There are certain VAT issues that are unique to public houses and other commercial properties that either contain existing self-contained domestic accommodation; or properties that don’t have existing self-contained properties but have been used as dwellings.
This subject is very complicated and involves different VAT rules that apply to the end use of the converted property, the VAT liability of contractors services and when you can claim VAT from HMRC.
The principles explained in this article apply equally to pubs, shops, factories, offices or any commercial property converted for use as dwellings.
This article summarises the main issues with some links to HMRC’s guidance and you WILL need to refer to HMRC’s guidance to make sure that your conversion meets the detailed criteria for to get the reduced VAT on contractors services or claim VAT whether the property is for business use or, if the property is for family or personal use, under the DIY scheme.
The article assumes that you understand the basic VAT rules and the difference between taxable and exempt supplies. I’ve explained the main principles below and you can find more information in my “Beginner’s Guide dwellings to VAT” which is free to download http://tinyurl.com/y7dg2z6p.
- When you can claim VAT on costs
- Converting for business purposes
- Converting for personal or family use
- So what IS a conversion for VAT purposes?
- Who can make a DIY claim?
- DIY home converters and property developers and conversions
- When you can save VAT if you’re buying a commercialor mixed property
- Properties with existing self-contained and the “90/10” split
- When you can save VAT on reduced rated conversionservices and renovations
- Properties with existing self-contained dwellings
- When you can claim VAT on non-residentialconversions
- The difference between reduced rated conversionservices and non-residential conversions
- The self-contained anomaly
- Commercial developers, the DIY Refund scheme and the zero-rated anomaly
When you can claim VAT on costs
Before I start talking about conversions, there’s one very important issue – and it’s that there are different procedures for claiming VAT on your costs depending on whether you’re converting to sell or lease or if you’re going to use the property for your family home.
As I’ve explained below, the “DIY” refund scheme ONLY applies to conversions for personal or family use as a home, not if you’re converting for business use even if you do a lot of the work yourself!
Converting for business purposes
The main principle is that if you’re converting for business purpose; i.e. you’re going to sell or lease the property as a business activity; then you can only claim VAT if you are registered for VAT and will use the property to make taxable supplies.
What does this mean?
If you’re a business, your sales of goods or services will be either “taxable” or “exempt”.
If your sales are “taxable”, there are 3 different rates:
- the standard rate of 20%
- the reduced rateof 5%; and
- the zero-rate*
VAT registered businesses who sell taxable goods and services can claim VAT if they are registered for VAT through the normal VAT return system. The VAT on their sales is output tax and the VAT on their purchases is called input tax.
For residential property developers, this can include the following:
- the freehold sale or long lease (over 21 years in England and Wales and over 20 years in Scotland – see below for more information) of certain converted residential properties – see below for further details; and
- the provision of holiday or serviced accommodation.
If your sales are VAT exempt this means that the business doesn’t charge VAT on their sales but because their income is VAT exempt, they can’t normally claim VAT on their purchases. For example, if you’re currently renting your home, the rent is VAT exempt so your landlord can’t claim VAT on his costs. Sales of existing dwellings are also exempt from VAT.
Converting for your personal or family use
If you’re converting a commercial property to use as your home or family home, then you may be entitled to claim VAT on costs under the DIY Home-converters scheme.
The term “DIY” ONLY applies to conversions for personal use, not if you’re converting for business use even if you do a lot of the work yourself!
YOU CAN ONLY CLAIM VAT CORRECTLY CHARGED!
The other important thing is that even if you’re entitled to claim VAT on your costs, you can ONLY ever claim VAT that has been correctly charged. What does this mean? It means that if a contractor charges 20% VAT for work that qualified for the 5% rate, you can’t claim the 20%, even if the contractor has already paid the VAT to HMRC. In this situation, the only thing you can do is to ask the contractor to issue a credit note for the work charged at 20% and re-issue the invoice at 5% VAT. The contractor can claim the overcharged VAT from HMRC as long as it has been refunded to you.
So what IS a conversion for VAT purposes?
You’d assume that the term “conversion” means the same thing – you’re carrying out building work to change the use of a property from one thing to another. Unfortunately, it’s not that simple.
In the world of VAT, the word “conversion” has 2 different meanings and different criteria that apply to the VAT liability of construction services on the one hand zero-rated sales/DIY claims on the other hand.
It’s all to do with how the buildings were used before the conversion.
- To qualify for reduced rate conversion services, there must be a change in the number of “single household dwellings”.
- For conversions for personal and family AND for property developers who will make zero-rated sales for business purposes, the conversion must be a “non-residential conversion” which means that the property must not have been lived in or “used as a dwelling” in the previous 10 years.
What does this mean in practice?
The most important factor is the distinction between “single household dwelling” and “used as a dwelling”.
So let’s look at about a typical scenario that illustrates both of these factors.
Converting a pub
Before the conversion, the downstairs was the public and the landlord and family lived upstairs. There’s a bathroom and other rooms used as a living room and bathrooms, but it isn’t a self-contained dwelling, so isn’t regarded as a “single household dwelling”. But because the manager and his family lived in those rooms before the conversion, the property has been “used as a dwelling”.
