by Ian Cruickshank
Last year saw major changes in VAT law affecting both landlords and tenants. For the first time VAT became payable, at the landlord’s discretion, on rents of land and commercial premises. In addition, from April 1 1989 the rules governing the supply of building and civil engineering services in the course of the construction of new buildings were revised so as to impose VAT on new buildings other than dwellings and certain residential and charity buildings.
This article highlights those areas where charities may still be able to benefit from zero-rating, with particular emphasis on church buildings. An article of this type can, however, give only general guidance, and is not a substitute for professional advice on individual circumstances.
Since April 1 1989, construction services have been liable to the standard rate of VAT. Exceptions to this general rule are where the building is a new dwelling or is to be used for a qualifying residential, charitable or community purpose, in which cases the work remains zero-rated. Before a charity can receive a zero-rated supply of construction services, it must issue a valid certificate to the building contractor stating its intention to use the new building for a “qualifying purpose”, defined as use by a charity otherwise than in the course or furtherance of a business or as a village hall or similarly in providing social or recreational facilities for a local community.
Some charities will also benefit from the relief available for new buildings to be used as residential accommodation, for example at schools, hospices and other homes or institutions providing residential accommodation for children, the elderly and sick.
If only part of a new building is to be used for a qualifying purpose, zero-rating is available only for that part. The law does not prescribe a particular method of apportionment, although relative floor areas may be an appropriate measure in many cases. Of course, if the non-qualifying part of the new building is to be used by the charity in support of its taxable business activities (for example, a charity shop selling donated goods), the VAT chargeable on the construction services will be reclaimable by the charity, provided it is registered for VAT. In contrast, if the new building, or part of it, is to be used for business purposes other than the making of taxable supplies — which may be the case with a fee-paying school or private hospital — the VAT which the building contractor would be obliged to charge on that building (a gymnasium or classroom block in the case of schools, for example, or a new ward or theatre in the case of hospitals) would not be reclaimable by the recipient of those services and would therefore represent an additional cost.
Where apportionment between qualifying and non-qualifying parts of a building is necessary, Customs & Excise will normally require a copy of the relevant plans/drawings and so on as evidence to delineate that part entitled to zero-rating.
It is also noteworthy that notwithstanding the wording of the new legislation, which refers to a building or part of a building being used “solely” for a relevant charitable purpose before zero-rating is applicable, Customs & Excise has stated that, by administrative concession, a charity may ignore such business usage (which would otherwise disqualify the building from relief) where it is likely to be less than 10% of the total time when the building is normally available for use. A valid certificate issued in these circumstances will therefore entitle the charity to zero-rated relief, and this will be of particular benefit for church halls used for worship or the pastoral care of the church community (non-business) and also let or hired to outside groups or individuals for wedding receptions, birthday parties and so on (business). The charity, however, will need constantly to monitor the business usage of the hall to ensure that it does not forfeit its entitlement to zero-rating under the rules relating to a change of use.
Zero-rating of construction services for qualifying buildings is not automatic, but is conditional upon the charity providing a certificate to the appointed building contractor. Zero-rating then applies only between the main contractor and the charity. Any subcontractor employed by the main contractor is not entitled to zero-rating, although any VAT which he charges would almost certainly be fully recoverable by the main contractor.
The format of the required certificate is given in Customs & Excise leaflet 708/4. The department do not supply blank certificates and a charity wishing to claim zero-rating must prepare its own certificate using its own stationery. Such a certificate must contain all the details shown in Customs specimen forms.
Any building materials, builders’ hardware, sanitary ware or other articles of a kind ordinarily installed as fixtures in the type of building under construction will also be zero-rated where supplied by the contractor in conjunction with his zero-rated services. Customs & Excise leaflet 708/2, entitled Construction Industry, gives a list of examples of items which would be zero-rated in appropriate circumstances in the course of construction of non-business charity buildings, including churches and schools. These include organs, church bells, amplification equipment, air-conditioning and central heating systems, fire and burglar alarm systems as well as altars, pulpits, lecterns and fonts.
Where a charity building is “self-built” by volunteers and is to be used for non-business purposes a new procedure has been introduced from January 1 1990 which enables the charity to recover VAT incurred on materials. This replaces the previous self-help scheme for charity buildings, introduced by extra statutory concession in 1978.
Change of use of qualifying building
Once a charity has given a certificate and received zero-rated construction services it must continue to use the building (or part of it) for a qualifying purpose for 10 years after its completion. If the building is disposed of, let or otherwise used for a non-qualifying purpose within that period, a taxable supply will have been made on which the charity will be required to pay VAT. In the case of disposal or letting of the building (or part of it), VAT will be due on the amount received by the charity, assuming an arm’s length transaction, but if the purchaser also intends to use the building for a qualifying purpose, he can give the vendor a certificate to that effect, thereby avoiding a VAT charge.
For change of use of the building from a qualifying to non-qualifying purpose, the VAT payable by the charity will equal the VAT which would have been charged had the certificate not been given at the time of the original construction, and this will in some cases necessitate a VAT registration for the previously unregistered charity. As a side effect, this could mean that the charity would have to account for VAT on the other standard-rated supplies that it made, the value of which, had previously not necessitated a VAT registration.
Charities will need to be certain before giving a certificate that they are entitled to zero-rating in the particular circumstances. The normal VAT rules require the person making the supply to decide whether VAT is chargeable but, under these particular rules, if a person provides an invalid certificate and Customs discover this at a later date, that person, rather than the building company, will be liable to a potential 100% penalty of the tax which should have been charged. This feature is particularly worrying where only part of a building may qualify for zero-rating, and therefore some means of apportionment that gives a fair and reasonable result has to be calculated.
