24 January 2001
Replies to Queries - 4
Building plans
My client is a self-employed builder who has purchased a site on which, assuming planning permission is granted, he proposes to build a residential block of ten flats. The intention is that the flats will not be sold, either individually or as a block, but all will be rented out with management factoring being applied to the whole block. The long term aim is to retain the whole block as a yielder of income to retirement and beyond. My questions are:
Building plans
My client is a self-employed builder who has purchased a site on which, assuming planning permission is granted, he proposes to build a residential block of ten flats. The intention is that the flats will not be sold, either individually or as a block, but all will be rented out with management factoring being applied to the whole block. The long term aim is to retain the whole block as a yielder of income to retirement and beyond. My questions are:
Replies to Queries - 4
Building plans
My client is a self-employed builder who has purchased a site on which, assuming planning permission is granted, he proposes to build a residential block of ten flats. The intention is that the flats will not be sold, either individually or as a block, but all will be rented out with management factoring being applied to the whole block. The long term aim is to retain the whole block as a yielder of income to retirement and beyond. My questions are:
(1) As regards trading, on completion will there be a Schedule D, Case I uplift of cost to market value, with the profit assessed on the builder if the flats are retained for letting?
(2) Can the project be identified from day one as a personal one and, if so, would it be advisable for the construction costs, including site purchase, to be debited to personal drawings as opposed to work in progress?
(3) In relation to VAT –
(a) As the first supply will be an exempt one, should VAT input claims be disregarded on construction costs from the start of the project?
(b) Would VAT input claims be available if, prior to letting, a family company (controlled by the builder) purchased the residential block; what other taxation ramifications would then apply?
(c) If the builder took his wife into partnership in the building business with the block of flats then being transferred to his own name on completion, would VAT then be reclaimable albeit with adverse Case I ramifications?
(4) What if, due to cash flow pressures, there is a change of mind and the flats are sold off on completion; presumably income tax under Schedule D, Case I is applicable to the proceeds derived, but can VAT inputs then be claimed?
(Query T15,743) – Factorman.
I suspect that the direct tax implications will determine which is the best way for the client to avoid the loss of input tax, which he will incur if he simply builds flats and grants short term leases. Assuming that he bought the land without paying VAT on it, the tax so far at risk is limited to that on the professional fees associated with the purchase and, perhaps, with obtaining planning permission.
If the client now sells the site to a company set up for the purpose and waives exemption for the sale, he will recover that tax. First, however, check if the sum at risk, together with any other exempt input tax he may have, is sufficient to exceed the partial exemption de minimis limit. Below this, he will recover it all anyway.
If the VAT incurred so far is either recoverable or is not material, would it not be preferable from a long term point of view to form a company to do the construction work, rather than to own the finished property? This of course depends on other tax considerations but would avoid the inflexibility inherent in ownership by a company.
The querist mentions charging the expenditure to drawings but, from a VAT point of view, this would be disastrous. Actually, I do not see how it could be correct in law anyway, given that this is not the construction of a private property but of a property investment. In any case, the substantial sum of VAT at stake on the building costs means that VAT planning is essential. Presumably, the client will do some of the work himself and will employ subcontractors for other parts of it, many of whom may not be VAT registered. If so, he will suffer VAT on many of the materials bought since the zero rating for goods supplied in conjunction with services in constructing a dwelling will not apply.
It is to obtain that zero rating that I suggest putting the work through a limited company. The main problem will of course be to get it into the client's head that he must ensure that all goods bought in must be ordered by and invoiced to the company and that he must invoice to it plus VAT for any materials transferred from his own stock. Similarly, all services of subcontractors must be invoiced to the company.
That leaves only his own services, which he will have himself to invoice to the company in order that it can zero rate them back together with the materials, which he installs himself. Of course, this will create a profit on which he will have to pay income tax, but my near non-existent knowledge of direct tax suggests that this may be required anyway when the property is either sold to another company or becomes a capital asset.
None of this would be necessary if major interests, i.e. leases over twenty-one years, were granted instead of short leases or, of course, if the entire block were sold. Item 1 of Group 5 of Schedule 8 to the Value Added Tax Act 1994 would then zero rate the initial premium or the sale price, thus enabling the input tax to be recovered.