So what does this mean for VAT purposes?
- Because the upstairs wasn’t a self-contained dwelling means that the conversion of all or part of the property into a “single household dwelling” would qualify for reduced rate contractors’ services, whether you’re converting the property for personal use or for business purposes.
- However, because the property has been “used asa dwelling“ within the prior 10 years means that DIY home developers can’t claim VAT under the DIY refund scheme, while property developers cannot claim VAT on the costs even if they sell the freehold or long leasehold in the property.
Remember that these same principles apply to ANY type of commercial property, including offices, shops and restaurants as well as pubs.
As explained above, if you’re converting a property to sell, then the sale of the freehold or long lease may qualify for zero-rating under the provisions set out in Notice 708, paragraph 5 http://tinyurl.com/mdc8465. The developer must satisfy a number of criteria, including that the conversion is a “non-residential conversion” as explained above. The criteria are similar for the purposes of the DIY refund scheme.
In either case, you can only claim VAT if the specific criteria are met.
Who can make a DIY claim?
The issue of DIY claims causes some confusion, because a lot of people assume that it applies to any type of property conversion if they are organising and managing the project themselves; or they carry out a lot of the construction services themselves instead of employing contractors.
Remember that the DIY refund scheme is ONLY for housebuilders and property converters who intend to use the finished property for PERSONAL OR FAMILY USE. If you intend to rent or sell the property, then you can only claim VAT if the property will be used to make “taxable supplies”, such as the zero–rated sale or lease or using the property for serviced accommodation, which is normally liable to VAT at 20%.
So if you can’t claim VAT, then it’s important that you don’t pay more VAT than necessary on the purchase of the property itself and any contractor’s services.
Buying a commercial or mixed property VAT free: The VAT 1614D procedure
So if you’re planning to convert a commercial property to a dwelling for personal or family use or for exempt business use, it’s important to buy commercial property that is subject to the “option to tax” VAT exempt by issuing a VAT 1614D certificate. It’s a relatively straightforward procedure but you need to follow the rules exactly to buy the property VAT exempt, so make sure you understand how it all works. See VAT Notice 742a, section 3 for details of the procedure http://tinyurl.com/qbrewhq.
You can use the VAT 1614D scheme whether you’re buying to convert for personal use OR business purposes. In either case, it can also help to reduce your stamp duty land tax bill.
Buying a property VAT exempt can also make life a lot easier if you’re converting for business purposes for a number of reasons, including cashflow but also it helps to avoid certain situations where you might have to adjust the amount of VAT you’ve claimed in future years. So buying exempt, where possible, is usually the best route. In some cases, the vendor may want to increase the sales price to cover their VAT costs, so you may need to do some negotiating on the price. Either way, this can be a somewhat complicated issue.
N.B. You can’t use this certificate to buy the freehold of a “new” commercial property (i.e. three years from the date of completion) VAT exempt. If the property is new and you’re planning to convert it into dwellings as a business activity, you may be able to claim the VAT on your VAT return if you plan to use it to make taxable supplies.
Properties with existing self-contained dwellings and the “90/10” apportionment
If you can’t use the VAT 1614D procedure and have to pay VAT on the property, then make sure that you aren’t charged too much VAT.
For example if you’re buying a commercial property with existing self-contained dwellings and you DID NOT issue the VAT1614D certificate, the vendor should only charge VAT on the commercial parts of mixed properties. This is because the sale of existing residential property is exempt from VAT. You should agree this apportionment as early as possible through the negotiation process. It will also help minimise any stamp duty land tax liability because this is paid on the VAT inclusive purchase price
How do you agree this apportionment? .
In the case of public houses, industry practice is to treat 90% of the property price as business and 10% as domestic for VAT purposes. This means that you’d normally be charged VAT on 90% of the property cost. However, as far as I’m aware, there’s no legal basis for using this apportionment for all property sales.
This apportionment was originally agreed between HMRC and the brewery industry and it is supposed to be used by tenants to calculate how much VAT they can claim on the running costs of the pub.
Also, HMRC state in their internal guidance that this apportionment should not apply if it’s clearly inappropriate. So ask the vendor to apportion the selling price on a more accurate basis, for example based on the relative proportions of floor area.
When you can save VAT through reduced rated conversion and renovation services
As explained earlier, some or all of the construction services which create an additional single household dwelling(s) from an existing property are reduced rated.
- Properties with no existing self-contained dwelling
If you create a new dwelling out of a pub or other commercial property, which doesn’t contain any existing single-household dwellings, then some or all of the contractor’s services should qualify for the reduced rate. The reduced rate can also apply to conversions of properties that have been used as dwellings as long as they don’t contain self-contained accommodation, for example a pub with bedrooms for staff. See VAT Notice 708, s7.3: http://tinyurl.com/mltpyzu.
- Properties with existing dwellings
If you convert a commercial property – e.g. a pub – which contains an existing self-contained dwelling, such as a flat on the first floor above the business area, into a single dwelling that incorporates the whole property, the conversion work would be liable to VAT at the standard rate. The reduced rate ONLY applies if you create additional single-household dwellings.
