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HMRC have clarified their policy on the input tax challenges facing house builders who rent out their properties for a period of time before selling them.
This situation has become very common in the last year because of the property downturn, but the builders still intend to sell the properties once the property market revives.
The input tax problem is caused by the fact that the first sale of a new dwelling (flat, house, bungalow etc.) is a taxable supply (zero rated) so input tax can be fully reclaimed on related expenses.
But income from renting out a dwelling is exempt from VAT, so related costs cannot be reclaimed. If a house builder rents out a property for even a short period of time, the costs then relate to both taxable and exempt supplies, and an input tax adjustment could be needed.
The process for a builder is as follows.
- For past VAT returns, carry out a test called 'a simple check for de minimis'; this test identifies the past exempt input tax based on the expected number of letting years (out of a ten-year total period).
- If an adjustment of past input tax is then needed because the business is not de minimis for partial exemption purposes (exempt input tax less than £625 a month on average and 50% of total input tax), HMRC will allow the business to use any method that 'fairly reflects the use of costs in making taxable supplies'. This could be based on income figures (expected letting income compared to expected sale proceeds from the property) or the number of letting years compared to a ten-year economic life of the building.
- For current and future VAT returns, the business must either adjust its input tax (if appropriate) by using the standard method of calculation for partial exemption (based on income) or formally request a special method from HMRC.
Note: any adjustment of past input tax is made on the VAT return relevant to when the decision was taken to rent out the property rather than sell it — there is no error notification issue because the original input tax was correctly claimed at the time.
Independent VAT consultant Neil Warren welcomed the HMRC guidance: 'HMRC have given a number of options for a business to deal with past and future input tax claims — these options need to be fully considered. For example, past adjustments based on income figures should be more favourable than adjustments based on expected letting years in most cases'.
The ten-year economic life figure quoted by HMRC is based on the same period that tax needs to be adjusted for property within the capital goods scheme and Lennartz mechanism.
The Information Sheet issued by HMRC gives full details and worked examples about input tax adjustments needed by builders for past, current and future VAT returns.
