The reduced 5% VAT rate for certain residential conversions and renovations has been available for more than 25 years. However, builders, developers and property owners can still miss out on the relief, potentially resulting in more VAT being paid than necessary.
While the standard rate of VAT is currently 20%, certain types of building work involving residential property can qualify for the reduced rate of 5%.
Understanding when the reduced rate applies can make a significant difference to the overall cost of a project.
When can the 5% VAT rate apply?
There are several circumstances where qualifying building work may be eligible for the reduced VAT rate.
Converting a non-residential building into a home
The 5% rate can apply where a building that was previously used for a non-residential purpose is converted into residential accommodation.
This could include, for example, converting an office, warehouse or agricultural building into houses or flats.
The reduced rate can also potentially apply when a non-residential building is converted for certain relevant residential purposes, such as qualifying student accommodation.
Renovating a home that has been empty for at least two years
Certain renovation and alteration work carried out on residential property that has not been lived in during the two years immediately before the work begins can qualify for the 5% VAT rate.
Evidence may be required to demonstrate that the property meets the necessary conditions, so it is important to consider the VAT position before work starts.
Changing the number of homes within a property
The reduced rate can also apply where a project changes the number of dwellings within a building.
For example, this could include converting one house into two separate homes or combining two existing dwellings to create one.
The precise conditions are important, particularly around how the property was used before and after the work.
What does the 5% rate cover?
Where a construction service qualifies for the reduced rate, the 5% VAT rate can generally also apply to certain building materials supplied and installed by the contractor as part of the work.
However, not everything supplied as part of a project will necessarily qualify.
HMRC has specific rules governing what constitutes qualifying building materials, and certain items can remain subject to the standard rate.
Builders and property owners should therefore avoid assuming that every element of a qualifying project will automatically attract 5% VAT.
Why is getting the VAT rate right important?
Incorrectly applying the standard 20% rate instead of the reduced 5% rate can have significant consequences.
For a private homeowner who cannot reclaim VAT, it could mean paying substantially more for the project than necessary.
For example, on £50,000 of qualifying work before VAT, charging 20% VAT would result in £10,000 of VAT. At the reduced 5% rate, the VAT would be £2,500, a difference of £7,500.
It can also create problems for VAT registered businesses. VAT that has been incorrectly charged is not automatically recoverable simply because it appears on an invoice.
Getting the VAT treatment right from the outset is therefore important for both the contractor and the customer.
What if too much VAT has already been charged?
Where a builder has charged 20% VAT on work that should have qualified for the 5% rate, the customer should normally approach the builder to have the invoice corrected and seek repayment of the VAT that has been overcharged.
The builder can then consider how the error should be corrected with HMRC.
Depending on the amount involved, some VAT errors can be corrected through a subsequent VAT return. Other errors must be reported separately to HMRC.
Generally, errors of £10,000 or less can be adjusted through the VAT return. Errors between £10,000 and £50,000 may also be adjusted this way where they do not exceed 1% of the business’s Box 6 figure. Larger errors, and certain other errors, must be reported separately to HMRC.
What about architects and surveyors?
Professional services provided separately by architects, surveyors and other consultants will generally be subject to the standard 20% VAT rate.
However, the VAT position can be different where design services form part of a genuine design and build contract.
Where a contractor provides an overall qualifying construction service and professional services form part of that overall supply, they may follow the VAT treatment of the wider construction service.
The contractual arrangements are important, so the position should be considered carefully rather than assuming the reduced rate automatically applies.
Do the rules apply to subcontractors?
The reduced rate can also apply to qualifying construction services supplied by subcontractors.
However, businesses in the construction industry also need to consider the VAT domestic reverse charge.
Where the reverse charge conditions are met, the subcontractor may not charge VAT in the normal way. Instead, the customer accounts for the VAT.
This can make VAT treatment particularly complex where several contractors and subcontractors are involved in the same development.
What about the DIY Housebuilders Scheme?
People converting certain properties into their own homes may also be able to recover eligible VAT through HMRC’s DIY Housebuilders Scheme.
However, the conditions are different from those governing the 5% reduced rate.
For example, where an existing residential property is being treated as a derelict property for the purposes of a DIY conversion claim, it generally needs to have been unoccupied for at least 10 years before the work began.
This should not be confused with the two-year empty property condition that can allow certain renovation work to qualify for the 5% VAT rate.
It is therefore particularly important to check which VAT rules apply to your particular project.
Planning a property conversion or renovation?
VAT on property and construction can quickly become complicated. Whether the 5% rate applies can depend on the previous use of the building, how long it has been empty, the nature of the work, the number of dwellings created and how the finished property will be used.
Getting advice before work begins can help ensure the correct VAT rate is applied from the outset and could potentially result in significant savings.
If you are planning a residential conversion, renovation or development and are unsure how VAT should be applied, speak to the team. We can help you understand the VAT implications of your project and make sure you are applying the correct treatment.
This article is intended as general guidance only. VAT treatment depends on the individual circumstances of each project and professional advice should be sought before taking action.