VQOTW: VAT recovery, or not, on premises for an exempt business

My client is a partnership buying a disused farm building from the owner who has opted to tax it. The client is then converting it into a children’s day nursery. They will occupy the building and run the nursery themselves. Are supplies by a nursery VAT exempt, and can they reclaim any of the input tax on the purchase of, and/or the works to, the building? The purchase price will be £250,000 and the conversion will be roughly the same amount again.

Well, the construction work itself will not benefit from the reduced rate for conversion work as the property is not being converted from non-residential use to residential use (VAT Notice 708 section7 refers). VAT will therefore be due on the building works at the standard rate.

There cannot be a Transfer of a Going Concern, involving an opted property, as there is no business being transferred, only a property. VAT will therefore be due on the purchase by virtue of the seller exercising the option to tax.

The provision of day-care for children under the age of eight is indeed exempt from VAT but not under the Education exemption as you might expect but rather the Welfare exemption (VAT Act 1994 Schedule 9 Group 7).

If the provision of childcare is the sole business activity of the client, then they will not be making taxable supplies and will not be eligible to register for VAT. If the client also has taxable activities, then they will be eligible to (or potentially liable to) register for VAT. The input tax incurred on the property purchase, and subsequent conversion costs, will be wholly attributable to exempt supplies and be subject to the Partial Exemption de-minimis test.

To be de-minimis their exempt input tax would need to be no more than £625 per month, on average, and not more than half of their total input tax.  In view of the scale of the works suggested, it is unlikely these tests would be met, and in that case no input tax will be recoverable.

Okay, so in order to try and reclaim the input tax, my client is now proposing to create a limited company that will buy the farm building, opt to tax and undertake the conversion to a nursery. The company will then rent the property to the nursery partnership and charge VAT on the rent. (I understand that this is a common practise). Will this then allow input tax recovery by the company on the purchase and conversion costs?

Potentially but there are checks to do first:

  • Will the property be a Capital Goods Scheme (CGS) item for the company?
  • Yes, the property and works will cost more than £250,000 + VAT.

 

  • Will the company be granting a licence to occupy the property to a ‘connected person’.
  • The ‘connected persons’ test is detailed in s13.7 of VAT Notice 742A. It says that:

The following persons are treated as connected with you:

  • your husband, wife or civil partner
  • your relatives and their husbands, wives or civil partners
  • your husband’s, wife’s or civil partner’s relatives and their husbands, wives or civil partners
  • if you’re in business in a partnership, your partners and their husbands, wives, civil partners and relatives
  • a company that you control, either by yourself or with any of the persons listed in these bullet points
  • the trustees of a settlement of which you are a settlor, or of which a person who is still alive and who is connected with you is a settlor

As the directors of the company are also members of the nursery partnership, they will fall under “a company that you control, either by yourself or with any of the persons listed in these bullet points”

The company will therefore be making a grant of the property to a connected person.

  • Will the connected person be using the building for ‘substantially wholly’ taxable purposes?
  • ‘Substantially wholly’ means using the property at least 80% for supplies which confer a right to input tax recovery. As the connected person is the nursery partnership, whose supplies are exempt from VAT, then it will not meet this condition.

As the CGS building will be let to a connected party which is not at least 80% taxable, the ‘anti-avoidance provisions’ described in section 13 of Notice 742A become relevant. This means that the option to tax that the company wishes to exercise will be ‘dis-applied’. That is to say, the rental income it receives from the nursery partnership will revert to being exempt from VAT.

As the rental will be exempt from VAT, the related input tax on the purchase and conversion of the property reverts to being wholly attributable to exempt supplies and not reclaimable.

Well, I’ve heard that it is common practise to hold the property in one company and rent it to a related company with the option applied and reclaim VAT. How can they do that?

Each transaction needs to be considered in view if its own circumstances. It may be that the lessee is ‘fully taxable’, or the property is not a CGS item for the lessor, and so their option is not disapplied.


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VAT Adviser

Paul has 32 years-worth of experience in VAT with HMRC. He has worked with many varied small, medium and large businesses and organisations, resolving varied VAT queries and dealing with compliance issues.

He has recent experience of assisting Academies and other complex partially exempt organisations with their calculation methods and declarations. He is also well-versed in working with Repayment Queries, VAT Refund claims and VAT Registration issues.

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