converting residential property: the VAT rules

14 March 2012


This paper deals with the 5% VAT rate for certain types of conversion in relation to residential properties. This is a very substantial area of legislation, and this paper will focus only on the relief which applies to the increase or reduction in the number of "single household dwellings" that such work might create. It is principally of interest to property investment companies dealing with residential portfolios, property agents and surveyors acting on behalf of such companies, and potentially for private home owners who are looking to reconfigure homes they already own, or to convert their non-residential property into residential units. It is also of concern to building contractors, as it is they who choose the rate of VAT.
With effect from 11th May 2001, it has been possible for building contractors to charge certain services at the 5% rate of VAT rather than 20%. This relates to the following work of transforming a property:
  • splitting a house into several self-contained flats
  • changing the number of self-contained flats in a building which already contains flats
  • converting a commercial building so that it contains one or more self-contained flats, or becomes a single house
  •  converting a block of flats back into a single house

The above descriptions are highly generalised, and in fact there is a good deal of detail in the legislation, comprising several traps for the unwary some of which are discussed below.
There are several potential traps, including HMRC giving defective rulings, areas where there could be dispute with HMRC over what the legislation actually means, or faulty legislative drafting. The following are just a selection of the issues that could arise.
  1. If a commercial building already contains an existing single household dwelling (for example, a flat used by a caretaker), and the whole building is then converted into a single house, the 5% rate does not apply, because there was a single household dwelling before, and one single household dwelling remains afterwards, even though it is of a completely different size. There has therefore been no change in the number of single household dwellings. 
  2. Where pub conversions are concerned the above rule applies to the landlord's flat within the pub but only as long as it was a self-contained single household dwelling. If the landlord shared the facilities open to the pub, such as kitchen or toilets/bathrooms, it is not deemed to be a single household dwelling, so such a pub conversion would attract the 5% rate.

  3. In the case of a pub, if there is a single household dwelling (for example, the landlord's flat), and the works carried out involving increasing the number of single household dwellings, only the extra flats are able to enjoy the 5% VAT rate, unless the original flat is split up between the newly created ones.

  4. The only works that carry the 5% rate are those which directly relate to the change in the number of dwellings. Thus, even if one changes the number of dwellings in a certain part of the building, but the remainder of the building involves mere refurbishment without an actual change in the number of dwellings, the latter work is subject to VAT at the standard rate. This is extremely difficult to interpret, and in general you will need to seek professional advice in situations where refurbishment does not change the overall footprint of the flat in question.

  5. There is a question of interaction between the 5% rate and the ability to reclaim VAT either as a speculative or DIY house builder on the conversion of a commercial building into a residential building. These rules can work in tandem involving the claimant making claims on VAT charged at the 5% rate.

  6. It can be seen from the above that there is scope for using VAT planning techniques to minimise the VAT liabilities, even at the potential expense of carrying out extra works or stages of works in order to create a desired VAT outcome.
Any of the above-mentioned organisations or persons becoming involved in a development which appears to create changes to the number of single household dwellings ought to take professional advice. In particular, owners of the properties ought not necessarily to accept the view adopted by the construction company, which may be overly cautious. The amounts of VAT that can be saved if the 5% rate is correctly applied in such cases would usually justify the cost of professional advice. The VAT arrears and liabilities that could arise if the 5% rate is wrongly applied could also be considerable in contrast to fees for professional advice.
The firm has a partner, a director and a consultant dedicated to advising on all aspects of VAT. They have specialist knowledge of the real estate sector and also the not for profit sector but advise organisations in all sectors. The team provides a range of review, advisory, transaction support and appeal services. Being at the cutting edge of developments, our specialists contribute to a number of media and are regular speakers at internal and external events. Yet they also speak in plain language and provide responsive and pragmatic advice in a commercial context.
For more information please contact:
Phil Salmon
020 7969 5611
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