In theory, I think the client could form a partnership with his wife to carry out this one project but, unless other tax considerations favour this, I suggest avoiding it in practice. It would be bad enough keeping separate records for a limited company and getting the purchase orders and invoices done correctly, as discussed above. The chances of the records all going wrong where the distinction is between the client trading respectively as himself and as himself plus wife seem to me higher still.
Two final points: if the finished building is sold to another entity, stamp duty will offset part of the VAT saving, unless there is a relief for a transaction between connected persons. Should the client run the building as an investment property, there will be service charges and, possibly, ground rent on which he will need further advice. – A St J Price.
This reply deals only with the direct taxation aspects.
Possibility (4) is straightforward, in that profits are taxed under Schedule D, Case I. It does seem necessary for the client to decide at the outset which business vehicle he will use for this project.
If a decision to sell off the flats is taken, the client and his adviser need to plan the disposals carefully in order to minimise tax liabilities. Accounting principles and the valuation of work in progress will come into play.
One's initial reaction is that, if the completed flats are retained as an investment and retirement vehicle, then this is a quite different business from that of a builder. The construction costs could not be available for taper relief if claimed as trading expenses, as they were incurred by the taxpayer – himself a builder, but retention of the completed building would then be appropriation of trading stock to non-trading purposes with a notional disposal arising under section 161, Taxation of Chargeable Gains Act 1992.
Despite the costs involved, a property management business might be the best vehicle for this project. It would be necessary to keep entirely separate books of account and records. Certainly, debiting costs to the drawings account of the existing business is not to be recommended.
From the viewpoint of flexibility, separation from the existing business and possible succession, the formation of a property investment company may be the best option. In such circumstances the question posed in (1) will be in the affirmative, as the sole trader builder will transfer the flats at market value to the company, on Sharkey v Wernher 36 TC 275 principles. – Bob the Builder.
Extract from reply by 'R.N.G.':
'Factorman' clearly appreciates that to recover VAT on all construction costs there has to be a taxable supply, in this case a zero-rated supply of a major interest, namely either a freehold sale or a lease in excess of 21 years. In none of the questions is the grant of a long leasehold considered, and this possibility should not be ignored.
Another possibility is that a builder can zero rate the supply of construction work on dwellings, thus reducing the amount of irrecoverable input tax if the only supplies by the property owner are exempt. A husband/wife partnership might look a sham and a company might be more satisfactory and remove risk of personal liability from the wife. If the company enters into a design and build contract, the recovery of VAT on architects' and surveyors' fees would also be possible.
As the property is to be held to retirement and beyond, there might be overall advantage in holding it in a pension scheme.
Building plans
My client is a self-employed builder who has purchased a site on which, assuming planning permission is granted, he proposes to build a residential block of ten flats. The intention is that the flats will not be sold, either individually or as a block, but all will be rented out with management factoring being applied to the whole block. The long term aim is to retain the whole block as a yielder of income to retirement and beyond. My questions are:
(1) As regards trading, on completion will there be a Schedule D, Case I uplift of cost to market value, with the profit assessed on the builder if the flats are retained for letting?
(2) Can the project be identified from day one as a personal one and, if so, would it be advisable for the construction costs, including site purchase, to be debited to personal drawings as opposed to work in progress?
(3) In relation to VAT –
(a) As the first supply will be an exempt one, should VAT input claims be disregarded on construction costs from the start of the project?
(b) Would VAT input claims be available if, prior to letting, a family company (controlled by the builder) purchased the residential block; what other taxation ramifications would then apply?
(c) If the builder took his wife into partnership in the building business with the block of flats then being transferred to his own name on completion, would VAT then be reclaimable albeit with adverse Case I ramifications?
(4) What if, due to cash flow pressures, there is a change of mind and the flats are sold off on completion; presumably income tax under Schedule D, Case I is applicable to the proceeds derived, but can VAT inputs then be claimed?
(Query T15,743) – Factorman.
I suspect that the direct tax implications will determine which is the best way for the client to avoid the loss of input tax, which he will incur if he simply builds flats and grants short term leases. Assuming that he bought the land without paying VAT on it, the tax so far at risk is limited to that on the professional fees associated with the purchase and, perhaps, with obtaining planning permission.
If the client now sells the site to a company set up for the purpose and waives exemption for the sale, he will recover that tax. First, however, check if the sum at risk, together with any other exempt input tax he may have, is sufficient to exceed the partial exemption de minimis limit. Below this, he will recover it all anyway.
