My VIP Tax Team VAT question of the week: Building Upwards

This seems to be an increasingly common question of late, no doubt sparked by the recent change in planning rules allowing developers to add two extra floors to detached blocks of flats.  The new permitted development right came into force on the 1 August 2020 and is set out as Class A, Part 20, Schedule 2 of the General Permitted Development Order (the GPDO).

The VAT liability will very much depend on the nature of the development and whether the enlargement creates additional new residential dwellings.

For new residential dwellings VAT zero rating for the construction services is by virtue of Schedule 8, Group 5 of the VAT Act 1994.  The rules around zero rating the construction are all contained within VAT Notice 708 ( https://www.gov.uk/guidance/buildings-and-construction-vat-notice-708#section3) and in particular paragraph 3.2.5 deals with enlargements and extensions that create additional dwellings.  The Notice states you can zero rate the enlargement of, or extension to, an existing building to the extent that the extension or enlargement contains an additional dwelling provided both the following conditions are met:

the new dwelling is wholly within the enlargement or extension;

the dwelling is ‘designed as a dwelling’ – see definition in paragraph 14.2 of Notice 708.

However, if the new dwelling is partly or wholly contained within the existing building, you cannot zero rate the work under the rules in this section; although you may be able to reduced rate (5%) the charge as a ‘changed number of dwellings conversion’ (s.7 N.708).

This has a been a contentious area for VAT in the past and further guidance can be found in the HMRC VAT Construction Manual – specifically VCONST02300.

VATA 1994 Schedule 8 Group 5 Note 16(b) states that the enlargement or extension of an existing building is ‘the construction of a building’ to the extent that the enlargement or extension creates an additional dwelling. HMRC state “In the clearest case, this relief applies to the construction of a new storey of flats on top of an existing block of flats.”

HMRC’s view is that it is important that the new dwelling is contained entirely within the enlargement or extension. If any of the original building is incorporated into the new dwelling the works are not zero-rated. Tribunals have not always agreed.

In the case of Michael, Gillian and Norman Smith (VTD 17035), works that involved the creation of a second dwelling, appeared to form a semi-detached house next to an existing one but in fact included a part of the original building within the new one. The Tribunal decided that where an enlargement or extension contained part of a new dwelling (the remainder of the new dwelling being formed within the original building) the words ‘to the extent that’ in Note 16(b) allowed zero-rating for the enlargement or extension containing part of that dwelling but not the other works.

Similarly in Jahansouz (TC00637) which was a DIY case, a pitched roof was removed and a flat was constructed under a new roof. The new flat incorporated nothing of the pre-existing building but was partly in the previous roof space. HMRC saw only the additional roof space as an extension although the Tribunal disagreed.

HMRC consider both cases were wrongly decided. HMRC remain of the view that the zero-rating provision at Item 2 is limited to dwellings and not parts of dwellings. It does beg the question do HMRC only ever consider zero-rating can apply to new dwellings on top of flat roofs?

As ever with VAT and building projects, each case will turn on its own particular facts and appropriate advice should be sought.

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