27 August 2014

VAT - New Homes and a New Scotland

Graham Elliott
Consultant | UK

What has VAT, the building of new homes, and possible independence of Scotland have to do with each other? This eclectic selection has more unity than you might first think. Let's start off with new homes. It is well known that, in the UK, the supply of new homes, and construction services to create new homes, are zero rated for VAT purposes, which is to say that they are subject to a 0% rate of VAT, but allow the developer or the contractor to reclaim VAT that he incurs on his expenditure, thus producing the best possible taxation outcome. However, the positive effect of full VAT recovery on costs by developers is subject to one restriction, namely that VAT on items such as white goods, carpets, and most kinds of fitted furniture, cannot be reclaimed, as to do so would allow such items into the wider market on a VAT-free basis, since they can easily be shipped in and out of properties. That all seems reasonable, but it has come under a major attack from the house building industry, led by Taylor Wimpey, who wish to be able to reclaim the VAT on such items. They succeeded to some small extent in the First Tier Tribunal which somewhat inconclusively said that there may be good grounds under European law for thinking that the block on reclaiming VAT on such items is illegal, since it does not necessarily conform to European VAT legislation. This point is somewhat in the balance, as the Tribunal was not particularly forthright in coming to this conclusion, and in any case there is a possibility that the corollary of this idea is that the supply of such items within the house is a separate taxable supply, at the standard rate, which would nullify the benefit of reclaiming the VAT. The litigation goes on and there is some possibility, at the end of lengthy litigation, that VAT will prove to have been reclaimable all along on such items. House builders need to consider putting in protective claims for VAT they may have under-recovered in the event that the litigation finally goes their way. But you could say that the house building industry is looking the proverbial gift horse in the mouth. The zero rate for new housing is, after all, a privileged exception to the usual EU rules. Ireland, for instance, applies VAT to new housing (albeit at their reduced rate). The purpose of the UK zero rate is to encourage house building in order to increase supply at reasonable prices. A successful claim of VAT on white goods installed in properties that have already been sold would only have a roundabout impact on the availability of new housing in the current market, but could have a much more obvious impact on the availability of dividends to the house builders' shareholders. All of this is equally true in Scotland, but here we have an interesting question as to how an independent Scotland would be able to tax new housing. There has been some debate as to whether an independent Scotland would be regarded as qualifying automatically for accession to the EU. Alternatively, even if it was to join the EU immediately, there is a debate as to whether it could keep the privileged VAT rates applicable to the UK, which are held over from the 1970s. Could Scotland find itself unable to retain the zero rate for new housing? It seems extraordinary if that were true, since independence would be by way of a partition of an existing state, and the new Scottish State would seem to have equal right to retain any privileges as the remainder of the United Kingdom would. That is not necessarily how the rest of the EU would see it, admittedly, and you would hardly blame them. They are unhappy enough with the privileges retained by the UK, and would hardly be enticed into allowing a new sovereign Scotland to continue with the same privileges. However, any mischievous ideas in the EU along the lines of punishing the rest of the UK for the unwanted divesting of Scotland by saying that neither are the former UK, and both must then lose their VAT rate privileges, would almost certainly impel the remaining UK down the path of exit from the EU. Most states in the EU would not regard that as being a sensible outcome, so the chances of inflicting upon the residual UK the same view as it inflicts on the new Scotland would be more or less unconscionable. It is in this connection that one notes with interest that the Scottish National Party is a specific supporter of the 'Cut the VAT Campaign'. For your information, a line to the website of the Cut the VAT Campaign is given here: http://www.fmb.org.uk/news-publications/newsroom/campaigns/cut-the-vat/whos-behind-us/organisations/ This campaign does not seek to remove the zero rate from brand new construction, but wants all other construction to be taxed at the reduced rate of VAT (currently 5% in the UK). In other words, it seeks to close the gap between new housing at the zero rate and extensions and remodelling of the existing buildings which it hopes would be taxed at only 5% rather than 20%. The Scottish Government is fully behind this, which is sensible, since, if it is denied the zero rate for new house building, it may have to rely on the reduced rate for all of its construction services in order to soften the blow on new housing. One assumes and hopes that their detailed tax yield calculations have taken into account this reduction of VAT on general building works, although it will be interesting to know whether it has also imputed that rate of tax on brand new house building. I will let the Cut the VAT Campaign make out its own case for the benefits of putting all other construction work on the reduced rate, but I would like to make one observation about the distinction between zero rated new construction and standard rated construction where new housing does not result. That is that the boundary line between the two different situations is of critical importance where there is such a huge discrepancy in the rates applicable. But that is famously true also for food. A significant number of cases arise in which this discrepancy distorts decision-making in the construction world. A recent First Tier Tribunal decision in the case of Boxmoor Construction Limited makes the point that this boundary line is treacherous. In that instance, the new house was intended to replace an existing residential structure. Brownfield development, of course, is a good thing, although, usually, it involves an industrial site demolished to make way for brand new housing. In this case, there was a need to rebuild where an existing house stood. It was easier to obtain planning consent for what was called 'alteration and extension'. This was something of a nicety, since the planning authority was happy to allow what was essentially a brand new house, complete with brand new foundations, to be built as long as a particularly distinctive part of the old fabric was retained, namely a bay window, which was the most visible part. It cost a lot more to incorporate this morsel from the previous building than it would have to demolish entirely and start again. It is not clear, particularly as the building was not even in a conservation area, why the feature could not be rebuilt almost entirely in the same style and why the original fabric had to be retained, and one can only conjecture on that point. However, a building which was substantively new, bar a few bricks, was treated by HMRC as being an extension of an existing property, and thus taxed at 20%. The Tribunal decided to back HMRC on this point. Whilst it is true that there is a provision that allows the retention of a simple façade if the planning authority requires it, and for this to be treated nonetheless as a new house, the planning consent did not require that particular façade to be retained. Indeed, it was a consent for alteration and extension, which is not the same thing as for a new house with a retained façade. It seems that the circumstantial evidence pointed towards the fact that, by retaining that bay façade, the planning authority was prepared to allow a completely new house to be built, albeit under the apparent aegis of permission for 'alteration and extension'. When reading the case it is very difficult to match up the permission given with the resultant building, although nobody alleged that the resultant building itself literally breached the permission given. Since there is no point in the permission expressing the need to retain a particular façade, as it was not contemplating the complete demolition of the building, it did not do so. The result was that a requirement which probably existed in reality, and which, if expressed in the documentation, would have allowed a zero rated new house to arise, was lost from view and the Tribunal felt unable to support the appellant's contentions. If construction in general were rated at 5%, the difference may not be too staggering, but at 20% the difference is enormous. Whatever you may think about reducing the tax burden on extensions or construction work aimed mainly at maintenance, it is difficult not to feel sympathetic towards a reduction in the VAT rates on the kind of work carried out by Boxmoor Construction. An independent Scotland would have to grapple with these issues. A 'still together' Scotland will have to turn its attention elsewhere.

Graham Elliott Consultant | London

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