HMRC has published a new VAT Information Sheet (reproduced in full below) on construction services and zero rated relief (relevant when a building is designed as a dwelling or intended for use solely for relevant residential  (RRP) or a relevant charitable (RCP) purposes.

VAT Information Sheet 07/17: construction services and zero-rated relief

1. About this information sheet

This VAT Information Sheet explains HM Revenue and Customs (HMRC) policy on how VAT is applied to the construction of buildings that keep or make use of, parts of a building that previously stood on, or was adjacent to, the site where the works of construction are taking place.

It explains the circumstances in which the services of construction may be zero-rated when a building is either:

• designed as a dwelling (or a number of dwellings)
• intended for use solely for a relevant residential or a relevant charitable purpose

This policy will affect the liability of the first grant of a major interest by the person who is constructing the building. In addition it sets out the evidence needed to confirm that a development qualifies for zero-rated relief.

The publication of this information sheet follows 3 Upper Tribunal (UT) judgments, Astral Construction Limited (‘Astral’) (2015) UKUT 0021, Boxmoor Construction Limited (‘Boxmoor’) (2016) UKUT 0091 and J3 Building Solutions Limited (‘J3BS’) (2017) UKUT 0253.

1.1 Who should read this

Owners and developers of buildings that are being constructed on sites previously occupied by buildings. It’ll affect those making the first grant of a major interest in the building or who will be in receipt of construction services, or will be submitting a VATrefund claim under the DIY House Builder Scheme.

VAT relief at the zero-rate, is available for the construction of buildings that are either designed as dwellings or are intended solely for a relevant residential or charitable purpose. As a first step, it’s important to establish that what’s being constructed is a building. This is necessary to establish the correct VAT treatment from the construction of other structures that aren’t regarded as buildings, such as those that have the effect of enlarging a building such as extensions and annexes (which generally don’t qualify for relief).

The general rule is that an existing building must be demolished completely to ground level in order for the construction of its replacement to be treated as the construction of a building. Otherwise the works would be seen as the construction of part of a building.

The effect of this is to deny VAT relief to buildings that aren’t constructed ‘from scratch’. This means that where a building already exists on the site of a development project, that building must have first been demolished completely to ground level in order for a building, which is to be constructed to replace it, to qualify for zero-rating.

The law allows this condition to be relaxed. Where there’s a legal requirement (for example under a statutory planning consent (SPC)) to retain a facade of the previously existing building (or 2 facades on a corner site) the law allows the work to be zero-rated as the construction of a building.

2. The cases of Astral, Boxmoor and J3BS

In these 3 cases the UT had to decide whether or not the works (that had taken place) constituted works of constructing a building or whether they amounted to something else (such as the alteration of an existing building). This could happen if any part of the building existing on the site hadn’t been demolished and was included in the building being constructed.

2.1 Astral

In the case of Astral the development included the retention of an entire existing building (a church) that was linked to another (much) larger structure, which was constructed in close proximity to form a nursing home.

The UT found that the test of whether a building had been demolished didn’t assist in determining the nature of the construction work that had taken place. The UT rejected HMRC’s argument that the retention of the church meant the construction of the nursing home couldn’t satisfy the demolition test. It found that as a ‘question of fact and degree’ (and considering the size, shape, function and character of the new work) the completed building (nursing home), was so different from the existing building (a church), that it couldn’t be said to constitute an alteration, enlargement of or extension to the church.

The UT supported the reasoning of the First-tier Tribunal (FtT) that if the sheer scale of the work, considered by an objective observer, as much more than an alteration, enlargement or extension and, that the finished structure was now being used for an entirely different purpose, it must amount to the construction of a building.

The question of whether works of construction can be zero-rated if any part of an already existing building is retained, is explored in the following 2 cases.

2.2 Boxmoor

The case of Boxmoor was heard by the same Judge who had presided over Astral. The case involved a house that had been demolished to ground level apart from the retention of a small portion of the front facade consisting of the lower part of a projecting bay. It had been decided by the FtT that the retention of the projecting bay wasn’t a ‘condition or requirement of the planning consent or similar provision’.

According to the UT in Boxmoor the law defines when a structure ceases to exist but doesn’t say what is or isn’t an extension or enlargement. Referring to the earlier decision of Astral the UT stated that the decision went no further than saying that simply because an entire building might be retained after preparation of the site it didn’t follow that all subsequent work of construction, no matter how extensive, must be regarded as an enlargement or extension.

In deciding for HMRC the UT held that the retention of part of the facade wasn’t a condition or requirement of statutory planning consent and therefore didn’t amount to the construction of a building but was rather the alteration and extension of the original house.

2.3 J3BS

In the case of J3BS the UT considered HMRC’s appeal relating to an earlier ruling by the FtT which had held that work to a coach house that involved the retention of several exterior walls and involved increasing the height and footprint of the overall building could be represented as the construction (rather than the alteration) of a building.

