opted building when the purchaser cannot necessarily recover this VAT.

Is it always necessary to opt to tax?

Situations when an option to tax is not necessary include:

1)      The freehold sale of new commercial property less than three years old

2)      Property owned and used by a person operating a full VAT charging taxable business

3)      Property used for certain property exploiting businesses eg hotels, holiday accommodation, storage etc

In all these examples VAT on costs will be recoverable without an option to tax due to the taxable nature of transactions.

The option to tax is generally relevant to those letting property for rental income. Whilst many tenants can recover VAT added to the rent they are charged some tenants cannot recover VAT due to the exempt nature of their business e.g. financial services and insurance businesses – it goes without saying that these companies would not be keen on letting a building which is subject to an option to tax.

 Buying a property business as a going concern

The Transfer of a Going concern (TOGC) rules are compulsory and if they apply they will take a transaction outside the scope of VAT. This can have useful cashflow advantages as no VAT has to be paid over to the seller by the purchaser.  Special conditions apply to opted investment property that is sold as part of a going concern sale where the property is sold with an existing tenant. In this case one of the key conditions is that the incoming purchaser must also opt to tax and register for VAT for the TOGC rules to apply.

One benefit of the TOGC route for commercial investment sales is that SDLT is added to the VAT free price, whereas on a non TOGC sale which is subject to VAT the SDLT is due on the total sum including any VAT element (even of the VAT is recoverable).

How is an option to tax made? 

An option to tax once made it is notified to HMRC on form VAT1614A. In certain cases a option to tax will require the prior permission of HMRC. In other situations the option to tax once made may be disapplied by a purchaser e.g. the sale of opted commercial property that is intended for conversion into dwellings.  This  can create issues for sellers who would make an exempt sale rather than  a taxable sale with the consequential VAT recovery restrictions. 

 

A saga where less (detail) means more (VAT)

Lady Henrietta Pearson must have thought the day would never arrive when HMRC refunded her the £40,000 or so of VAT she incurred in converting a disused barn into a home for her and her husband. Yet after three Tribunal hearings and two VAT tribunal decisions the day has finally arrived.  

Works started on the conversion in 2000 when there was a 1997 consent for the creation of holiday accommodation. By 2007 a revised consent had been granted for the creation of a live work unit. In 2011 Lady Pearson submitted a DIY converters claim for the VAT she has incurred in creating the live work unit.

HMRC rejected the claim on the basis the conditions to the 2007 consent meant the  definition for a qualifying dwelling for VAT purposes could not be satisfied – in particular the requirement that a dwelling for VAT purposes must not be prohibited from separate use or disposal in the terms of the planning consent.  HMRC said the conditions to the 2007 planning prevented the work element from being used or disposed of separately from the live element of the conversion.

In allowing the first appeal the Tribunal said that due to the lack of detail in the planning documentation and associated plans it was impossible to identify any work area and therefore impossible to see what the work area (where ever it was) might be separate to.  

Another condition of a qualifying dwelling for VAT purposes is the need for the dwelling to be built in accordance with the planning permission granted. In this case there were differences between the plans submitted and the actual works carried out however the Tribunal did not see this as a  blatant disregard of the planning consent and did not think the planning authority considered the development unlawful in this respect.

No doubt Lady Pearson thought this was the end of the matter however HMRC had different ideas. Whilst HMRC accepted the principle a DIY claim was possible they then reduced the claim by £30,000 or so on the basis that many of the contractor VAT invoices should have been correctly 5% rated at source. It is a requirement of the DIY scheme that invocies are charged at the correct VAT rate for instance 5% in the case of a qualifying conversion.  Lady Pearson was required to recoup this VAT from the suppliers by why of credit notes. However this was not possible as many of the invoices where over 4 years old and therefore not capable of amendment.

As a result Lady Pearson submitted a new Tribunal appeal where it was held that the first tribunal clearly allowed a VAT refund of £40,000 and therefore irrespective of the 5% rate requirement which HMRC picked up at a later date subsequent HMRC  must repay to Lady Pearson the full amount of VAT set out in the  first Tribunal decision. 

Zero rating denied for works where façade retained

The recent tribunal of Boxmoor Construction Ltd highlights the need for early consideration of the VAT rules when constructing a new dwelling with a retained façade. In particular, the need for there to be a level of unity between what is actually demolished and built on site and the original planning application describing the works concerned. There needs to be a degree of ‘specificity’ regarding the façade retention if the scheme is to meet the conditions for the zero VAT rate to apply to qualifying construction works.

In Boxmoor the works were described in the planning consent as being extensions and roof alterations. However the works on site involved the substantial demolition of the building apart from a small part of the front façade.  HMRC took the view ( a view that was ultimately confirmed by the Tax Tribunal) that zero rating was not available as there was no condition or requirement to retain the front façade in the relevant planning consent. 

VAT and perils of planning consent

In the recent appeal to the Upper Tribunal by HMRC against the decision of the First-tier Tribunal in the case of Patel it was held (overturning the decision of the First-tier Tribunal) that receipt of a backdated planning consent for the construction of a new dwelling after the 3 month time limit had elapsed for the making of a DIY builder’s VAT reclaim was not sufficient to make the DIY VAT reclaim valid for repayment.  

