Five Per Cent Conversions

The new five per cent VAT rate for some conversion and renovation work is not as straightforward as it may outwardly appear, warns JOHN PRICE FCA.

SO, WE'VE GOT it! The five per cent VAT rate for certain property conversions and renovation work took effect as part of the Finance Act from 12 May. Given that there has been little publicity for and no public debate about the changes, even in Parliament, how many builders and their clients know even now that the changes have become law, let alone understand them? Some invoices for work which qualifies at the five per cent rate are probably being issued with VAT at 17.5 per cent. It is also a racing certainty that many people will not realise the opportunity for crediting back VAT already charged on projects which are still in progress.

I believe that the changes are certain to be misunderstood. Applying them correctly will require careful study of complex rules by both architects and builders. I foresee trouble!

VAT Information Sheet 4/01 is available on Customs' website (www.hmce.gov.uk), although this is a prime example of the dangers of electronic information being mishandled! Customs have not thought out what they are doing on the site and are changing versions of documents without any trail of those changes. The original version of Information Sheet 4/01, available on 16 May, contained a mistake which was corrected on 22 May. However, neither the original nor the corrected version carry a date other than 'May 2001', and the corrected version has no indication that it is corrected, let alone in what respect.

That would be bad enough if this were routine comment. It is made far worse by the fact that the Information Sheet is the only guidance likely to be available for some time about complex rules, which have come in without warning and which affect large numbers of small businesses and their clients.

Imagine the reaction of a Customs officer confronted by a trader with a version of the Information Sheet, which appears identical to the officer's except for one paragraph in which it differs on whether VAT is chargeable at five per cent or at 17.5 per cent! At the very least, some distress is likely on both sides.

Key changes

There is a reduced rate of five per cent on conversion work which:

• changes the number of dwellings in a building, including creating one where none existed previously;
• converts a house containing one or more dwellings into one or more multiple occupancy dwellings, or vice versa. Multiple occupancy means a self-contained dwelling designed for occupation by persons not forming a single household;
• converts one or more buildings or parts thereof containing only dwellings, including multiple occupancy ones and any ancillary outbuildings, into a building intended solely for a relevant residential purpose, or vice versa;
• renovates or alters, including extends, a dwelling, currently a single household, which has been empty for at least three years. It can remain a single household. Empty means not lived in, so past use for another purpose, such as storage, is acceptable.

Secondly, there is a new ten year rule. The qualification for zero rating the sale of a building, which has been converted from a non-residential building into a dwelling(s) or a building intended for use solely for relevant residential purpose is to change. The definition of 'non-residential' currently requires a building designed as a dwelling not to have been used as such since 1 April 1973. The new requirement will be that it has been empty for ten years. This is presumably to be done by a Statutory Instrument, which has not yet been published as I write. It only takes effect from 1 August.

The part-of-a-building trap

Where work is done to a building but the number of dwellings changes in only a part of that building, it is only the work in that part which qualifies for the five per cent rate.

Customs quote the example of a four-story block of flats with four flats on each floor. A lift is installed, which requires alterations to the layout of each flat on the first three floors. On the top floor, the four flats become three. Only the work on the top floor qualifies for the five per cent rate, because it is only in this part of the building that the number of dwellings has altered.

If the four flats on a different floor were changed to make five smaller ones, the work on that floor would also qualify. It would not matter that there were still 16 flats in total, because each floor would be treated as a separate part of the building.

No doubt, this rule is intended to prevent the deliberate planning of renovation projects, so as to obtain the lower rate for an entire block merely by changing the number of dwellings in one part of it. However, it seems certain to catch people out, especially where extensive modernisation work is being done in large buildings.

Pub conversion problem

Under the zero rating rules, the conversion of a public house into a house often does not qualify for reasons which I need not explain here. It may well qualify for the five per cent however, because the existing living accommodation is not self-contained. Customs interpret self-contained as meaning that all the accommodation, including the kitchen, bathroom and toilet, are behind a door, which only one household may use.

Customs quote as an example that the kitchen may be shared with the public house. If so, the kitchen is likely to be on the ground floor, since it would be difficult to operate efficiently from one in the flat upstairs. However, it seems to me that Customs must mean an element of physical sharing, not just dual usage and that their guidance may well be misunderstood.

Certainly, it fails to point out that, if the living accommodation is self-contained and the building is converted into a single house, only the work to the public house part of the premises will qualify for the five per cent rate - assuming that Customs see that as a separate part.