If the VAT incurred so far is either recoverable or is not material, would it not be preferable from a long term point of view to form a company to do the construction work, rather than to own the finished property? This of course depends on other tax considerations but would avoid the inflexibility inherent in ownership by a company.
The querist mentions charging the expenditure to drawings but, from a VAT point of view, this would be disastrous. Actually, I do not see how it could be correct in law anyway, given that this is not the construction of a private property but of a property investment. In any case, the substantial sum of VAT at stake on the building costs means that VAT planning is essential. Presumably, the client will do some of the work himself and will employ subcontractors for other parts of it, many of whom may not be VAT registered. If so, he will suffer VAT on many of the materials bought since the zero rating for goods supplied in conjunction with services in constructing a dwelling will not apply.
It is to obtain that zero rating that I suggest putting the work through a limited company. The main problem will of course be to get it into the client's head that he must ensure that all goods bought in must be ordered by and invoiced to the company and that he must invoice to it plus VAT for any materials transferred from his own stock. Similarly, all services of subcontractors must be invoiced to the company.
That leaves only his own services, which he will have himself to invoice to the company in order that it can zero rate them back together with the materials, which he installs himself. Of course, this will create a profit on which he will have to pay income tax, but my near non-existent knowledge of direct tax suggests that this may be required anyway when the property is either sold to another company or becomes a capital asset.
None of this would be necessary if major interests, i.e. leases over twenty-one years, were granted instead of short leases or, of course, if the entire block were sold. Item 1 of Group 5 of Schedule 8 to the Value Added Tax Act 1994 would then zero rate the initial premium or the sale price, thus enabling the input tax to be recovered.
In theory, I think the client could form a partnership with his wife to carry out this one project but, unless other tax considerations favour this, I suggest avoiding it in practice. It would be bad enough keeping separate records for a limited company and getting the purchase orders and invoices done correctly, as discussed above. The chances of the records all going wrong where the distinction is between the client trading respectively as himself and as himself plus wife seem to me higher still.
Two final points: if the finished building is sold to another entity, stamp duty will offset part of the VAT saving, unless there is a relief for a transaction between connected persons. Should the client run the building as an investment property, there will be service charges and, possibly, ground rent on which he will need further advice. – A St J Price.
This reply deals only with the direct taxation aspects.
Possibility (4) is straightforward, in that profits are taxed under Schedule D, Case I. It does seem necessary for the client to decide at the outset which business vehicle he will use for this project.
If a decision to sell off the flats is taken, the client and his adviser need to plan the disposals carefully in order to minimise tax liabilities. Accounting principles and the valuation of work in progress will come into play.
One's initial reaction is that, if the completed flats are retained as an investment and retirement vehicle, then this is a quite different business from that of a builder. The construction costs could not be available for taper relief if claimed as trading expenses, as they were incurred by the taxpayer – himself a builder, but retention of the completed building would then be appropriation of trading stock to non-trading purposes with a notional disposal arising under section 161, Taxation of Chargeable Gains Act 1992.
Despite the costs involved, a property management business might be the best vehicle for this project. It would be necessary to keep entirely separate books of account and records. Certainly, debiting costs to the drawings account of the existing business is not to be recommended.
From the viewpoint of flexibility, separation from the existing business and possible succession, the formation of a property investment company may be the best option. In such circumstances the question posed in (1) will be in the affirmative, as the sole trader builder will transfer the flats at market value to the company, on Sharkey v Wernher 36 TC 275 principles. – Bob the Builder.
Extract from reply by 'R.N.G.':
'Factorman' clearly appreciates that to recover VAT on all construction costs there has to be a taxable supply, in this case a zero-rated supply of a major interest, namely either a freehold sale or a lease in excess of 21 years. In none of the questions is the grant of a long leasehold considered, and this possibility should not be ignored.
Another possibility is that a builder can zero rate the supply of construction work on dwellings, thus reducing the amount of irrecoverable input tax if the only supplies by the property owner are exempt. A husband/wife partnership might look a sham and a company might be more satisfactory and remove risk of personal liability from the wife. If the company enters into a design and build contract, the recovery of VAT on architects' and surveyors' fees would also be possible.
As the property is to be held to retirement and beyond, there might be overall advantage in holding it in a pension scheme.
