Building for the Future: When will a construction project benefit from the VAT zero-rate?
Fri 28 Apr 2017
Provided the various conditions can be met, the VAT zero-rate is a useful tool for house builders and charities planning new construction projects. This article will examine so-called ‘golden brick’ deals and the extent to which a charity can take advantage of the zero-rate.
The supply of an interest in land (e.g. the sale or lease of land) is VAT exempt (subject to some exceptions, like new commercial buildings). This means that a VAT registered supplier of that land will not be able to recover related VAT input costs. Developers and commercial land owners will often opt to tax land in order that they are able to reclaim those VAT input costs. The effect of the option to tax is that the grant of the interest in the land, and any income generated by the land (i.e. rent) will be subject to the standard rate of VAT. However, residential dwellings and buildings intended for use solely for a relevant residential or relevant charitable purpose (but not as an office) are excluded from the effect of an option to tax (and so would revert to simply being exempt) – which would result in big VAT losses for developers working with housing associations and charities to deliver new homes and charitable projects to meet current demand.
There is however a significant and widely used provision in the VAT legislation which allows certain supplies relating to the construction of certain types of building, and in certain circumstances the supply of land itself, to be zero-rated for VAT purposes (Group 5 of Schedule 8 to the Value Added Tax Act 1994). Zero-rating is different from a VAT exemption, as it means that technically, VAT is charged on the supply, but the VAT is nil. This means the supplier can reclaim its VAT input costs, which would not be possible if the supply was merely VAT exempt. This can be a very significant saving and can determine the commercial viability of a project.
The zero-rating is available in respect of buildings in the course of construction designed as a dwelling or number of dwellings or intended for use solely for a relevant residential or relevant charitable purpose.
In order to benefit from the zero-rating, a grant of a land interest must be made in the course of construction – not after the building work has been completed. Developers will usually want to make this grant as soon as possible, to enable cash flow. Typically a housing association will purchase the land at an early stage and then employ the developer to continue to build and deliver the project – allowing the housing association greater control. So at what stage precisely can the grant be made? There is well established case law determining what ‘in the course of construction’ means – it is not mere site clearance or preparatory works such as digging the trenches. HMRC guidance is less explicit than it once was, and now provides that the zero-rated grant can be made provided simply that the ‘building is clearly under construction’, reflecting the Tribunal’s comments in Stapenhill Developments Ltd (VTD 1593). This is commonly accepted to mean that work should have progressed above the foundation level - which is usually referred to as the ‘golden brick’. Given that one policy reason behind the zero-rate is to encourage and enable more housing to be built, surely it would be preferable for HMRC to allow the zero-rate to be applied at a much earlier stage in these types of deals between developers and housing associations, recognising that a lot of preparatory work needs to be undertaken before ‘golden brick’ is reached, which impacts viability and cash flow for developers. With the housing crisis rumbling on, now is the time for a pragmatic approach to make the zero-rate policy as effective as it should be.
Relevant Charitable Purposes
Meanwhile, HMRC recently won a Court of Appeal case resulting in a stricter interpretation of the meaning of a ‘building intended for use solely for a relevant charitable purpose’, limiting the scope of the zero-rate for charitable projects. In Longridge on the Thames  EWCA Civ 930 the Court of Appeal dramatically overturned an Upper Tribunal decision addressing the correct interpretation of the ‘relevant charitable purpose’ test.
Notes to the VAT legislation provide the following test: ‘use for a relevant charitable purpose means use by a charity in either or both the following ways, namely
(a) otherwise than in the course or furtherance of a business;
(b) as a village hall or similarly in providing social or recreational facilities for a local community.’
Limb (a) – the ‘business’ test - was scrutinised by the Court of Appeal. As a result, the ‘economic activity’ test, which is used to determine if there is a ‘business’ in operation, is now to be interpreted strictly, so that where there is a supply of services for directly linked consideration, the motives of the taxpayer and the purpose of the activity (however charitable these may be) will not be relevant, and the absence of profit will not negate there being ‘economic activity’. As such, any regular supply for a consideration (even at a concessionary or subsidised rate) may amount to ‘economic activity’ which would indicate the carrying on of a ‘business’ so that the ‘relevant charitable purpose’ test is not met. The Longridge case related to subsidised water sports training courses for young people run by volunteers. A means tested fee was charged to cover the running costs of the courses. The charity renovated its education facilities and wanted to apply the zero-rate to the construction work. Although it was accepted that the courses had a charitable objective and were not run for profit, the fact that there was a direct link between the supply of the training courses and the fees which were charged to cover the related costs meant that there was ‘economic activity’, so this supply was made ‘in the course of a business’ for VAT purposes and therefore the renovation of the education centre did not qualify for zero-rating.
A recent European Court of Justice (ECJ) decision, which was released after the Longridge hearing so will not have been taken into account, took a more tempered approach, looking beyond whether there is a direct link, to the proportion of the consideration given for the service. In Gemeente Borsele (C-520/14), the ECJ found that there was no ‘economic activity’ where there was a significant difference between the actual costs of the service and the token contributions received. However, the Longridge case demonstrates how strongly HMRC will pursue the point, so charities should proceed with caution if there is any likelihood their zero-rated building is to be used for ‘economic activity’.