Houses in multiple occupation

A house in multiple occupation conversion means the conversion from one or more single household dwellings into one or more multiple occupancy dwellings of a dwelling designed for occupation by persons not forming a single household which consists of self-contained living accommodation and with the same requirements of no direct internal access to another dwelling and no planning restrictions as for the construction of a new dwelling.

Similarly, the conversion of a multiple occupancy dwelling into a single household dwelling qualifies for the five per cent rate.

However, the conversion of a non-residential building into a multiple occupancy dwelling is not covered. Goodness knows why. Also not covered are alterations, such as the addition of extra bedrooms, to a multiple occupancy dwelling, which is already in multiple occupation.

So what is a house in multiple occupation? The law uses the phrases 'house in multiple occupation' and 'multiple occupancy dwelling' apparently meaning the same thing, but does not define them. Customs say that they mean a dwelling which is constructed or adapted for occupation by persons not forming a single household. They give as examples:

• bedsit accommodation;
• shared houses or flats;
• bed-and-breakfast establishments with a mix of short and long stay residents.

Customs say that the phrases do not cover:

• hotels;
• dwellings with attached granny annexes;
• accommodation for au pairs, guests or lodgers.

Relevant residential buildings

The law refers to a conversion for a qualifying residential purpose which has a similar meaning to that of relevant residential purpose in connection with the zero rating for the construction of new buildings. That is, it means communal buildings such as homes for children, students and old people.

There is one difference in the reduced rate rules. The premises being converted must be intended to form the entirety of the institution in question, such as an old people's home, unless the use is to be as accommodation for students, school pupils or members of the armed forces. In those cases, the accommodation would often be part of a university, school or a military camp and could not therefore be the entirety of the institution.

The conversion must be from one or more dwellings, either single household or multiple occupancy, although ancillary outbuildings occupied together with the existing dwelling(s) can be included. Thus, although conversion from a non-residential building, such as a group of stables or barns on its own, does not qualify, it does qualify if the buildings are associated with a dwelling and they are all converted at the same time into, say, a complete new residential home.

The use immediately prior to the conversion must not have been, even in part, for a relevant residential purpose.

The conversion of a qualifying residential building back into a dwelling is also eligible for the five per cent rate, being the change of the number of dwellings in a building from none to one.

Certificates of intention

The five per cent rate only applies when the supply is to the intending user of the premises for a relevant residential purpose. The builder needs a certificate confirming that intention, signed by a responsible person on behalf of the home or institution.

Renovation of empty dwellings

If a dwelling, which has been empty for three years, is now occupied:

• the supply of the conversion work must be to the person whose occupation ended the empty period;
• that person must have acquired, at the time of occupation, a major interest in it;
• the work must be done within 12 months of that major interest being acquired.

This creates a trap for anyone buying a property which has been empty for under two years. The five per cent rate cannot apply even if the work is delayed until the property has been empty for three years because, by then, it will be outside the 12-month period.

Another trap is for the builder, who will have to obtain evidence that the building was unoccupied for at least three years. A letter from an empty property officer confirming this will suffice. A best estimate of the empty period is required if the officer is unsure of it and Customs may then require other evidence, such as electoral roll and council tax data.

Subcontractors

A subcontractor must standard rate for his services to the main contractor in the case of:

• conversion for a qualifying residential purpose; only supplies direct to the intending user of the building are eligible for the five per cent rate;
• renovation of a dwelling, which was empty for three years but is now occupied; only supplies direct to the occupier are eligible.

Eligible work

The five per cent rate applies to a supply of qualifying services to convert or renovate, which is defined as:

• work on the fabric of the building; or
• within the immediate site of the building in connection with providing for the building water, power, heat, access, drainage, security or waste disposal.

The tax point for construction services where projects are already in progress is the earlier of:

• a tax invoice being issued;
• payment being received.

Thus, the five per cent rate will apply to tax points for construction work created by payment on or after 12 May, even though the work has been done before that date.

Better still, the builder can issue a credit note for the extra VAT on work already done and paid for. It should be noted that the work must still be in progress as at 12 May.

Brief synopsis

The above is just an outline of the rules and some of the key points from Information Sheet 4/01. My full notes already run to nine typed pages and cover a number of traps for the unwary for which I do not have space here. I just hope we find, as a community, that the benefits of this additional complexity are worth the mental and financial anguish which I expect it to cause!

A St J Price is a VAT consultant in Gloucestershire. He may be contacted on tel: 01285 851888; fax: 01285 851889; e-mail: asjprice@aol.com.

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