The VAT system allows registered persons to reclaim VAT on costs incurred that relate to their business activities. Rural businesses and estates can face VAT recovery challenges, but also welcome opportunities, with respect to their residential property portfolios. In particular, VAT recovery on the upkeep of residential properties is not always a straightforward matter. In this article we explore the issues, and some of the opportunities.
When VAT is not recoverable
Generally, VAT incurred on costs that are wholly attributable to a supply which is exempt from VAT is not recoverable. This VAT is known as exempt input tax. The granting of an assured shorthold tenancy (AST), or equivalent, is an exempt supply and VAT on costs of repairing, maintaining and upgrading properties subject to a residential tenancy is not recoverable. When planning major expenditure on tenanted residential property, it is necessary to factor in the VAT cost into the overall budget.
Residential lets in this context would include renting to an employee who pays a lower than market rate rent, as a condition of their employment. However, VAT on costs associated with accommodation provided free of charge to an employee who is required to be on site is not subject to a full restriction.
Construction costs with respect to residential properties are not necessarily always subject to the standard rate of VAT and in certain circumstances the zero rate or the reduced rate of 5% does apply, and it is important that businesses confirm with their contractors that the correct rate is being applied. The 5% rate can often be applied to the renovation of empty homes (subject to the property having not been lived in for a period of two years and other conditions), and the conversion of agricultural barns into new dwellings. The zero rate applies to the construction of new build residential properties (subject to the property qualifying as a dwelling), Where VAT is recoverable, it can only be reclaimed at the correct rate of VAT and if a contractor has not charged the correct rate, issues can arise.
A lifeline under partial exemption
Under partial exemption rules, there is a de minimis limit and if this is not exceeded, exempt input tax can be reclaimed in full. The limit, which applies annually, is less than £7,500 of exempt input tax and below 50% of total input tax. If this limit is exceeded, none of the exempt input tax is recoverable. However, if residential property costs are relatively low then full VAT recovery is still possible subject to the de minimis limit. Rural businesses with large property portfolios often have in-house maintenance teams that can help to keep down contracted out building costs and, as a consequence, incur less exempt input tax, keeping them below the de minimis limits in some cases.
Because the partial exemption position is crystallised each year, for residential property improvement projects which span two years it may be possible to achieve full VAT recovery over both years if the costs are spread. It might be helpful to carry out such projects towards the end of the partial exemption year so the costs are incurred across the two years rather than being concentrated in one. This opportunity should not be manipulated however, and contractors should still charge VAT at the appropriate time for works carried out.
- Farmhouse property costs.
Whilst the status and role of the traditional farmhouse has evolved over recent times, it is often still the heartbeat of a working farm, with a relatively clear link to the farming activities being undertaken. There is a long standing agreement between HM Revenue & Customs (HMRC) and the National Farmers Union of a 70/30 VAT recovery split in favour of the taxpayer. However, this should be applied with caution if you are without any other supporting information to demonstrate why 70% recovery on farmhouse property costs represents a fair and reasonable outcome. It is generally the case now that a much lower percentage could reasonably be said to apply to the business.
Improvements to farmhouses can be of a type that have little bearing on the business and are more associated with the comfort of the residents, so care does need to be taken. If the farming business has restructured and is no longer in-hand, then the connection between farmhouse and business begins to weaken and arguing high VAT recovery rates on property costs, in the face of HMRC scrutiny, can become difficult.
- Employee accommodation
In instances where a farming business provides residential accommodation to an employee, the position is more clear-cut. If the accommodation is provided as part of an individual’s employment, because it is necessary for them to live in close proximity to the farm, then VAT is recoverable on the upkeep of the property because it is seen as a cost directly related to the taxable farming business. If the employee makes any contribution in lieu of rent, it would create an exempt supply with no VAT recovery.
- Furnished Holiday Lets
Another example of where a business can reclaim VAT on costs associated with the upkeep of a residential property is when it is made available as holiday accommodation and is available to book for short breaks (including Airbnb-style arrangements). The provision of holiday accommodation is subject to VAT, which provides the entitlement of VAT recovery to the supplier. Care should be taken if VAT has been reclaimed based on the intention to grant Furnished Holiday Lets, but before that intention is fulfilled, there is a change in intention and the property is instead put to residential rent or even private use (eg a family member moves in free of charge). This would trigger a clawback and VAT would need to be repaid to HMRC. Furthermore, if the extent of any refurbishments, renovations or extensions means capital costs of £250,000 or more are recognised in the accounts, a capital goods scheme item would be created and change of use VAT adjustments may be applicable within 10 years of the capital asset first being put to use.
Large estates and rural businesses can have all or some of the above scenarios present within their operation. It is imperative to effectively track property-related costs to ensure input tax is being reported correctly and opportunities to claim VAT relief is maximised. HMRC officers often scrutinise VAT recovery on residential property costs and will focus on this as part of any VAT return review or inspection.
The future VAT treatment of land and property transactions, including construction services and repair and maintenance-type activities, may need to change significantly. There are calls for the government to apply a reduced or zero rate of VAT to works to maintain current residential property, as part of its ‘net-zero’ initiatives. Maintaining an existing property generally has less impact on the environment than building new properties from scratch, and the government is being encouraged to keep this in mind as it shapes its future environmental and housing policies.
HMRC is currently inviting evidence to be provided from the relevant sectors and advisers with respect to its consultation on simplifying the VAT land exemption. Applying one lower VAT rate to works on properties would simplify the VAT position, reduce the VAT cost incurred by residential landlords and incentivise regenerating existing properties rather focusing on new build developments.
Nick Hart, Director