Are you involved in converting mixed use properties to dwellings?

In general terms, VAT on costs incurred in order to generate income that is exempt from VAT cannot be recovered. VAT on costs incurred to generate income that is subject to VAT (at whatever rate) can be recovered, providing the VAT on the costs was charged at the correct rate. Subject to certain conditions being met, the reduced rate of VAT (currently 5%) is relevant to many property conversion projects that result in new dwellings.

The examples in italics below illustrate the VAT recovery policy of HM Revenue & Customs (HMRC) for developers selling dwellings created from mixed use properties:

To qualify for zero-rating the conversion must only use non-residential parts of the building. For example, you convert a two-storey public house containing bar areas downstairs and private living areas upstairs into two flats: one being created out of the bar areas and the other being created out of the private living area. The onward sale or long lease of the former is zero-rated but that of the latter will be exempt.

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 dwelling(s) cannot be zero-rated and is exempt.

An Upper Tribunal decision released on 28 July 2017 supports the HMRC policy illustrated by the above examples.

Three tips for property developers:
  1. Take VAT recovery into account at the design stage – in the above example, two flats provide better VAT recovery than two semi-detached houses.
  2. Ensure that the contractor charges the reduced rate of VAT, rather than the standard rate of VAT, as much as it is allowed to.
  3. When in doubt, consult the Garbutt + Elliott VAT team.

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