If you incorporate parts of both the existing commercial areas and the residential areas to create new dwellings, some or all of the work may be eligible for the reduced rate, usually based on how the layout of the new dwellings compares to the previous dwellings. For example, the VAT can differ where similar properties are converted in different ways; such as converting horizontally or vertically. It depends on the precise circumstances of each development.
The renovation of any existing dwelling may qualify for the reduced rate if it’s been unoccupied for two years or longer. So if you’re buying an old house and renovating, whether for resale or personal use, make sure that your contractor only charges VAT at the 5% rate as explained in VAT Notice 708, section 8 http://tinyurl.com/pv9wvxh
Commercial developers, the DIY Refund scheme and the zero-rated anomaly
The DIY Refund scheme ONLY applies for conversions if you’re creating an additional dwelling from an existing non-residential property; i.e. a “non-residential conversion”. To qualify as a “non-residential conversion” for the purposes of the DIY Refund scheme, you have to create an additional self-contained dwelling from non-residential property. However, as explained below the definition of “non-residential conversion” for commercial developers (i.e. those converting to lease or sell as a business activity) is slightly different due to a bit of an anomaly in HMRC’s interpretation of the term.
So what does this mean?
The “self-contained” anomaly
The rules are a bit different for claiming under the DIY refund scheme and if you’re converting to sell as a business. The anomaly concerns the situation where commercial property has been USED as a dwelling but where the living accommodation is NOT self-contained.
In VAT Notice 708, paragraph 5.3.1, HMRC say:
“A building is ‘used as a dwelling’ when it has been designed or adapted for use as someone’s home and is so used. ”
The conversion of such properties to create a single household dwelling normally qualifies for the reduced rate of VAT on contractors’ services, as explained above. However, this isn’t sufficient to be regarded as “non-residential conversions”, so don’t qualify for the DIY Refund scheme.
This means that if you convert a pub which doesn’t contain a self-contained apartment, but has been adapted for and used as a dwelling, the conversion into a single self-contained dwelling wouldn’t be a “non-residential conversion”. The conversion would only be eligible for a DIY Refund scheme claim if the properties were unoccupied under the 10 year rule.
There’s no legal definition of “adapted” as a dwelling, but HMRC’s position is that even relatively minor adaptations can be regarded as adapting a property to use as a dwelling. So if, say, a bathroom has been installed for the private use of the residents, this would be regarded as “adapted” as a dwelling.
However, HMRC say that if you create an ADDITIONAL dwelling in the property which incorporates PART of the existing residential area, then you can claim VAT under the DIY Refund scheme but only to the extent that the costs relate to the conversion of the commercial part of the original property.
The definition of “non-residential conversion” has been discussed at length in various VAT Tribunal cases and court cases over the years. HMRC take a very strict approach to the definition and the Tribunal and courts have, typically, agreed with HMRC’s interpretation.
These rules are complicated so it’s not surprising that both DIY and commercial converters get confused.
If you want to be certain about whether your conversion would qualify for the DIY Refund scheme, you can ask HMRC for a ruling before starting the project, but remember that HMRC won’t give “rulings” about hypothetical situations; nor if they believe that the issue is clearly covered in their public guidance.
If you want to be certain, consider investing in professional advice to find out whether/how much VAT you can reclaim and how much VAT you should be paying on contractor’s services.
And if you find out that you can’t claim under the DIY Refund scheme, it’s better to know in advance so that you can make sure that you have sufficient money in your budget to fund any VAT you can’t claim from HMRC.
Commercial property developers and VAT on non-residential conversions
Finally, the criteria for zero-rating the sale or lease of commercial property into a number of dwellings to sell or lease are strictly enforced. If you meet these criteria, you should be able to register for VAT and claim the VAT on your costs on your VAT returns. You have to make “zero-rated” supplies of the converted properties, which is when you sell the freehold, or a long lease, in a property and you meet the following criteria:
- You grant a major interest in, a building.
- The building is the subject of a ‘non-residential conversion’.
- The building is not converted into a holiday home.
- You have ‘person converting’ status.
- The grant of a major interest is your first grant.
- Where necessary, you hold a valid certificate.
See VAT Notice 708, paragraph 5 for more detailed explanation of these criteria http://tinyurl.com/kfatbb6
- You can normally claim VAT under the DIY HomeConverters Refund Scheme if the conversionof a commercial property creates an additional self-contained
- You can’t claim under the scheme if the property was previously used asor adapted as a dwelling within the previous 10 years, even if the domestic accommodation wasn’t self-contained.
- If you’re creating an additional dwelling, you can only claim VAT on the cost of converting the non-residentialpart of the property.
- The reduced ratefor conversion services normally applies to both conversion of properties with existing dwellings to change the number of dwellings, or any other accommodation used as or adapted as a dwelling, even if it wasn’t self-contained.
- If you create additional dwellings to sell or lease, you may be able to register for VAT and claim VAT on costsif they you sell zero-rated freeholds or long leases in the converted properties.