Andrew Needham looks at how an exempt business can recover VAT on the refurbishment of a rented property.
The essential point for a business making exempt supplies is that it cannot recover the VAT on costs relating to those supplies. If a business only makes exempt supplies, then it cannot register for VAT or recover any VAT on its costs. A business that makes both taxable and exempt supplies can register for VAT and recover a proportion of the VAT on its costs.
Previous VAT planning ideas
Following the introduction of the option to tax in 1989, many exempt businesses realised that there were tax planning opportunities that would allow them to recover the VAT on the purchase and refurbishment of commercial properties they traded from.
The plan was simple; the exempt business (‘ExemptCo’) set up another company (‘NewCo’) that purchased the building, opted to tax it, and then recovered any VAT on the purchase or refurbishment of the property. ExemptCo then became NewCo’s tenant and was charged VAT on the rent, which it couldn’t recover, but there was a massive cash flow saving as all the VAT on the purchase/refurbishment was recovered upfront.
This planning opportunity was blocked with anti-avoidance legislation. Any property that came within the capital goods scheme (CGS) had the option to tax ‘disapplied’ if a ‘grant’ was made to a ‘connected party’ that could not recover at least 20% of its VAT. The option to tax was disapplied and the VAT on the purchase/refurbishment became irrecoverable and the planning opportunity was blocked.
The CGS affected any commercial property where the VAT was recovered on its purchase, refurbishment or enlargement and the costs exceeded £250,000. This caught most of the larger properties at the time, but as the limits for the CGS have not been raised, almost any commercial property is caught at today’s prices.
‘Loophole’ in the legislation
The anti-avoidance provisions only affect properties covered by the CGS, so if an exempt business is planning to rent a property from a third party landlord and the property needs costly renovations before it can be occupied then this planning arrangement can still be used in order to recover the VAT on the renovation costs. This is because rent (other than a premium of over £250,000) is not covered by the CGS.
Example: Two business structure
ABC Ltd is a children’s nursery and plans to rent an old school building from a third party landlord for £50,000 per annum. However, it is in disrepair and needs £150,000 plus VAT of £30,000 spending on it, so the landlord has provided for a reduced rent of £20,000 per annum for the first three years.
ABC Ltd sets up NewCo and agrees with the landlord that they will rent the property to NewCo and permit a sub-lease to ABC Ltd. NewCo registers for VAT and opts to tax the property. It recovers the VAT of £30,000 on the refurbishment and rents the property to NewCo for £25,000 per annum plus VAT of £5,000, which cannot be reclaimed by ABC Ltd.
As NewCo’s turnover is less than the de-registration limit of £80,000 per annum it can de-register from VAT. So after twelve months NewCo de-registers from VAT. The effective VAT cost to ABC Ltd is £5,000 on the first year’s rent, thereby saving £25,000.
As the refurbishment costs are classed as a supply of services, not goods, no VAT is due on de-registration as it not classed as ‘goods on hand’.
Practical Tip:
If you are an exempt business and going to rent a property that needs refurbishing you can set up a two business structure that allows you to recover the VAT on the refurbishment without long term costs.
