Before letting dwellings which are failing to sell in the current climate, careful consideration should be given to the VAT implications which may apply.

Many housebuilders may be considering letting new properties they have built or converted (from non-residential to residential properties), where it is not yet possible to achieve a suitable sale. However, by opting to let, rather than sell new or converted dwellings, the VAT application will be different.

The sale or grant of a long lease (over 21 years) in new or certain converted dwellings is zero-rated, giving rise to full VAT recovery for the builder. However, the letting of a residential property is VAT exempt. Input VAT is not normally reclaimable on expenditure attributable to exempt business activities. So, the shortterm exempt letting of an unsold dwelling may affect the housebuilder's ability to recover input tax on construction and other costs. A VAT exempt temporary letting may require the housebuilder to do one or more of the following:

  • restrict input VAT recovery on current and future VAT returns
  • repay input VAT previously reclaimed on returns already submitted (a one-off clawback adjustment)
  • agree a special method with HM Revenue & Customs (HMRC) for recovering future input VAT.

HMRC recently issued information on two methods to calculate the one-off clawback adjustment. The calculation must be made as soon as the temporary letting starts and must be based on a realistic expectation of the letting period or eventual sale value. HMRC may also require the housebuilder to provide evidence in support of the estimations used in its calculations.

The first method calculates reclaimable input tax based on the estimated eventual sales value as a percentage of the sum of the estimated sales value, plus estimated exempt rents.

The second method uses the expected letting period as a percentage of the deemed ten-year economic life of the dwelling, but this calculation is strongly discouraged by HMRC and is unlikely to provide housebuilders with a higher VAT recovery rate than the first method.

In addition to repaying VAT reclaimed on direct construction costs, the receipt of exempt rental income may also require businesses to restrict VAT recovery on past and future overhead expenses, particularly if there are VAT return periods where exempt rent is the only income.

However, it is possible that housebuilders may be able to restructure their property ownership prior to granting a temporary letting so that a VAT clawback does not arise.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.