House builders looking to beat the downturn by renting out properties can end up incurring big VAT bills, a West Midland accountant has warned.
RSM Bentley Jennison says major problems with sub-prime lending and the losses that banks and other financial institutions have suffered have caused them to be far more cautious in lending. Statistics indicate that only 40 per cent of mortgage applications are now accepted compared with nearly 100 per cent a few months ago.
One of the effects is that house builders have found it harder and harder to sell new properties.
Indeed, a number of house builders have reported that reservations of new properties are down 50 per cent or more compared with 12 months ago.
Some house builders have responded by adopting a strategy that was widely used 15 years ago in the last property downturn – they are letting out their properties in order to minimise their costs until the market recovers.
However, they could incur substantial VAT liabilities.
The sale of new houses is zero rated for VAT but the builder can get back all of the input VAT which it suffers. The letting of houses is an exempt supply which, once again, means that the builder does not have to charge VAT on the rent, but there is a restriction on the amount of input VAT which the builder can reclaim.
The issue currently facing house builders is the amount of input VAT which they will lose through letting.
In the last major property downturn, HM Revenue & Customs was supportive and advised house builders that lettings of no more than six months could be ignored in calculating input VAT recovery.
In other words, says Bentley Jennison, provided that a builder didn’t let a particular house for more than six months and could show that they were still trying to sell the property throughout the letting period, they could recover all of their input VAT.
At the end of the downturn, HMRC withdrew the concession. The authority’s current view is that if a property is let input VAT should be disallowed in the ratio that the letting period bears to 10 years.
So if a property is let for one year then only nine tenths of the VAT in respect of that property is recoverable.
Builders who sub-contract building work to other companies will be in a better position because the companies that build the houses for them will zero rate the work.
Many builders however, will purchase raw materials such as bricks and timber and will build the house themselves using sub-contract labour. They will incur significant amounts of input VAT.
So far there is no sign of the same support being reintroduced even on a temporary basis.
If no relief is forthcoming, house builders already facing very difficult market conditions, could find that they are hit with a considerable disallowance of input VAT.
One question that arises is whether it is fair to look at input VAT using a possible 10-year period. Ten years is used in the capital goods scheme on the basis that commercial property generally requires major refurbishment every 10 years.
Can the same said to be true for residential houses? Experts say it might be more reasonable to take a period of 25 years.
In this case, letting a property for one year would only result in one twenty-fifth of the input VAT in relation to that property being disallowed.
Keri Pay, VAT director at RSM Bentley Jennison, said: “There is a further argument that in these circumstances the right to recover input VAT should be determined solely at the time that the VAT is incurred.
‘‘It could be argued that only input VAT incurred from the time that it is decided to let a property should be restricted.
“Surely HMRC should reintroduce the concession bought in 15 years ago to help the beleaguered house builders simply trying to survive.
In the current economic climate a period of 12 months rather than six for temporary letting might be more appropriate.
“Alternatively as a minimum they must reconsider the period that they use for calculating the input VAT disallowance.”
His colleague Carol Barrie, head of property & construction services, added: “We are regularly being approached by house builders who cannot sell their trading stock for an acceptable price and intend to let the properties until conditions improve.
“Each case has to be looked at on its merits, but for some of our clients the best option has been to take the trading stock out of the house building company and own it separately as an investment asset.
“Not only does this overcome the VAT problems referred to earlier but where properties are going to be held long term as investment properties, matters can be structured in such a way that the owners of the investment properties pay only 18 per cent capital gains tax on the ultimate sale. In appropriate circumstances it is possible to transfer the properties without any Stamp Duty Land Tax.”