Construction services — existing buildings
Any works of repair and maintenance, or any alterations, enlargements, conversions or extensions to an existing commercial or residential building continue to be standard-rated, except “approved alterations” to Grade I or Grade II listed buildings used or to be used as dwellings or for other qualifying purposes, which can be zero-rated.
Construction services — listed buildings
From April 1 1989 “approved alterations” to a protected building are zero-rated only if the building is a dwelling, any other type of qualifying residential building or a building to be used by a charity for a relevant charitable purpose. It is the use to which the building will be put after alteration which is important. Thus, work in converting a listed warehouse or listed commercial office block into a qualifying charity building would be zero-rated. Again, in order to obtain zero-rating, a charity will need to provide the building contractor with a certificate before the work is started, although it is understood that Customs & Excise will be prepared to accept the issue of a credit note by a contractor who had received the requisite certificate only after he had issued an invoice for VAT.
An “approved alteration” is normally an alteration for which listed building consent is needed from the appropriate local planning authority and consent for which has been given. However, not all work carried out under a listed building consent is necessarily an “approved alteration”: repair and maintenance work, for example, is always standard-rated, and in such cases it is necessary to apportion the building services between zero-rated and standard-rated elements.
Slightly different rules apply to churches. Any alteration to a church is an approved alteration, provided the church is a listed building and is currently used for religious purposes. However, any repair or maintenance work to a listed church is standard-rated. A building used, or available for use, by a minister of religion wholly or mainly as a residence from which to perform the duties of his office does not benefit under the special rules applicable to churches and it is only “approved alterations” to such buildings which are zero-rated.
A new building constructed in the grounds of a listed building may be zero-rated only if it qualifies for zero-rating in its own right, either because it is a dwelling or a qualifying residential, charitable or community building, such as a church hall. The fact that the new building is being constructed in the grounds of a listed building does not automatically bestow zero-rating on that building.
Purchase or lease of a new building
The sale of the freehold title or the grant of a lease in excess of 21 years to a charity by a developer who has constructed a new building on his own land can be zero-rated provided:
(a) the charity has given the developer a certificate stating that the building will be used by the charity either for a non-business purpose or as a village community hall providing social or recreational facilities; and
(b) this is the first supply by the developer in relation to that building.
Where a charity intends to use a building for business and non-business purposes, the “10% business usage” concession referred to above can apply and a valid certificate issued in these circumstances will secure zero-rating.
The building must be a completely new building. A developer can zero-rate the grant of a major interest in the building he has constructed only if that building is new, rather than the conversion, reconstruction, alteration or enlargement of an existing building. Again, however, less stringent rules apply for the substantial reconstruction of a protected building to be used for a qualifying purpose.
It is only the first rent or premium payment for a new qualifying building which is eligible for zero-rating: all subsequent rents or payments are VAT exempt. This means that, if a charity’s landlord incurs VAT in future years (eg on refurbishments, enlargements, alteration or repair of the building), he will not be entitled to reclaim the VAT charged to him on those works and, in consequence, he may seek to pass those higher costs on to his tenants through higher rents.
Where a charity has bought or taken a long lease in a zero-rated building similar rules to those explained above apply if that building is disposed of, relet or put to some other non-qualifying use within 10 years of purchase. Again, up to 10% business use of a qualifying building will be disregarded.
Responsibility to advise Customs & Excise of any change of use or disposal resides with the charity. Charities are well advised to retain the relevant documents showing the cost of a zero-rated building for at least 10 years after its completion, so that if VAT does become payable the correct amount can be calculated.
Purchase or lease of existing buildings
The sale or the grant of a long or short lease in a building which is more than three years old is an exempt supply and no VAT is chargeable thereupon. In the case of non-domestic buildings, however, the vendor or landlord has a choice and can elect to charge VAT at 15%, under what is known as the “option to tax”. This option cannot be exercised in relation to a building, or part of a building, intended for use solely for a relevant charitable purpose, other than as an office. Because the purchaser’s/tenant’s status and proposed use of the building may not be readily apparent to the vendor or landlord, it is advisable to provide such persons with a certificate indicating that they cannot add VAT to all or some of the sale price or rent. It should be noted that landlords are entitled to opt to tax the rent of charity office premises, whether used for business or non-business purposes — though precisely what constitutes “an office” will not be clear in all circumstances. Customs & Excise’s view is that landlords can elect to tax “offices used by a charity, other than those which are within, and incidental to, the charity’s operational establishment”.
Rents payable by charities in respect of business premises and offices will have VAT added to them if the landlord has opted to tax. There are, however, concessionary phasing-in reliefs for charities occupying buildings completed before August 1 1989, to the effect that landlords can charge VAT on only 20% of the rents in the year from August 1 1989; 40% in the year from August 1 1990; and so on, until VAT is payable on the full rent in the year commencing August 1 1993.
A charity which takes up a new lease before August 1 1993 is entitled to the phasing-in reliefs at the level appropriate to the date when it enters into the lease.
Conclusion
As can be seen, the VAT implications affecting charities’ property interests are far from simple. With the new “default interest charge” and “serious misdeclaration” penalty applying from April 1 1990 to charities in the same way as other persons liable to VAT, charities would be well advised to assess their position so as to avoid falling into the numerous pitfalls which now exist in the VAT system.
