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VAT update: house builders letting property

16 September 2008

A new Information Sheet published by HMRC on 15 September 2008 contains a helpful relaxation in the way the clawback operates where a house builder temporarily lets dwellings before selling them.

What happens when a house builder become partly exempt?

Where a house builder defers its intended sales of dwellings and temporarily lets them out instead, it is likely to become partly exempt, and so might have to:

adjust the VAT previously recovered on his submitted VAT returns (‘clawback’)
restrict the VAT to be recovered on current and future VAT returns
both adjust VAT previously recovered, and restrict current and future VAT recovery.

Making a clawback adjustment

A house builder must make a clawback adjustment as soon as his actual or intended use of a property differs from his original plans against which input tax was recovered. A clawback adjustment is a one-off event, and a house builder would only make a second adjustment if the building is never let. There is no need to amend the adjustment if the actual period of letting proves to be longer or shorter than anticipated.

Clawback: two stage process

House builders who are not already partially exempt must first apply a simple de minimis check. If he does not fail this, there is no need to make an adjustment and no need to go on to the second stage. If he fails this, then it is necessary to go on to the second stage to work out the actual clawback adjustment.
Where a house builder already has a partial exemption method he will need to apply his partial exemption method to check for de minimis.

The simple de minimis check

The ‘simple check for de minimis’ is carried out by reference to the expected time period the house builder will let his building for as a proportion of the economic life of that building, which for VAT purposes is 10 years. Provided the total exempt input tax does not exceed £625 per month on average (up to £7,500 per year), and is not more than half of his total input tax, then the input tax is de minimis and the clawback is not required.

Example: simple check for de minimis

A fully taxable house builder recovered £20,000 input tax on a house that he expected to sell for £300,000. After the end of the tax year he decides to defer the sale by letting for two years and so becomes partly exempt. A simple check for de minimis is:

£20,000 input tax x two-year lease/10-year economic life = £4,000 exempt input tax.

The £4,000 of exempt input tax is de minimis because over the tax year it does not exceed £7,500 or 50% of his total input tax. The builder has no need to adjust the VAT previously recovered on his VAT returns. An important point is to note if the input tax was incurred over more than one tax year, the de minimis test should be applied to the input tax incurred in each of the tax years separately.

Second stage test

If the de minimis test is failed it will be necessary to make a clawback adjustment which must be based on the house builder’s realistic expectation, judged at the time his original plans were set aside. HMRC may ask for evidence to support this, for example the business plan showing the price originally expected; reports of estate agents showing this price to be unobtainable and maybe estimating when a sale will be achievable; board minutes from the time of the decision to grant short leases, or any other commercial documentation that backs up the estimated use.

Calculating a clawback adjustment

The house builder calculates his clawback adjustment by comparing the input tax deducted with the input tax he would have deducted had he held his changed intention all along. If he was already partly exempt (which is typical for large house builders) then he calculates the input tax he would have deducted by using his partial exemption method at the time the costs were incurred. But, if he was not already partly exempt, then he must apply the standard method unless he obtains HMRC approval to apply a special method instead. If he prefers, he can exceptionally base his clawback adjustment on an alternative calculation (and without prior approval) so long as that calculation is fair.

Bases of calculation

A calculation based on the values of supplies is normally fair and straightforward provided it is based on reasonable estimates and valuations;
Estimated eventual sale value
_________________________

Estimated eventual sale value plus estimated short let premiums and rents

Example: house builder preparing a clawback adjustment using values

A house builder expects to sell two houses for £500,000 each. The input tax recovered during the tax year was £50,000. After the end of the tax year the decision is taken to rent them for a period of three years generating estimated rental income of £200,000. The house builder makes no other supplies.

£50,000 input tax incurred x £1,000,000 / £1,200,000 = £41,667 recoverable input tax

£50,000 input tax previously recovered - £41,666 = £8,334 to be repaid to HMRC

No adjustment should be made for potential bad debts during the letting period. If it is not possible to fairly estimate the values then a different calculation may be needed. Apportionments based on the expected time period of the rental or short-term lease are not recommended except as a quick de minimis check.

Restricting recovery of current and future VAT

A house builder that decides to temporarily let before selling will need to apply a partial exemption method if he continues to incur exempt input tax in his current or future VAT periods. The exceptional treatment can only apply for the clawback adjustments. If he is not already partly exempt (most smaller-sized builders are not), then he must either apply the standard method or seek HMRC approval to apply a special method.

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