VAT and Property Conversions
It is widely recognised that there is a shortage of housing stock in the UK and the Government is keen to encourage residential developments on brownfield sites. These type of brownfield site developments often involve creating homes by converting properties that were previously partly commercial and partly residential, for example a pub with living accommodation for the manager. The question is, what is the VAT treatment of the sale of new homes created from this type of property? Is the sale exempt from VAT or does the zero rate of VAT apply? What difference does it make, after all regardless of the answer, no VAT will be charged on the sale?
The answer is important because it affects whether the developer can recover VAT on the property conversion costs. If the sale is exempt VAT cannot be recovered, if the sale is zero rated VAT can be recovered.
HMRC guidance on the subject is included in paragraph 5.3.5 of the 14 August 2014 of VAT Notice 708 (on buildings and construction). The paragraph includes an example of converting a two storey public house containing bar areas downstairs and living areas upstairs. The guidance confirms that if the building is converted into two flats, one of which is created using only the bar areas and one of which is created using only the living areas, the sale of the flat created from the bar areas is zero rated and the sale of the flat created from the living areas is exempt. That part of the HMRC guidance is not controversial. The controversial part of the HMRC guidance is included in italics below:
On the other hand, if the conversion uses a mixture of non-residential parts of the building and other parts such as when you:
- convert the same property into a single house or
- convert the same property by splitting it vertically into a pair of semi-detached houses, each of which use part of what was the living accommodation
The onward sale or long lease of the house/houses cannot be zero-rated and is exempt.
The guidance is controversial because in two VAT cases Alexandra Countryside Investments Limited (TC02751) and Languard New Homes Limited (TC04917) the First Tier Tribunal decided that zero rating applied to the sale of homes created by using a mixture of residential and non-residential parts of what existed before the conversion work was carried out. The First Tier Tribunal did, however, come to a conclusion that is consistent with the controversial HMRC guidance in the DM & DD MacPherson (TC04756) VAT case. These three VAT cases illustrate the VAT complexities that can arise when converting mixed use properties to dwellings.