I’ve received a lot of queries over recent months from people buying pubs, either to convert for their own private use as their main dwelling, or to use for a mixture of business and private purposes.
I thought it would be useful to summarise the main VAT issues that can arise for those of you investing in such properties to convert into your own home. This article isn’t for those of you who purchase such properties for business purpose, such as buying to let, though some of the issues mentioned here may apply. It’s for those of you buying such properties for personal use, to save you a bit of time hunting through the relevant HMRC notices for information on the subject.
Although this article focuses on buying a pub, the principles applied to the purchase of any type of commercial property which you intend to use as a dwelling, but please appreciate that the information given in this article is only for general information purposes. Your own situation may be similar to the scenarios I discuss below, but I’d always recommend that you take proper VAT advice, whether from myself or another VAT adviser, before investing your hard earned money. It is particularly important that you do this if the vendor has told you that the building is liable to VAT, as you will have to take certain action before you exchange contracts or make any payment or do else anything that could “legally fix” the price, to avoid paying the VAT.
For most of us, purchasing our home is the most expensive purchase we make during the course of our lifetimes. Over the years, I have seen many situations where people have paid thousands of pounds in legal fees, surveyor’s fees, agent’s fees and even gone to the expense of paying for contractors to carry out conversion or refurbishment work on the property before realising that they haven’t taken into account the VAT on costs. And this can mean the difference between ending up with a financially viable and saleable home or very beautiful but overpriced property.
And please bear this point in mind: however good your solicitor is, however experienced your building contractor and however well the property agent knows the market in the local area, none of them will be able to advise you properly on the VAT implications of your proposed purchase. So I’ve set out the main issues that you need to consider.
Purchasing the property
As private individuals, most of us will have purchased our existing or previous homes free from VAT, because the VAT legislation either exempts or zero rates the sale of dwellings. This means that most members of the public won’t have come across the concept of paying VAT on property. This is in keeping with EC VAT principles which provide that the supply of homes for private individuals should be free from VAT.
However most new commercial properties are now liable to VAT and owners of older commercial properties can “opt to tax” their properties, a procedure which means that they normally have to charge VAT on rent or sale proceeds.
Most homebuyers will be surprised if they are told that the vendor has opted to tax the property and will be charging VAT on the selling price, but it’s not necessarily a problem as there is a procedure within the legislation that enables you to (legally!) avoid paying the VAT.
Furthermore, even if the vendor has opted to tax the property, VAT can only be charged on that part of the property used for commercial purposes. So, in the case of a pub or similar property, they should never charge VAT on any existing dwellings, such as a self-contained flat. Vendors should apportion the selling price between the commercial part and any dwellings, so that they only charge VAT on the commercial property sale.
Using the certificates
You could be charged VAT if you purchase an existing commercial property or part of a commercial property – such as a pub - for use as or conversion into your home. However, it is possible to prevent the vendor from charging VAT by issuing a certificate to the vendor confirming that you intend to use the property as a dwelling. As long as the vendor receives the certificate before the price for the property is legally fixed (see below), the vendor must sell the property to you free from VAT.
You can find guidance about the use of such certificates in HMRC's VAT notice 742a: Opting to tax land and buildings http://tinyurl.com/3g32uz. Section 3 of the notice explains the circumstances when such certificates can be issued. Different certificates apply to situations when properties are to be used/converted as dwellings, or for certain other residential purposes and certain charitable purposes.
The certificate that applies in the case of conversions into dwellings is the VAT 1614D which can be downloaded from the HMRC website here http://tinyurl.com/le7vfh.
These certificates must be given to the vendor before the price of the property is legally fixed.
This is normally the earlier of the dates on which contracts are exchanged and/or any payment is made to the vendor. Most solicitors are pretty good at ensuring that these certificates are in place when required, but it is your own investment so I'd recommend checking up on the rules for yourself and make sure that you have the right certificate ready to provide to the vendor or at the right time.
What if I’m buying at auction?
Normally, buying at auction entails making some payment on the day and signing an agreement to the bid price. So if you're intending to bid, you should contact the vendor or auction house before the auction to see whether they'll accept a certificate in advance, or alternatively, how this would be handled on the day itself. Most commercial property vendors, especially the larger breweries, are familiar with the certificates and will normally have a procedure set up to deal with such situations.
The key with any tax issue is to make sure you're prepared well in advance so that you’re not taken by surprise if the subject of VAT arises. So if you're tempted by the idea of buying a pub or other commercial property to convert to a dwelling, whether for yourself or to sell, make sure that you prepare in advance by checking up on the VAT rules and making sure that your solicitor and agent are familiar with the rules.
What about VAT on the conversion costs?
The other major VAT issue is the VAT cost of converting any such property.
Most construction work on existing buildings is liable to VAT at 20%. However certain conversion work is liable to VAT at the reduced rate of 5% where it relates to the first time conversion into a dwelling or a change to the number of dwellings in a property. The information relating to this subject is included in HMRC’s VAT Notice 708: Buildings and Construction, section 7 http://tinyurl.com/6nv7tcc.
The VAT liability of construction work is very complex and there are many different rules to consider. For example, while certain services may be eligible for the reduced rate, goods and materials supplied in connection with those services might not qualify for the reduced rate. Also, if you purchase goods separately, and engage a contractor to install those goods, you have to pay 20% VAT on the purchase of the goods, even if the services of installation are liable to the 5% rate.
So it’s important to read up on the VAT liability rules to make sure that you're taking full advantage of the reduced rate of VAT. The rules are quite complicated and a number of different conditions have to be fulfilled before any of the conversion work will qualify for the reduced rate. Many building contractors are experienced at dealing with the VAT rules and will be able to work with you to identify those parts of the conversion work that are eligible for the reduced rate. If the contractor charges at the lower rate for work that HMRC think is liable to the standard rate, the contractor is ultimately liable to pay the difference to HMRC, not the customer.
What if I don’t get planning permission for conversion to dwellings or have to let the property before I move in?
As I mentioned earlier, the VAT issues relating to property are complicated and it’s not possible to cover every eventuality in this article. Each of these scenarios has their own issues and has to be considered in the context of the business use of the property. So in these situations, I’d strongly recommend that you take proper VAT advice, preferably well in advance of purchasing the property.
Is there a way to claim the VAT on the conversion costs from HMRC?
In certain very limited circumstances, it is possible to arrange the property transactions so that you can recover the VAT on the conversion costs. However, this involves selling the property after its conversion to a separate legal entity, for example a limited company and therefore treating the project as a business for VAT purposes.
It sounds like a good idea, but before you get carried away by the possibility of claiming back the VAT on the conversion costs, you should consider other issues that apply to businesses. These include the costs of setting up a business, whether a limited company, partnership etc; the costs of preparing and submitting accounts and tax returns for that business and of course, any tax that the business might have to pay on its profit. You can easily see how the potential VAT benefit could be wiped out.
I'm not saying that you shouldn't do it. In the event that you incur massive amounts of VAT on your conversion, or if you want to convert commercial properties into dwellings as a business activity, it's certainly worth considering this option. But I definitely recommend taking property professional advice from an accountant about the other tax and accounting issues that would be involved and preferably before you have purchased the property in the first place.
Finally it's also possible, in certain limited circumstances, to reclaim VAT on conversion costs under the DIY Housebuilders' Scheme. This can also be used when buildings are converted into first time dwellings for personal use. See the HMRC guidance here http://tinyurl.com/yh9y5j5
If you are considering such a project and need formal advice on the subject, please contact me at firstname.lastname@example.org with your details.