The VAT problem with pubs

Two recent cases, Languard New Homes Ltd and MacPherson illustrate the continuing VAT issues with non-residential conversions, particularly problems with conversion of pubs and shops.

Normally if a developer carries out work on an existing flat or house and sells a long lease in it afterwards, he will incur VAT of 20% on the works and the sale of the lease will be exempt. The exemption means that the developer can’t claim the VAT on the works and related costs.  This additional VAT cost increases the cost of residential conversions, particularly in comparison with new builds where the construction services and sales are normally zero-rated.

However, the sale of a newly converted non-residential property which creates additional dwellings can be zero rated, which is important, because it means that the developer can claim VAT on contractors’ fees and related costs.

The problem lies with the legislation on conversions, which states that this only applies to conversion of non-residential buildings or non-residential parts of buildings. If there is any part of the building which was residential before, the conversion of a non-residential part does not allow you to zero rate the sale of the final dwelling unless the result of that conversion was to create an additional dwelling or dwellings.

This causes a big headache for pub and shop conversations, where often there was some associated residential accommodation for the landlord or staff. Often this accommodation is on upper storeys with the commercial below, but on conversion the building may be divided into new residential units vertically, not horizontally, meaning that the new dwellings all incorporate a part that used to be commercial and a part that was always residential.

This is what happened in the cases of Languard and MacPherson. The Upper Tribunal has decided that none of the dwellings in either case had been created by converting part of a building that had not been previously designed for use as a dwelling, because they had been created from an amalgamation of the non-residential parts and the residential parts. Consequently, nether company has succeeded so far in obtaining zero -rating and thus recovery of input tax.

Why it matters:These are disappointing decisions because the point of this legislation was to encourage the redevelopment of existing commercial properties into dwellings, to address housing shortages and use “brownfield” sites. It is hoped that the Office of Tax Simplification will look at this as part of its current review of VAT,  as the complexity of the rules and HMRC’s enforcment of them appears to be thwarting that policy intention.

Developers and builders need to understand the rules about conversions to maximise VAT recovery and avoid errors. If you would like to discuss this case or similar developments give us a call.