Without doubt, one of the most confusing subjects in VAT is the 5% VAT rate and residential renovations. Every now and again, I get a sudden rush of queries from developers and private individuals about when they can claim the reduced rate of VAT and how they can claim any overcharged VAT. So I thought it was time for a reminder about the subject, explaining when the 5% rate applies and how to get it. I’ve also answered a few of the most common FAQs about the subject from property owners, both property developers and private individuals.
The 2 year rule
If you’re reading this blog, chances are that you know that the 5% rate applies to certain renovations of dwellings if the property has been unoccupied for 2 years or longer. HMRC’s guidance about this subject is in VAT Notice 708, section 8 http://tinyurl.com/pv9wvxh. Section 8.1.2 sets out the basic conditions that must be met to enable contractors to charge the reduced rate on their services.
|1||You renovate or alter ‘qualifying residential premises’.||paragraph 8.2|
|2||The premises have not been lived in for two years or more.||paragraph 8.3|
|3||Where necessary, you hold a valid certificate.||section 17|
|4||Your services are ‘qualifying services’.||paragraph 8.4|
So what does this mean in practice?
It means that if you employ a VAT registered contractor to carry out the renovation work, their work qualifies for the 5% if all of these conditions are met.
Seems simple enough, but this is where the confusion starts. Most of the queries I get come from people who’ve read this part of Notice 708 and then ask “so how do I get the 5% rate for my new windows/doors/materials that I’ve bought direct from the supplier. Does the supplier refund the difference or can I claim it from HMRC?
This is why it’s important to understand how the 5% rule works.
If you look at the list above, you’ll see the 4th condition reads: Your services are “qualifying services”; i.e. renovating the property.
This is what it means:
- The 5% rate applies to contractors’ services or services of installing goods by the suppliers, not the goods on their own.
- However building materials that are supplied and installed by the contractor/supplier in the course of the renovation services also qualify for the reduced rate. This includes basic building materials; bricks, mortar, wood, etc and other goods that are “building material”. It never includes carpets, most electrical and gas appliances and fitted furniture.
- The 5% rate does not apply to goods/materials bought directly, even if installed or used in the course of the renovation.
Let’s consider a typical scenario:
Example 1 Bathroom suite bought directly from retailer and installed by the contractor. In this case, the retailer charges 20% for the suite. The contractor can charge 5% for his services of installing the suite.
You CANNOT claim the VAT difference from HMRC. It doesn’t make any difference whether you’re converting to sell or converting for your private use.
Example 2 Bathroom suite bought directly from retailer and installed by retailer. In this case, the retailer can charge the 5% rate for both the suite and their services of installing the suite.
Example 3 The contractor purchases the bathroom suite from the retailer and installs it for you. In this case, the contractor can charge the 5% rate for both the suite and their services of installing the suite.
What if the contractor charges too much VAT?
There will, of course, be situations where the contractor charges the 20% VAT rate for labour and building materials that qualified for the reduced rate. For example, in Example 3 above, the contractor may charge 20% for both the suite and the labour to install the suite.
In these situations, you have to ask the contractor to refund the overcharged VAT. The contractor has to follow a procedure, starting with issuing a credit note and correcting the error on their VAT return. HMRC will then refund the overcharged VAT to the contractor. The contractor is then liable to repay the overcharged VAT to you.
HMRC DO NOT REFUND OVERCHARGED VAT TO CUSTOMERS.
That’s why it’s important that you understand how and when the 5% applies before you pay any bills from contractors/suppliers. You should also check the small print in the contract to ensure that the contractor follows the correct procedure to refund any overcharged VAT.
It’s a bit of a messy subject, because sometimes you can buy directly at a better price if you install the goods yourself. However, the additional VAT cost may wipe out any potential savings, so you have to do your calculations to see which is the most cost effective.
If you want more information about this subject, check out my e-book: VAT for DIY property developers written for those of you who are buying and renovating for your private use, or my paperback: VAT for residential property developers and contractors; which is available from Amazon.