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Mixed use
HMRC policy on the recovery of VAT incurred on certain goods and services supplied to a business and used for business and non-business (including private) purposes is to change, in the light of the judgment of the European Court of Justice in P Charles, T S Charles-Tijmens (C-434/03). The Court found that Member States cannot use the derogation under Article 6(2) of the Sixth VAT Directive to deny taxpayers the right to treat all VAT incurred as input tax when they purchase capital goods for mixed business and private use and allocate the goods wholly to their business. It means that UK legislation introduced in 2003 to prevent the Lennartz mechanism being used for certain construction services, combined with the UK rules for input tax deduction, is ultra vires.
Where businesses incur VAT on certain construction services or on purchasing land, buildings and civil engineering works for mixed business and non-business use, they can now rely on the direct effect of the Sixth VAT Directive to treat all VAT incurred as input tax and, subject to the normal rules, recover all the tax up front. They must then account for output tax on the non-business use over the economic lifetime of the asset.
The services concerned are those resulting in the construction of a new building or civil engineering work, or a major refurbishment or extension of an existing building. HMRC will require the output tax charge under the Lennartz mechanism to be calculated over a maximum 20-year period. Martin Scammell of Ernst & Young says that is welcome and that 20 years is 'quite a reasonable life for a building'. He adds that it helpfully 'ties in with the capital goods scheme rules', and that consistency is useful.
There is no change to the way that partial exemption operates. If the asset is to be used for both taxable and exempt purposes, input tax can only be deducted in accordance with the partial exemption method in place for the business.
The Lennartz mechanism continues to be available for other types of goods, for example, computers, yachts, motor caravans, etc. with mixed business and non-business use where those goods are allocated wholly to the business. HMRC will normally require the output tax charge under the Lennartz mechanism to be calculated over a maximum five-year period based on straight-line depreciation.
The Lennartz mechanism also continues to apply in respect of purchases of services where those services are incorporated into goods used in the business and significantly increase the value of the goods to the business. VAT on services that are consumed in relation to day-to-day activity, such as repair and maintenance, must continue to be apportioned.
Taxpayers who wish to make claims for input tax on the supply of construction services or on purchasing land, buildings, and civil engineering works or past claims for other services may do so by making a voluntary disclosure to their local VAT office.
Back claims will be accepted for supplies made after 9 April 2003, provided they are made no later than six months from 9 August 2005. Claims will not be accepted for periods prior to 9 April 2003, because businesses already had the option of using the Lennartz mechanism for periods before that date and, having chosen not to use it then, cannot change that choice now. HMRC's stance that if a taxpayer has not made a claim that Lennartz applied before 9 April 2003, he cannot now change his mind is 'questionable and could be subject to further litigation', says Mr Scammell.
Overall, however, Mr Scammell says that HMRC's change of mind as a result of the Charles decision will be a benefit to businesses which have mixed use assets, particularly charities, educational establishments and individuals.
