VAT - PITFALLS FOR HOUSE BUILDERS

We have linked up with Wilkins Kennedy, Chartered Accountants for this important advice for house builders:

CAN’T SELL A NEW-BUILD HOUSE? TAKE CARE BEFORE YOU RENT IT OUT

If you are a house builder having trouble selling a new home you might, quite logically, be tempted to rent it out until house prices pick up again.

However, under HMRC regulations, you might be letting yourself in for some complex potential VAT problems.

Due to the current slowdown in the residential property market, some house builders are deferring their intended sales of dwellings and temporarily letting instead, and so becoming partly exempt.

As you are probably aware, if a new house is sold freehold or on a long lease (over 21 years in England; 20 years in Scotland) you can reclaim all of the VAT incurred on your building costs.

However, for short leases or lettings, HMRC can insist on a claw-back of some of the VAT incurred on building and development costs.

Put simply, the reason for this is that VAT on freehold sales is rated as zero, so you can recover all the VAT, whereas short lettings of new property are VAT exempt – so you have no right of VAT recovery.

How to check your position
For many house builders the amount of ‘exempt input tax’ related to their temporary lets is small (known as ‘de minimis’) and as a result they can continue to recover all of their input tax; but they must check to avoid VAT mistakes.

If you are in a large building firm you may already be partly exempt and familiar with operating a partial exemption method. However smaller building firms may not be so aware of the intricacies surrounding the whole area.

The ‘de minimis’ is a simple check which is based on the expected time period you will letting your building as a proportion of the economic life of that building, which for VAT purposes is ten years.

How de minimis works
Your exempt input tax is determined by applying the proportion to your total input tax. Provided your exempt input tax does not exceed £625 per month on average (up to £7,500 per year) and is not more than half of your total input tax, then your exempt input tax is ‘de minimis’ and you can recover it in full. What’s more, the ‘de minimis’ test applies to the total input tax incurred - including for example any input tax on general overheads such as bookkeeping costs.

However, if your building or buildings do not qualify for de minimis exemptions, you will almost certainly have to do one or more of the following:

* adjust the VAT previously recovered on your submitted VAT returns
* restrict the VAT to be recovered on your current and future VAT returns
* both adjust your past VAT recovery and restrict your future VAT recovery.

So, for example…
Let’s assume you have recovered £20,000 input tax on a house that you originally expected to sell for £300,000. Because of market conditions, at the end of the tax year you decide to defer the sale by letting for two years and so become partly exempt. A simple check for de minimis is:

£20,000 input tax x 2 year lease divided by a 10 year expected economic life of the building (the standard) = £4,000 exempt input tax

The £4,000 of exempt input tax is de minimis because over the tax year it does not exceed £7,500 or 50 per cent of your total input tax. So there is no need to adjust the VAT previously recovered on your VAT returns. If the input tax was incurred over more than one tax year, the de minimis test should be applied to the input tax incurred in each of the tax years separately.

A word of warning
The starting point for the repayment of VAT when you rent a house is the moment you decide to rent it – not when you sign leases – so you could be liable to VAT even though there is no rental yet coming in.

It’s well worth seeking advice
Naturally this article is only an outline of the VAT situation on letting new houses. If you are not familiar with all the complex issues that lie behind the legislation, simply call Bob Southey on 01483 306318 quoting CD Property Finance.