What is a 'dwelling' for VAT and why does it matter?

When building work is carried out on residential property, the VAT treatment can potentially have a big impact on the overall profitability of the project. Where the standard rate of VAT applies, an extra 20% is effectively added to the cost.

If VAT is suffered on building development work, the developer will usually want to recover that VAT, if possible, to keep their costs down.

However, residential property is normally exempt for VAT purposes which means that any input VAT suffered on building work and materials cannot be recovered by the developer. Unlike commercial property, it is not possible to claim back the VAT by ‘opting to tax’ a residential property.

But all is not lost. If the supply falls within one of the following areas of the legislation, input VAT can potentially be either reclaimed or incurred at a reduced rate.

New houses and flats that are zero-rated dwellings

(s30 VATA 1994/ Schedule 8 Group 5)

Zero-rating applies to the first grant of a major interest in a dwelling by a person who is either:

• constructing a building designed as a dwelling/ number of dwellings or
• converting a non- residential building into a building designed as a dwelling/ number of dwellings

Zero-rating also applies to the supply of any services in the course of construction of a building designed as a dwelling (excluding architect/ surveyor/ consultant/ supervisory fees). This means that the contractor builder does not have to charge VAT on their services.

Where zero-rating applies, the developer ‘charges’ 0% VAT on the sale and can reclaim any VAT that is suffered on development costs.

Building conversions/renovations of qualifying dwellings at a reduced VAT rate of 5%

(S29A & Schedule 7A, groups 6 and 7 VATA 1994)

Whilst building work to alter/renovate existing residential property is not normally zero-rated, it may qualify for the reduced rate. This applies to:

Building conversions: The supply of qualifying services and building materials relating to a ‘qualifying conversion’. A qualifying conversion is one where there is either:

• A changed number of dwellings (i.e. the number of dwellings after the conversion is different than beforehand and there is at least one dwelling). For example, this will apply where a house is converted into flats or vice-versa. Each dwelling after the conversion must be one designed for occupation by a single household.?The reduced rate will also apply where commercial buildings are converted into at least one ‘dwelling’ and the requirements for zero-rating are not met (for example where the landowner rents out the property on a ‘short lease’ after conversion and does therefore grant a ‘major interest’ in the property for zero- rating purposes) or
• A house in multiple occupation or a special residential conversion.

Renovations: The supply of qualifying services related to the renovation/alteration of qualifying residential premises (which includes a dwelling) which have not been inhabited for at least two years.

The types of services the reduced rate applies to are broadly those relating to the fabric of the building (for example, floors, roof, walls, windows, doors), and to works within the immediate site of the building that are in connection with specific services (for example, providing water, mains electricity, heat, access, drainage, sewage pipes, security or waste disposal). This is a narrower scope than the types of services qualifying for zero- rated properties, as noted above.

Where reduced rating applies, the developer is generally unable to reclaim the input VAT suffered on the building work because the supply of the property itself would still be exempt. However, the overall VAT suffered on their costs is significantly reduced (from a standard rate of 20% to a reduced rate of 5%) meaning that this is still a valuable ‘relief’ where zero-rating is not available.

Building your own home/ dwelling

(S35 VATA 1994)

This applies to works, otherwise than in the course of business, on the construction of a building designed as a dwelling or the conversion of a building into a dwelling. This is a special relief whereby the developer can reclaim VAT on building work carried out by a contractor.

As can be seen, a common theme of the above is that ‘dwellings’ can potentially qualify for these reliefs. So this leads to the question, what is a dwelling for VAT purposes?

What is a dwelling?

Broadly, a ‘dwelling’ will only qualify for these reliefs if they meet all of the following conditions:

• (a) The dwelling must consist of self-contained living accommodation

This means that it must be possible to use the dwelling independently of other property, including businesses.

The basic elements of living (sleeping, resting, washing, preparation of food, etc.) must be located together within a defined area. The house/ flat will therefore need to have its own bathroom, sleeping area and cooking facilities.

