Historically, HMRC has usually been content for builders to claim back overpayments, however, a more stringent approach from the tax man could see developers end up in financial hot water.
Traditionally, some contractors have charged their developer clients a flat rate of 20% VAT, mainly because this was simple and straightforward. For the developer, this has not been a particular issue in the past, as they are normally entitled to recover in full any VAT on development costs. For example, if the work should have really been charged at 5% VAT, the 15% overpayment would have been relatively simple to claim back from HMRC.
However, such a simple blanket approach is no longer viable and less leniency from HMRC – combined with the complicated nature of VAT in the construction sector – can trip up SME developers if they are not aware of the issue.
Depending on the type of work being undertaken, there are many different VAT rates that apply. Some residential construction work is rated at 5%, new-build residential at 0% and other types of works – for example, those which alter the conditions of buildings to suit people with disabilities or involve installing mobility aids for the elderly – also have different VAT ratings.
The list of VAT exceptions is long and it is easy to see how smaller developers may get tripped up. In comparison to their larger counterparts – who may have in-house departments to check the VAT status of construction costs – many SMEs simply will not have the capacity to double check every invoice.
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Getting VAT payments wrong could be costly both in terms of expense and time. Generally, if it is found that VAT payments have not been correctly calculated, then HMRC may assume that reasonable care and attention has not been taken in preparing the returns. Penalties of up to 30% can be imposed, as well as a requirement to pay any interest accrued on the amount owed.
If HMRC does say that a developer has overpaid, then the challenge lies in recouping the money from the contractor who charged for the work originally. In many cases, this is easier said than done, particularly as the original payment could have been made up to four years previously. The contractor may have disappeared and gone out of business or simply may not want to cooperate. In this instance, the developer may consider launching a legal claim against them for wrongly charged VAT, however, this is both time-intensive and costly.
Ultimately, SME developers must make every effort to ensure that their VAT payments are correct. This includes – to a large extent – understanding the various VAT treatments as best as possible for different types of work and carefully assessing which projects are charged at what rate. Agree with the contractor before the work starts what is going to be zero-rated, reduced rated or standard rated and – if in doubt – seek third-party advice. Putting the effort in at the start is much better than paying for getting it wrong later.
VAT exemptions can be very complicated, especially for smaller developers. However, with the days of leniency by HMRC coming to an end, now is the time to get up to speed and ensure that payments are made correctly first time. Finding out years later could be a nasty surprise, which may prove costly.