VAT implications of converting redundant farm buildings into commercial lets
In anticipation of the future reductions in Basic Payment Scheme income, many farmers are exploring the possibilities of converting redundant farm buildings into commercial lets in order to create an additional revenue stream. It is not unusual for there to be significant amounts of VAT incurred on such projects, so it is important to plan carefully in order to maximise VAT recovery.
Where a farm building is converted and then let to a commercial tenant, provided that it is not being let for storage purposes, the default position tends to be that this is an “exempt supply” for VAT purposes, meaning that no VAT is added to the rent. However, as a result, it is likely to follow that any input VAT incurred in relation to the cost of converting the building relates to this exempt supply. The implication of this is that in most cases the VAT on the conversion works and other directly related costs cannot then be reclaimed from HMRC. This can present a serious problem as there is often a significant amount of VAT at stake.
There is potentially some relief for businesses who also make “taxable supplies” for VAT purposes, such as the sale of crops and farm produce. Where there is a relatively modest cost to the conversion, coupled with measures such as non-VAT registered tradesmen being used where possible and the work being spread over two VAT years, it is sometimes possible to utilise the partial exemption de minimis rules to recover the ‘exempt’ input VAT. This is a very complex area and requires detailed calculations to assess whether or not the VAT is recoverable and, in our experience, the level of VAT on costs associated with many of the conversions that we advise upon breaches these de minimis thresholds and further VAT planning is required.
One possible planning route is to elect to charge VAT on supplies of the building, often referred to as “opting to tax”. Electing to charge VAT on future income from the building means that taxable, rather than VAT exempt supplies, will be made and that the associated input VAT can usually then be recovered. It is important to note that HMRC must be notified of the option to tax within 30 days for it to be effective and once in place it cannot be revoked for 20 years. There are some unusual situations where permission is required to opt to tax or a particular supply may be excluded from an option, but these are outside the scope of this article. If an option to tax is intended it is important that this is made before there are any supplies of the converted building to avoid exempt supplies and potential VAT recovery issues.
Although securing the recovery of the input VAT is clearly desirable, it is important to consider the impact of charging VAT on the rent on any potential tenants. Where tenants are able to recover the VAT charged they are unlikely to object. However, if a tenant cannot recover the VAT from HMRC (if for example they are not VAT registered) then the VAT may become a cost to them, which may in turn lead to pressure to reduce the rent. In this situation, the benefit of upfront recovery of VAT on costs will need to be compared with the potential future cost of a reduced rent.
Where the total cost of the conversion work exceeds £250,000 plus VAT, changes to the VAT status of the building over the first 10 years of use will need to be considered and change in use could result in a proportion of any VAT recovered at the outset being clawed back under the “Capital Goods Scheme”. Particular care is needed (regardless of whether an option to tax has been made) if there is any change of use of the building during this period.
This article only provides general guidance and it is important to assess each project on the specific facts as there may be further issues and options to consider. Although similar principles are likely to apply for any new build commercial lets on the farm, the VAT rules surrounding residential property conversions / builds and holiday lets are very different to those in relation to commercial property.
Finally, there are a number of other tax consequences to be considered when undertaking diversification on a farm so VAT should not be considered in isolation.