Use it or Lose it
Tue 29 Sep 2015
Use it or lose it? The UK’s 5% VAT rate on installation of energy saving materials in residential buildings deemed illegal by the EU and may be increased to 20% in the Finance Act 2016.
Housing providers should consider acting now to benefit from the current reduced rate VAT treatment of the installation of energy-saving materials. The European Court of Justice (ECJ) has decided that the UK’s blanket application of the reduced rate to all housing is illegal. According to EU VAT rules, the reduced rate should apply to social housing only. HMRC has stated that the current legislation will not be amended before the Finance Act 2016 – this still gives housing providers and their residents some time to benefit from the current reduced VAT rate before the VAT rate may be increased to 20%.
VAT rules are set out in an EU Directive (2006/112/EC). All member states of the EU have their own regimes for implementing VAT charges, but these must be in line with the EU rules. This ensures consistency in pricing across the single market. The European Commission can take court action against a member state if its VAT regime is at odds with EU law, since EU law has supremacy over national law. Financial penalties can be imposed on member states which fail to comply with rulings of the ECJ.
The reduced VAT rate of 5% applied to supplies of energy saving materials and to the service of installing energy saving materials in all residential properties and charitable buildings in the UK. This included, amongst other things, installation of insulation materials, solar panels, wind and water turbines, and wood fuelled boilers. The rationale behind the broad application of the reduced rate was to promote energy efficiency.
However, the European Commission complained that this was not in line with the EU’s VAT rules, since the reduced rate is only supposed to be applied to the ‘provision, construction, renovation and alteration of housing, as part of a social policy’ (our emphasis).
Prompted by the Commission, the UK Government removed charitable buildings from the scope of the reduced VAT rate. However, the Commission was still not satisfied and eventually took the UK to court, since the UK was still applying the reduced VAT rate to all types of housing. The UK argued that it was not in breach of the EU VAT rules, since the reduced rate was applied as part of the ‘social policy’ of encouraging energy efficiency.
Decision of the ECJ
The ECJ decided in June of this year that the UK was in breach of EU law (see case C-161/14). The court said that because the UK applied the reduced rate irrespective of the type of housing concerned and with no differentiation among the people living in the housing (e.g. regarding income level, age or other criteria), the application of the reduced VAT rate could not be ‘regarded as adopted for reasons of exclusively social interest or even for reasons of principally social interest, within the meaning of EU law’. This was therefore an infringement of the VAT Directive.
Further, the VAT directive provides that the reduced rate may be applied to the renovation and reparation of private dwellings, but this should exclude materials which account for a significant part of the value of the service supplied. Therefore the ECJ found that the UK’s application of the reduced rate was incompatible with EU law to the extent that it was applied to the installation of energy saving materials where the materials accounted for a significant amount of the value of such services falling within the scope of ‘renovation and reparation of private dwellings’.
HMRC has issued a briefing note (13/2015) outlining the UK’s plans in response to the judgment. The note states that any legislative changes will not be implemented before the 2016 Finance Act, and until then the reduced rate will continue to apply. Any changes made will apply to future supplies only; not to supplies which will have already been made prior to any legislative change.
The ECJ’s decision cannot be appealed and so the government must now decide how to ensure UK law is applied in line with the VAT Directive, and how far the reduced VAT rate in respect of installation of energy saving materials will extend to all the different types of ‘social’ housing tenures and to what extent such installations would amount to renovation and repairing of private dwellings. Providers of mixed housing may end up having to charge different VAT rates for different tenants on the installation of materials such as new boilers or insulation in future.
In light of the current political climate, it is far from certain that the government will be willing to make the changes to UK VAT rules sought by the Commission. The referendum on UK membership of the EU will happen within the next two years, and as promised in the Queen’s Speech, the Finance Bill 2015-16 contains a ‘VAT lock’ which will prevent supplies currently charged at the reduced rate from being charged at a different rate until the next general election. It remains to be seen how the government will reconcile this judgment with these wider political implications.
An alternative means of encouraging energy efficiency could be to provide direct subsidies for the installation of energy saving materials. However, this seems unlikely given the government’s recent announcement that it will no longer fund the ‘Green Deal’ loan scheme. Nevertheless, ensuring buildings are energy efficient remains a key means of meeting EU and UK targets, such as the EU Energy Efficiency Plan 2011 to improve energy efficiency by 20% by 2020, so housing providers should keep an eye out for new government policies to encourage the adoption of energy efficient measures across the range of housing stock.
Given HMRC’s briefing note, housing providers may want to act now to allow their private tenants to benefit from the reduced VAT rate on installation of energy saving materials in residential buildings before the government makes any changes to UK VAT rules. The reduced VAT rate could represent significant savings to pass on to customers, so providers who have ongoing improvement plans or energy efficiency goals, should consider bringing forward any long term plans to install energy saving materials in private housing stock.
Note that the installation of energy saving materials as part of the construction of new residential buildings is not affected by this ruling and will remain at the zero VAT rate.