Land and property VAT – VAT recovery on conversion of pubs to houses?

In the current economic climate, there are an increasing number of pubs being converted to residential accommodation.  If carefully managed, conversion works can qualify for the reduced rate of VAT of 5%.  However, if the developer then goes on to sell the dwelling(s) and part of that space was previously used for residential purposes e.g. as staff living accommodation, input VAT recovery is usually blocked. Whilst the input VAT can be minimised to 5%, this still creates a VAT cost.

HMRC’s position was challenged in the recent case of Alexandra Countryside Investments Limited. The appellant converted a pub into two semi-detached houses. The company claimed input tax in relation to the conversion, on the grounds that the sale of the houses would be zero-rated. HMRC denied the input tax arguing that the sale of the houses would instead be exempt as before conversion the pub included a manager’s flat (parts of which were incorporated into both the semi-detached houses). In HMRC’s view, this prevented the sale of the houses from being zero-rated and meant the related VAT was irrecoverable.

However, the Tribunal found in favour of the taxpayer, concluding that previously residential elements could be used in the conversion where additional dwellings are created. This meant that contrary to HMRC’s guidance, the sale could be zero-rated and the related input VAT recoverable. Whilst a Tribunal does not set a legal precedent and HMRC could still appeal the decision, if you are carrying out similar conversions, you may wish to consider putting in a protective claim for input VAT recovery.  Please let us know if you would like to discuss this possibility.

Another interesting point brought out by the Alexandra case highlighted HMRC’s formal review of the matter which was prepared by an HMRC Higher Officer. Apart from the preamble and the standard onward appeal rights, the letter consisted of just two sentences. The Tribunal commented that “…this review in effect says nothing other than “we are right and you are wrong”. We feel that taxpayer confidence in the statutory system of HMRC internal reviews – most of which, in our experience, are conscientiously and carefully drafted – requires better performance than in the current case…”

For further information please contact Ward Williams’ Corporate Tax Director - Sarah Brock:  sarah.brock@wardwilliams.co.uk