The current economic climate means that businesses must manage their finances in smarter ways, maintain effective credit control and look to make efficiencies and savings where they can. One area often overlooked is VAT on construction projects, as Gerry Myton, Partner at Streets Chartered Accountants, explains.
A review of current and ongoing projects could lead to improved cash flow, or even a VAT refund depending on the taxable status of the developer or use of the property. A review of future projects could present cash flow savings through decreased funding or borrowing and again, could save some developers the cost of irrecoverable VAT.
But isn’t VAT just ‘in and out’?
For some developers, yes. They pay VAT to the contractor and then claim it back from HMRC. There are two potentially negative aspects of this. Firstly, the VAT cost must be factored into the financing of a project which increases borrowings and overall costs. Secondly, as anyone who has had a VAT enquiry regards a VAT repayment claim can attest, sometimes getting a VAT refund can be like getting blood from a stone.
Depending on the type of property being developed and the ultimate use of the building, some developers cannot recover VAT on construction costs and professional fees. The VAT becomes an absolute bottom-line cost. But there are ways to mitigate this and in some cases, remove the VAT loss completely.
So how exactly can you ‘save’ on the VAT?
The best way to mitigate VAT is to remove it completely, or as much as possible, from the equation. If a contractor does not charge VAT in the first instance, then there can be no issues with either input tax recovery or irrecoverable VAT.
Most developers are aware that new residential dwellings are covered by legislation for the construction to be zero-rate VAT. Some developers will be aware that a conversion from commercial to residential use is covered by legislation to allow the reduced rate to apply. A smaller number of developers will have heard that contractors can apportion their VAT charge if they are working on a mixed new-build development, say new commercial and new dwellings. And an even smaller number of developers are aware that zero-rate on construction applies to buildings being used for Relevant Residential Purposes (RRP) and Relevant Charitable Purposes (RCP), or that the reduced rate also applies to renovations where a dwelling has not been lived in for two years (empty homes rule) or where a conversion results in a different number of dwellings in a building – e.g. a house converted to flats (changed number of dwellings conversion).
These VAT reliefs exist for a reason, and it is up to developers and contractors to use them to best effect.
So how do we make sure we are not ‘overcharged’ VAT?
Whilst some contractors and construction companies are very good in this area, our own experiences with small, medium and even large contractors is that they often take the path of least resistance. Many take the view that simply applying VAT at 20% means they themselves will have no issues with HMRC. Some just don’t want the hassle of having to consider applying VAT at different rates. Some just don’t understand that VAT does not always have to be levied at 20%.
What we can do, and have done for many clients, is review the work involved with a construction project to determine whether or not some or all the work qualifies for VAT relief through either zero-rating (0% VAT) or reduced rating (5% VAT). We can work with the contractors to ensure that VAT is charged correctly moving forwards, or seek refunds for past projects.
Some projects could have a mixture of two VAT rates; some could have a mixture of all three.
By analysing the specifics, we can determine the appropriate VAT rate for each element of work undertaken, or to be undertaken, and agree on an apportionment method with the main contractor(s). We have found that by working with contractors in this way, and by explaining everything in advance (where possible), they are usually more receptive to the idea of issuing invoices with different VAT elements.
We have helped a number of developers in this way, and this has led to significant VAT savings for them.
A £70m+ saving
On behalf of our developer client, we worked with a large multinational contractor on a £70m+ project involving both new-build and renovation of existing buildings, with commercial and residential units, and had a mixture of 20%, 5% and 0% VAT rates on different aspects of the work.
By agreeing to apportionment with the contractor, this removed approximately £7m of VAT from the initial construction cost, which translated into decreased borrowing for the developer and greater flexibility if the intention to dispose of changes.
Refunds in overpayment
A developer converted a basement area of an existing block of flats into new residential units. The contractor initially applied VAT at 20% on the basis that this was refurbishment work. Our analysis provided for a different approach in terms of VAT, which saw the majority of the work liable to 5% VAT.
The contractor issued a credit note along with a refund for over £200k in overcharged VAT. As the building was being used for exempt residential lettings, this was a significant cost saving to the developer.
Whilst each project is different and can have different VAT issues and solutions, the scope to save VAT applies equally to major development projects and smaller-scale conversion contracts.
What can be done?
The VAT position for previously completed construction projects to ensure that VAT has been correctly charged can be checked. This is especially useful for developers that have constructed property where VAT could not be claimed, such as dwellings constructed as portfolio stock for residential lettings.
Where a project has been incorrectly billed with VAT, say in the last four years, there is scope to have the contractor issue a credit note and a VAT refund.
Where a developer constructs new dwellings to be retained for residential lettings, there is scope to utilise a mechanism which allows for ownership to be retained, whilst providing for full VAT recovery on construction costs and professional fees.
Whatever your individual position is, if you have been engaged in previous development projects, it is well worth asking professionals to review the VAT position if you have been unable to claim VAT in full. Similarly, if you are currently or soon to be undertaking a major renovation, refurbishment or new-build works, it would be prudent to review the project from a VAT perspective to ensure optimum cash flow is achieved.
Gerry Myton is a Partner at Streets Chartered Accountants