HM Revenue and Customs (HMRC) provides clarity over buildings which qualify as zero-rated for VAT purposes

HMRC has issued guidance on when charitable and residential properties can qualify for zero-rated VAT treatment. But what does this mean for the developers of such properties?

What are the benefits of a building being zero-rated?
The construction of a new building and work to an existing building is normally standard-rated for VAT purposes. There are, however, exceptions and certain construction services may qualify for the zero rate of VAT. Other construction services may be taxable at the reduced rate of 5%.

Where the developer of a property is able to recover all of the VAT incurred on the related development costs, there may be a cash flow cost but not an absolute one. However, where the developer cannot recover the VAT at all (because of the use to which the property will be put), the tax becomes a significant 'real' cost. Zero-rating will therefore remove any VAT cash flow cost and, more importantly, will remove what would otherwise be an additional development cost for those that cannot reclaim all their VAT.

What buildings can qualify for zero-rating?
If you are constructing a building which is to be used for a 'relevant charitable' or 'relevant residential' purpose, you are entitled to zero-rated development costs.

A 'relevant charitable' property includes one used by a charity other than in the course or furtherance of a business, and any property used as a village hall or similarly in providing social or recreational facilities for a local community.

'Relevant residential' property refers to a home or other institution which provides residential accommodation for children, or for those which need personal care due to age, disablement, dependence on drugs or alcohol, or a mental disorder. Residential accommodation for school pupils, students and members of the armed forces is also included. A hospice, monastery, nunnery or similar establishment would also qualify, together with any institution, which is the sole or main residence of at least 90% of its residents, except hospitals, prisons, hotels or similar establishments.

Where have difficulties arisen?
This simple proposition has always been complicated by the qualifying test that has applied. To qualify for zero-rating, the building has to be used solely for relevant charitable purposes (RCP) or relevant residential purposes (RRP). This has been enormously restrictive. HMRC has tried to be helpful over the years and introduced concessions. However, there has been an uneven playing field for some time as the 10% concession was withdrawn for RRP but remained in place for RCP.

What guidance has HMRC provided?
HMRC has now sought to simplify the situation by giving a clear definition of what will be accepted as 'used solely' for the purpose of the relevant residential and relevant charitable definitions. However, there is both good news and bad news. The good news is that a certain level of non-relevant use is now allowed under legislation, without losing the zero-rated status. The bad news is that RCP buildings can only have 5% non-qualifying use, rather than the 10% previously allowed under the concession.

When do the new rules apply?
From 1 July 2009, 'used solely' will be defined as 95% or more qualifying use and can be calculated in accordance with any method which is fair and reasonable. Although this does not need to be agreed with HMRC, we would recommend that agreement is sought in most cases bearing in mind the new penalty regime and the need for certainty with funding requirements. Contractors and users will probably benefit from agreeing this together and certifying accordingly.

Lorraine Parkin, VAT Partner at Grant Thornton says: "There are transitional provisions in place for a 12 month period. This means that where organisations have already begun to develop or have made a substantial contractual commitment prior to 30 June 2010, they can either treat the project under the old rules or, if they wish, apply the new interpretation. However where the new interpretations apply, all previous concessions relating to charitable use have been withdrawn. Therefore, the continued qualifying use of a charitable building over the first ten years of its life must again be monitored."

Please contact us if you would like further advice on any of the above.