No: C&E 5 29 November 1994 BUDGET 1994 : VAT CONSTRUCTION, LAND AND PROPERTY The Chancellor proposes a package of measures on the VAT treatment of construction, and land and property. Customs have consulted trade interests on most of these measures. The Chancellor's intention is to deregulate and simplify a complex area of VAT law and to introduce new reliefs to assist the building industry. At the same time he is blocking a tax avoidance device. The main measures are: (a) Construction From 1 March 1995: - VAT zero-rating for conversion of non- residential property into dwellings (flats and houses), which was introduced by Extra Statutory Concession (ESC) in July, will be legislated for and extended to cover most other forms of accommodation. The measure means that developers will be able to reclaim the VAT incurred in the course of conversion and follows consultation with trade interests; - the distinction for VAT between new and existing buildings will be clarified. Until now the absence of a satisfactory distinction has been a source of much litigation as developers have tried to get the benefit of the zero rate for new housing; and - there will be legislative cover for two ESC's which allow builders to reclaim the VAT on ventilation, burglar and fire alarms, and other safety equipment installed in new housing. (b) Land and property From 30 November 1994: - the "lease and lease back" tax avoidance scheme, which some developers have used to spread their VAT bills on business property for between 20 and 2000 years, will be blocked. From 1 March 1995: - the developers' self-supply charge on business property will be repealed as a deregulatory measure at the request of the trade; and - the rules which give landlords the choice of charging VAT ("the option to tax") on business rents will be simplified and relaxed. From shortly after Royal Assent: - the VAT rules governing property owned by more than one person will be simplified as a deregulatory measure at the request of the trade. NOTES FOR EDITORS (a) Construction 1. The zero-rating of dwellings converted from non- residential buildings was introduced by ESC on 22 July 1994. At the same time, the existing ESC on the supply of equipment for new housing was supplemented by a further ESC which extended the range of equipment on which builders could reclaim VAT, and draft legislation covering all three ESC's was exposed for comment. The draft legislation also covered the definition of new dwellings and some minor matters. 2. As a result of the comments received, the Chancellor proposes two major changes to those proposed in July. The zero rate for converting non-residential property into dwellings will be extended to most other forms of accommodation, and buildings can still be classified as new if they retain one or two facades of a previous building as a condition of planning consent. 3. The zero rate for accommodation converted from non- residential buildings allows developers to recover the VAT incurred in the course of conversion e.g. from a barn to a house. Previously dwellings produced in this way were exempt from VAT so that the tax incurred in the course of construction could not be reclaimed. 4. A special provision has been made to allow buildings originally designed as dwellings, but not used as such since the introduction of VAT on 1 April 1973, to qualify for the zero rate if reconverted to dwellings. This will encourage some derelict properties to be brought back into use. 5. The provisions will apply to DIY builders as well as commercial developers and there will be a special relief to ensure that registered housing associations can benefit. 6. The distinction for VAT between new and existing buildings is to be clarified. This has been the source of extensive litigation by developers, who have sometimes successfully argued that the retention of a substantial part of an existing building does not prevent zero-rating as a new dwelling. Up to now there has been no satisfactory legal definition. A new building will be defined as one not incorporating any part of an existing structure other than foundations or a basement, and one or two facades retained as a condition of planning consent. The new definition will remove doubt. 7. The list of equipment installed in new dwellings on which the VAT can be reclaimed replaces two ESC's. The object of the restrictions is to prevent buyers of new dwellings getting things such as fridges and carpets without having to pay VAT. However, the original restrictions also included items installed to comply with the Building Regulations. The wording of the law is being changed so that VAT can also be reclaimed on most forms of ventilation, burglar and fire alarms, fire safety equipment, waste disposal units in flats, emergency call systems, stair lifts and chair lifts. (b) Land and property 8. The "lease and lease back" avoidance scheme has been used by developers to spread VAT liabilities incurred in the course of constructing a new building intended for use in a business making supplies which are exempt from VAT. Typical users are insurance companies and banks developing their own properties. 9. New buildings constructed for business use are standard-rated for VAT. If the building is purchased for an exempt business use the purchaser cannot reclaim the VAT on the purchase price. If the developer is building for their own exempt use, they cannot reclaim the VAT incurred on the cost of construction, i.e. the VAT "sticks". 10. Developers operating the lease and lease back scheme use an associate company (which has generally been set up specifically for the purpose) to buy the lease of the development and rent it back to them. The supplies of the lease and rent do not have to be taxable (there is an option to tax), but both the developer and the associate company then exercise their option to tax the lease and rent. This means that the developer can reclaim the VAT incurred in the course of construction and the associate company can reclaim the VAT on the purchase of the lease. The associate company has to charge VAT on the rent, which the developer cannot reclaim, but since the rent in any one year is much less than the value of the lease the sticking VAT is spread out, in extreme cases, to over 2000 years. 11. The developers' self-supply charge on developments for business use ensures that VAT is charged on the value of the site as well as the buildings. When the building is supplied for a taxable business use, the VAT can be reclaimed, so in these cases the charge leads to no revenue loss. There will be some loss of sticking VAT from exempt end users but many of these will have been affected by the blocking of the "lease and lease back" tax avoidance scheme. The industry feels that the self-supply charge has led to an unnecessary administrative burden, and its abolition is a response to this. In July 1993 a consultation document was published and earlier this month Customs exposed a first draft of the legislation. 12. The option to tax business rents gives landlords the choice of whether to charge VAT. Most commercial property is exempt from VAT, so although no VAT is charged to tenants, VAT sticks on the landlord's purchases. If the rent is taxed, the landlords can recover the VAT on their purchases. 13. Once landlords have opted to tax rents, they cannot change their mind as long as they own the property. In future, landlords will be given a short period of grace in which to change their minds if they opt to tax (provided they have not reclaimed any VAT on the property), and they will also be able to revoke the option after 20 years. 14. The repeal of the developers' self-supply charge and the changes to the option to tax follow the publication of a consultation document in July 1993. Customs exposed a first draft of the legislation earlier this month. 15. The changes in the VAT rules for property owned by more than one person are being made in response to trade representations. At present, co-owners are treated as partnerships, and although this works quite well in practice, co-owners are not partnerships and do not want to be classified as such. In future, co-owners will be registered as a single taxable person with joint and several liability. 16. In total the net additional revenue to the Exchequer is estimated at Pounds 15 million in 1994-95 and Pounds 150 million 1995-96, when the yield of Pounds 210 million from the anti-avoidance measure will be partly offset by the pounds 60 million cost of the deregulation/ simplification changes. 17. Compliance Cost Assessments are available for these measures, copies of which can be obtained from Jill Lewis, BACU3, 10th floor W, HM Customs & Excise, New King's Beam House, 22 Upper Ground, London SE1 9PJ (Tel No: 0171-865-5570). The reference numbers are as follows: CCA 3 Construction liability : package of changes CCA 4 Land and property deregulation package CCA 5 Land and property anti-avoidance measure 18. Details for traders can be found in Budget notices : BN 90/94 "VAT : Package of Building Liability Measures"; BN 68/94 "VAT : Co-ownership of land"; BN 70/94 "VAT : Abolition of the developers' self supply charge"; and BN 22/94 "VAT : Modifications to the election to waive (Option to tax)". ISSUED BY: HM CUSTOMS AND EXCISE, PRESS AND INFORMATION OFFICE, NEW KING'S BEAM HOUSE, 22 UPPER GROUND, LONDON, SE1 9PJ TELEPHONE: 0171 865 5468/5470/5471 FAX: 0171 865 5625