The Spectre of VAT Clawback and why it can appear at the worst point in a Development

Simon Merry is the Director of Berthold Bauer VAT Consultants Ltd. In this article, he explains what is VAT Clawback and what it means for your business.

VAT Reclaim is only permitted on Property Development when two key tests are met; firstly, that it is the right type of development, and, secondly, the development is put to the right use. In broad terms, this restricts VAT reclaim to new build residential schemes (or units created from non-residential space) that must then be sold.

That said, property development is a forward or future ‘trade’, and the VAT reclaim hinges on your intended use of the site upon completion. Where this intention changes from the ‘right’ type of use to the ‘wrong’ type of use - for example, an unforeseen short-term let instead of a planned sale – you are obliged to repay the initial VAT back to HMRC; commonly referred to as VAT Clawback.

How can it be mitigated?

In the current climate, it is hard to avoid unforeseen market conditions that may affect a site that is not due to complete for some months. What you can do, however, is to mitigate the VAT you pay in the first place, limiting the VAT you reclaim and thus minimising the VAT at risk should Clawback be sprung upon you.

VAT on acquisition

Not all sites are truly ‘plus VAT’ when you purchase:

• Sites with existing residential areas

• Site for intended conversion to residential

• TOGC’s

• Sites falsely Opted by the Seller

Comment: Extreme care is required here as often this VAT is never reclaimable in the first place! 

It would not be the first time a routine Clawback check by Customs has opened a pandora’s box of incorrectly claimed VAT, and you can imagine trying to recoup it months or years later from the Vendor…

VAT on construction

VAT Relief is based upon the nature of the physical development and is largely unaffected by the use to which it is put. It is therefore a very risk averse strategy (with the cash-flow advantages to boot).

• Zero Rate for New Build Residential schemes

• 5% rate for Conversions, Change in Number and Empty properties

Professional Fees

Architects, Designers and Professionals are obliged to charge VAT at 20% irrespective as to the nature of the scheme.

Using a Design and Build contract, however, amalgamates the fee into the Contractors valuations, effectively making them part of his Lower Rated Prelims.

Comment: A D&B style contract is also perfect for Build to Let schemes.

You are not permitted to reclaim any VAT on B2R schemes, so converting Standard Rated fees and materials into a Zero or Reduced rated D&B Contract has instant advantages.

Method of Payback

Fortunately, Clawback is rarely a 100% repayment and HMRC will accept any method that is ‘fair and reasonable’. It is therefore in your interests to propose a method that is truly reflective of your (fluid) plans, yet is still the least painful course available.

Comment : smaller Developers and those not requiring the formality of Board Minutes often struggle to correctly document their original intention. 

Where HMRC have doubt and you do not have documentary evidence in support – a 100% Clawback can be demanded.

What should you do?

Look at historic and current schemes first, and then schemes near completion.

• Can you lay your hands on formal documents that prove your intention to completely dispose of the units upon completion?

• For commercial units, have you applied for an Option to Tax? You do not inherit an Option from the original Vendor.

• Where leases have occurred, notify HMRC instantly. Do the calculation in the background.

• Consider which units to rent, as Penthouses and larger units will have a disproportionate impact.

At the same time, check for other VAT that has been treated incorrectly; ‘Blocked’ fixtures and fittings, show home items, and of particular importance - Sub-Contractors and Trades who have lazily charged 20% VAT instead of 0% or 5%.

The default penalty for this type of mundane errors is the VAT plus 70% on top, yet unravelling them  voluntarily removes the penalty in virtually all instances.

In summary, HMRC will allow VAT recovery only against certain types of development, as in the main property transactions do not support VAT recovery (whether you are VAT Registered or not).  It is therefore unsurprising that VAT needs to be repaid if your plans for a site change.

Take advance advice from your Accountant or VAT Advisor to ensure repayments are known about in advance and incorporated into your financial modules.

Here at Berthold Bauer, the Property Team are happy to offer informal guidance as part of our Free Helpline Service, and I am always available to Qandor members for any VAT related property matter.

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