Left unchallenged the FtT’s finding would have pushed the boundaries of the Astraldecision to such an extent that the legislation in this area would be redundant as virtually any work that included partial demolition of an existing building could be treated as the construction of a building.

HMRC had appealed the decision arguing that alteration, for which zero-rating wasn’t available, is a concept broad enough in scope to cover all works and the UT agreed. The significance of J3BS is that it limits Astral to exceptional cases as covered in paragraph 2.1.

Although a project may involve conversion of the original building, in cases that are similar to Astral the work will be far too extensive for the term conversion to be an adequate description of what’s taken place.

3. HMRC policy in light of these decisions

3.1 Explanation of terms

Demolished to ground level

This means that there must be no part of the former building, such as external and internal walls or any part of its structure, remaining above ground level. The retention of any part of a building, such as a basement or cellar, below ground level wouldn’t prevent the replacement building from meeting the conditions for zero-rating.

Following the decision in Boxmoor HMRC now accepts that a very minor part of a building may be retained above ground level if it’s small enough to be ignored as ‘de minimis’.

However, in Boxmoor the retention of brickwork under a ground floor bay window was held not to be de minimis so the building could not be treated as having been completely demolished to ground level.

Facade

There is no definition within VAT legislation of the term ‘facade’ but HMRC’s view remains that it’s the complete front of a building that usually faces a street, road or some other thoroughfare (including a river or canal) and is the exterior part of a building that’s most likely to be seen by passers-by or approaching visitors.

For this reason a facade will usually be designed to a higher standard than the other exterior walls and local authorities may require its retention for aesthetic reasons. Which could include the fact that it’s in a conservation area or because it’s a particularly fine example of its kind.

A corner site will also look out onto, for example, a street or road, but from 2 sides and as a result, will have 2 facades. The 2 facades that are required to be retained must connect to form a corner.

HMRC doesn’t accept that all external walls can be regarded as facades. For example, a wall that forms the back of a property will generally not be treated as a facade unless there’s evidence that the local planning authority (LPA) regards it as possessing some aesthetic merit and its retention is required for that purpose.

Party walls

Party walls may be ignored if they’re walls that are shared with adjoining buildings such as in semi-detached or terraced houses.

3.2 Evidence needed that facades are being retained as a condition or requirement of SPC

Under UK legislation, for zero-rating to apply, a facade (or 2 facades in the case of a corner site) must be retained as a condition or requirement of an SPC or similar permission.

As it’s been the practice of planners to include this requirement as a condition within their planning agreement letter, it’s usually been a straightforward matter to demonstrate that the condition had been met. However, HMRC now accepts that it’s now more common for owners or developers to meet planners in advance of submitting an application. So submitted plans may already show the retention of a facade when it’s known in advance that this will be required within the terms of the planning consent.

In Boxmoor the UT found that for the purpose of satisfying the demolition test more than mere inference to the requirement to retain facades was necessary as the planning consent must require, rather than merely permit, the retention of the facade. Usually HMRC would expect to see an explicit condition within the SPC to that effect. However, this won’t be necessary where the documents make it clear that the work will be carried out in accordance with the plans in which the retention of the facade(s) is clearly shown.

As that retention must be as consequence of an imposition placed upon the developer, the plans submitted to the LPA must have been endorsed with a statement to the effect that ‘the facade(s) has, or have, been retained in accordance with the policy of the LPA’ with evidence that they’ve been seen and approved by the LPA.

3.3 Construction of buildings that incorporate existing buildings

HMRC accepts that in order to establish whether a building is being constructed one needs to take into account the nature of the work. The retention of a minimal amount of an already existing building will be sufficient to disqualify the work from zero-rated relief. However, if the scenario is similar to that which occurred in Astral, the incorporation of an entire building into a development may qualify if the works are so extensive that they can’t be described as works of alteration but are to be as the construction of a building.

HMRC considers the position in Boxmoor and J3BS will be far more common. In cases such as these, most, if not all, of the work will fall within the footprint of the previously existing building. Only where full demolition cannot take place, because of a condition imposed by the LPA requiring the retention of the facade(s), may the works to replace the original building be treated as the zero-rated construction of a building and not merely the alteration or enlargement of the one that preceded it.

In an Astral scenario the situation is different because although an original building isn’t demolished, and indeed may be wholly retained with minimal alteration, the nature of the work can still be accepted as the construction of a building. This is because what emerges from the completed works is something that’s vastly different from that which existed before.

This will be evident from the nature of the works which will be of such a size in relation to the original building that they can’t be characterised as an alteration to the building but must be seen as something much more. Where the size of the addition to the existing building greatly exceeds the original building and the function changes HMRCis prepared to accept that such works are entitled to be zero-rated.