The Builder, the Reverse Charge and the Option to Tax
Harrow & Stone Ltd is a VAT-registered building contractor, not in a VAT group, which has made a valid option to tax on a commercial warehouse it owns. It is contracted by a VAT-registered property developer to carry out £240,000 (net) of construction services on that warehouse; the developer will on-charge the completed building. Separately, Harrow & Stone lets the warehouse to a small unregistered sole trader for £3,000 per month plus VAT. Harrow & Stone also sells a residential property it developed, for £400,000, and pays £1,200 (gross) of VAT-inclusive professional fees on that sale. Its VAT quarter is the three months to 31 December 2024.
1. Explain the VAT treatment of the £240,000 construction services and the £3,000 monthly rent, and compute the output tax Harrow & Stone must account for in the quarter on those two items.
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Construction services - domestic reverse charge (VATA 1994 s55A). Where a VAT-registered customer receives specified construction services and is itself liable to account for VAT on its onward supply (the developer is, being a taxable person on-charging the building), the domestic reverse charge applies. Harrow & Stone does not charge VAT on its invoice; it must show the reverse-charge note, and the developer accounts for the output tax and recovers it as input tax (subject to its own partial exemption position).
Output tax for Harrow & Stone on the construction = £nil. The reverse charge shifts the accounting to the customer. (Harrow & Stone still records the net £240,000 in box 6.)
Rent - option to tax. The option to tax makes the supply of the warehouse standard-rated, notwithstanding that the tenant is unregistered and cannot recover. The rent is £3,000 × 3 = £9,000 net for the quarter; VAT at 20% = £1,800 output tax. The tenant bears this as an irrecoverable cost.
Total output tax in the quarter = £0 + £1,800 = £1,800.
The judgement: the reverse charge does not apply merely because both parties are VAT-registered. It applies only where the customer is liable to account for VAT on the onward supply. And the option to tax is not disapplied by the tenant's unregistered status - it bites precisely because the tenant cannot recover.
2. Harrow & Stone sells a residential property for £400,000 and pays £1,200 gross of professional fees. State the VAT treatment of the sale and the input tax recoverable on the fees, and explain the principle that drives your answer.
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Sale of the residential property. The sale of a new residential property is zero-rated (VATA 1994 Sch 8). Zero-rated, not exempt - the distinction matters because zero-rated supplies carry full input tax recovery rights.
Professional fees. £1,200 gross at 20% = £1,000 net + £200 VAT. Because the sale is zero-rated (a taxable supply), the £200 VAT on the fees is recoverable in full as input tax, subject to the normal rules (valid VAT invoice, attributable to the taxable supply).
The principle: the distinction between zero-rated and exempt. Exempt supplies (for example, the sale of an old residential building, or land without an option to tax) carry no recovery of attributable input tax. Zero-rated supplies are taxable at 0% and carry full recovery. This is the single most examined VAT principle in property transactions.
Caveat to flag. If the fees related to the warehouse (opted, standard-rated) they would be fully recoverable for the same reason. If they related to an exempt letting, recovery would be nil. The attribution of costs to the correct supply is where the marks are won or lost.