Letting instead of selling and its effect on input VAT recovery

13 October 2008

The extent to which input VAT is deductible is based on the use or intended use at the time relevant goods and services bought. However, in certain circumstances that intention can change requiring a ‘clawback’ of VAT by HMRC if the planned use was for taxable activities but is now for exempt activities, or a ‘payback’ to the taxpayer under the opposite scenario.

This is confusing in itself, but what happens where the original intention remains, but the goods and services are put to an interim use involving a different VAT treatment i.e. there is a dual intention?

The prime example of this concerns housebuilders who build new houses for sale (zero-rated) and recover input VAT accordingly, but because of a depressed property market, arrange short-term lets first (exempt). Since the early 1990s, practice has been based on the joined High Court cases of Curtis Henderson Ltd and Briararch Ltd but now HMRC have introduced greater clarity for affected business by issuing VAT Information Sheet 07/2008 (15 September 2008).

This document provides helpful guidance on judging an intention and when it changes; how the partial exemption de minimis limits might help; how to make a clawback adjustment; how to restrict recovery on past, current and future returns once the intention changes and, perhaps most importantly, alternative bases of calculation to one based on expressing the period of letting as a proportion of 10 years (the economic life of a property). For instance, it might be more cost-effective to use estimated values of rental income as a proportion of estimated sales income.

Significantly, though, a special apportionment basis cannot be used if the business already has a partial exemption method in place, unless formally agreed in advance with HMRC. It should be noted that any costs directly attributable to either zero-rated sales (e.g. solicitors’ fees) or exempt lettings (e.g. managing agents’ fees) do not require apportionment and are recoverable in full or not at all accordingly.

As well as providing assistance to housebuilders, it may be that the principles involved can be used in other cases of dual intention.