Mr Patel had originally received planning permission for the enlargement of an existing dwelling however the dwelling was actually fully demolished and a new dwelling constructed. The local authority was aware that a new dwelling was being built. Upon completion of the works Mr Patel submitted a DIY builder’s VAT reclaim to get a refund of VAT on the building materials he had bought. HMRC rejected the claim saying at the time fo the claim there was no planning consent for a new dwelling.  

Mr Patel obtained retrospective consent for the dwelling. The local authority dated the consent in 2009 before the works commenced. The First-tier Tribunal decided this was sufficient to make the VAT reclaim valid. The Upper Tribunal in overturning this decision held that as the consent was not produced before the end of the three month time limit allowed by the VAT regulations  for submitting a DIY builder’s VAT reclaim and therefore the refund of VAT to Mr Patel could not be made. 

This case again highlights the need to ensure the VAT rules are understood from the outset of any building project.

Annexe or extension?

The recent tribunal decision of Gateshead Jewish Nursery held that a single storey rear addition to an existing nursery facility operated by a charity was an extension and not an annexe with the consequence that works were VAT standard rated. If the structure had been classified as an annexe and met the other conditions for zero rating (i.e. separate access not via existing building and capable of independent function) then the works could have been zero rated.  

PLAN OF NEW EXTENSION

The floor plan above shows the property concerned. This case highlights the potential benefits of early consideration of the VAT rules as the design of the new building and subsequent planning application could have been drafted with these specific VAT rules in mind.  

VAT recovery on white goods and carpets considered

The tax tribunal has released its lengthy judgment in the preliminary hearing of Taylor Woodrow plc (TC03700) which concerned a VAT claim by a house builder in relation to VAT incurred on kitchen white goods and carpets that it did not recover as a result of the residential developer’s Blocking Order. The claim amounted to a figure in the region of £60 million and related to the period from 1973 to 1997. Different versions of the law over this timeframe were considered.

The principal argument of Taylor Woodrow was that the items concerned were not ‘incorporated’ into the dwellings and were therefore not covered by the Blocking Order.  The tribunal disagreed saying all the items were ‘incorporated’ under UK law. The Judge went on to say the following:

346. And even if I am wrong on the meaning of ‘incorporates’ and some or all of the Claim Items were not incorporated, that would not have meant that the appellant wins its case. It would have to go on and establish that either those Claim Items were part of the zero rated supply with the house, which, if they were not ‘incorporated’, is not accepted by HMRC or that even if not zero rated, the appellant is entitled to reclaim its input tax without offsetting the output tax on what would have been a standard rated supply.

The judge also considered whether the Blocking Order was authorised under EU law and concluded that if Taylor Woodrow wanted to rely on the EU law the outcome would be that the sale of the items would likely be standard rated and any adjustment to VAT recovery would have to be offset by the VAT that should have been charged. This is not the end of the matter and the issue of whether the goods formed the part of a single zero rated supply needs to be addressed. It is not known at this stage whether an appeal will be lodged.

http://www.financeandtaxtribunals.gov.uk/judgmentfiles/j7813/TC03700.pdf

Zero rating available for ancillary accommodation

In the recent case of MIM Construction it was held that a 'pool barn' was ancillary accommodation and could be treated as being part of an adjacent dwelling. Acceptance of this by the tribunal based on the facts of this case then opened the door for the alteration works to be zero rated under the now largely defunct listed building VAT rules. The alterations included the creation of a play room, yoga space, laundry, gym and changing rooms to an adjacent pool. The case mentioned the Fox and Catchpole VAT decisions which also concerned dwellings spread over more than one building. It has long been HMRC's view that for VAT purposes a dwelling must be contained in a single building (excluding garages which are specifically mentioned in the legislation). The case distinguished the House of Lords Zielinski Baker decision. It is understood that HMRC are rethinking their policy in this area. 

 Site plan of the ancillary accommodation 

Site plan of the ancillary accommodation 

Qualifying conversion did take place

In the recent VAT tribunal decision of Nabarro the judge held that the 5% VAT rate was available in a situation where a house with an adjacent self contained flat was converted into a single dwelling. HMRC had issues with whether the flat was actually a separate dwelling and whether the pre-conversion flat and house existed within one building. It was held there was a single building comprised of two 'single household dwellings' prior to the works and one 'single household dwelling' after the works therefore the 5% rate was applicable on the qualifying works. The fact the flat was completely demolished in the course of the works to allow for the extension of the main house was held not to be relevant nor the fact that the pre-existing flat did not have separate incoming utilities.  

Reverse charge on pub refurbishment

in the recent tribunal decision of Muster Inns it was held that the pub should have applied the reverse charge on building services received from a builder established in Guernsey on the basis that builder had no permanent status in the UK and therefore the supply of building work was deemed to be made by the pub to itself - this is despite the fact the Guernsey builder had a UK VAT registration.