For zero-rating to apply, these basic living facilities must not be shared by more than one household or tenant. A studio flat where all the elements of living are contained within the flat would therefore qualify for zero-rating but a block of bedsits, where the occupant households share the bathroom or kitchen, would not (although we note that the reduced rate may be available for ‘multiple occupancy’ dwellings).

• (b) There must be no provision for direct internal access from the dwelling to any other dwelling or part of a dwelling

It must not be possible to move from one dwelling to another dwelling or part of a dwelling, without first moving across an area outside the dwelling, such as a landing or corridor. For example, an annexe with an internal door directly into the main house would not meet this test.?

• (c) The separate use or disposal of the dwelling must not be prohibited by the terms of any covenant, statutory planning consent or similar provision

For a condition to amount to a prohibition, it must be an imposition that is placed upon the developer by an appropriate body, such as a local planning authority. Any arrangements entered into by two contracting parties for commercial purposes would not be relevant for this test as they are not ‘prohibitions’ for these purposes.

HMRC’s view is that the condition is not met where the use or disposal of the dwelling is tied to another building (irrespective of whether that other building is a dwelling or not), or is tied to another structure or land. They consider that this clause would normally exclude ‘granny annexes’ constructed in the grounds of a main house; a caretaker’s house at a school and assisted living units within the grounds of care or nursing homes.”

Separate disposal must not be prohibited

‘Disposal’ includes the position where there is a prohibition on the freehold disposal or on the grant of a long lease (i.e. of 21 years of more, or 20 years in Scotland). Prohibitions on granting short leases are not caught.

What about the position where there are several properties on one land title- for example, farms and landed estates which include the main farmhouse and other properties?

At face value it might seem that a dwelling on the same legal title as other properties might fail to meet this test, because it cannot be disposed of without a separate legal title. However, fortunately that does not constitute a ‘prohibition’ in itself, and it is a fairly straightforward procedure to separate the title. It is generally only if the separation of title is expressly prohibited by the planning permission/ local authority that the dwelling would not qualify.

Separate use must not be prohibited

If the dwelling is described as being ‘ancillary’ to another property, land or structure in the planning permission then HMRC expects that it would normally fail this test.

The test is also likely to fail where the planning documentation specifies that the dwelling can only be used by employees of a particular business. HMRC’s view is that if the use of a dwelling is tied to a commercial activity being carried on in another building, it will fail this test.

This was the ruling in Roy Shields (2014) UKUT 0453 where the planning permission for an equestrian manager’s residence stated that it could only be occupied by employees of a named business and their dependents.

However, HMRC’s manuals confirm that more generic occupancy restrictions which identify a particular class of person who can occupy the dwelling are not necessarily caught by this rule. They say, for example, that restrictions limiting occupancy to people either “over a certain age” or “working, or last working, in the locality in agriculture or in forestry, or a widow or widower of such a person, and to any resident dependents” would still meet this condition.

It would therefore follow that if residential accommodation is only to be used by the employees of a specific named business, it would not met this requirement. But if the restriction is defined more widely and is, for example, available to ‘local agricultural workers’ then it should pass this test.

• (d) statutory planning consent must have been granted in respect of the dwelling and its construction or conversion must have been carried out in accordance with that consent

This condition applies to the covenant/planning permission that is in place whilst the works are carried out, up until the point of completion. If the work is not carried out in accordance with that agreed plan, it will fail this condition.

So how far can you deviate from the original plan?

HMRC’s view is that minor variations to the planning consent “resulting in a change in appearance, or to the composition or distribution of the accommodation" should not fail this test. However, they say that “more radical departures resulting, for example, in a much larger dwelling being constructed, should be rejected.”

Obtaining retrospective planning permission for a project would usually fall foul of this rule because the work would not have been carried out in accordance with the agreed plan at the time. This has been confirmed by the courts, who have held that this test is not met even when the change in plan was due to circumstances unforeseen at the start of the project.

Summary

VAT and dwellings are a complicated area of the legislation and the above conditions will need to be considered carefully to determine whether a particular property project will qualify for relief. If you are unsure we would recommend that you first seek expert tax advice.

If you would like our assistance, please get in touch.

Author: Christa Humphreys, Tax Manager at Rickard Luckin

This article was published at rickardluckin.co.uk.