The present difficulties in the housing market are causing some house builders to look at the rental market as a temporary solution. Whilst this will produce income in the short term, it also gives rise to potential VAT problems.

What’s the problem?

If a new house is sold freehold or on a long lease, all the VAT incurred in the build costs is reclaimable. This includes costs in assembling the land bank, professional fees, materials and marketing costs etc. However, if a new house is let on a short lease before it is sold, this will result in a claw-back on some ofthe VAT incurred on build/development costs. (Technically this is because freehold sales and long leaseholds are zero rated for VAT purposes which allows VAT on costs to be recovered. Short leases, on the other hand, are exempt from VAT which means there is no right to VAT recovery on costs).

What’s the approach of HM Revenue & Customs (HMR&C)?

When this situation has arisen in the housing market in previous years, HMR&C have insisted on a claw-back of a proportion of VAT reclaimed by the builder during the construction phase. They have announced they will take a similar approach this time and require builders to review the VAT recovery position as soon as they form an intention to enter the rental market.

Is there a solution?

Yes. Depending on the amount of VAT involved, house builders may be able to take advantage of a so-called ‘de minimis’ waiver and avoid a clawback. Otherwise, they will have to agree a basis for apportionment using, for example, ratio of rental income against anticipated future sales value or some other formula which produces a reasonable outcome. Careful consideration needs to be given to the chosen method. Where the VAT amount is significant, the builder can also look at other arrangements such as restructuring the new housing holdings prior to letting, which may largely remove the problem.