If the four houses were always meant to be kept, they never become trading stock and the SPV pays £183,125 of corporation tax on the sales. Decide to keep them at completion and a deemed sale at market value adds £69,250 now. The £16,000 of fee VAT linked to the lets is lost either way.
Key facts
- A residential letting is an exempt supply of an interest in land[1].
- VAT recovered for taxable use is clawed back if the costs are used for exempt supplies within six years[2].
- Trading stock taken out of the trade other than in the course of the trade is treated as sold at market value[3].
- An asset taken out of trading stock is treated as acquired, for capital gains, at the value at which it left the trading account[4].
- Short tenancies don't stop the developer's first freehold sale of a new house being zero-rated[5].
Where does VAT sit when some houses are kept?
The contractor's work on new dwellings is zero-rated[5]. The ten freehold sales are zero-rated too, because each is the first grant of a major interest by the person constructing[5].
The four houses kept to let are different. A letting is an exempt supply of an interest in land[1]. VAT on costs used for both taxable and exempt supplies is residual input tax, and only the taxable share is recoverable[2].
Our SPV pays £56,000 of VAT on £280,000 of professional fees, at 20%[6]. On a simple unit split, 4/14 of that, £16,000, sits against the lets. Spread over a two-year build, that's about £667 a month. The de minimis limit is £625 a month on average, and half of total input tax[2], so the £16,000 is a cost. Our guide to VAT partial exemption covers the methods.
What if you change your mind after recovering the VAT?
Plenty of developers plan to sell everything and then keep a few units when the market turns. That's where clawback bites.
If VAT was recovered on the basis of taxable use, and the costs are then used for exempt supplies within six years, the over-claimed VAT goes back to HMRC[2]. HMRC's construction notice makes the same point about letting before sale: you may need to adjust the input tax you've claimed[5].
In our example that's the same £16,000, paid back on the return for the period in which the letting starts[2].
What happens for corporation tax when stock becomes an investment?
This is the bigger number. A disposal of trading stock that isn't made in the course of the trade is treated as a sale at market value[3]. HMRC's guidance excludes assets intended as fixed assets from the outset[3].
So there are two versions of the same scheme. If the SPV always meant to keep four houses, they were never trading stock. If it built all fourteen for sale and decided at completion to keep four, those four leave trading stock at market value.
Our four houses are worth £400,000 each. Their share of costs is £1,323,000. The deemed sale creates £277,000 of trading profit and, at the 25% main rate[7], £69,250 of corporation tax. No cash has come in to pay it. Our post on property trading vs investment explains how HMRC reads intention.
What happens when a retained house is sold later?
For capital gains, an asset taken out of trading stock is treated as acquired at the value at which it left the trading account, at the time it left[4][8]. So the deemed sale lifts the base cost to £400,000 a house.
On VAT, short tenancies don't affect the zero-rating of the first freehold sale[5]. If restricted VAT is later used for a taxable sale within six years, the developer can apply to HMRC for payback[2].
Sell the four houses after five years for £480,000 each and the result differs only in timing. The worked example below sets out the figures.
What changes the result?
When the decision is made. Intention at the outset keeps the units out of trading stock[3]. A decision at completion triggers the deemed sale.
Evidence. Board minutes, the finance terms and the letting appraisal are what show intention. Make them before the first fee is paid.
Rates. Our totals match because the 25% rate[7] is assumed for both periods. If rates change between now and the later sale, so does the comparison.
The fee split. A unit-count split is the simple answer. A floor area or cost-based split may be fairer, but it needs to be applied consistently.
An invented North West SPV with no associated companies and profits above £250,000. It builds 14 houses, sells 10 and keeps 4. All figures exclude recoverable VAT.
Site purchase: £900,000
SDLT at non-residential rates: £0 on the first £150,000, £2,000 on the next £100,000, £32,500 on the remaining £650,000. Total £34,500[9]
Build contract: £3,360,000, zero-rated[5]
Professional fees: £280,000, plus £56,000 VAT
Total costs before VAT: £4,574,500, or £326,750 a house
VAT linked to the 4 lets: £16,000, which is a cost. Retained houses then cost £330,750 each, £1,323,000 in total
Version 1: kept from the outset
Sales: 10 at £400,000 = £4,000,000, less costs £3,267,500. Profit £732,500
Corporation tax at 25%: £183,125[7]
Later sale of 4 at £480,000 = £1,920,000. Gain £597,000 on a base of £1,323,000. Tax £149,250
Total tax: £332,375
Version 2: decided at completion
Sales profit as above: £732,500
Deemed sale of 4 at £400,000 = £1,600,000, less costs £1,323,000. Profit £277,000[3]
Corporation tax on £1,009,500: £252,375
Later sale: gain £320,000 on a base of £1,600,000[4]. Tax £80,000
Total tax: £332,375
Same total. Version 2 pays £69,250 up to five years earlier, with no sale proceeds to fund it.
Keeping units is a good long-term move for many developers. The tax cost is mostly about timing, and timing is cash.
Decide before the fees start which units are for sale and which are to hold. Minute it. Run the VAT split from day one rather than waiting for a clawback. If the plan changes at completion, get a proper valuation, because that figure sets both this year's tax and the future base cost.
Common questions
Can I zero-rate the sale of a house I've let on a short tenancy?
Yes, if it's your first freehold sale or long lease as the person constructing. Short leases don't affect zero-rating, though you may need to adjust input tax[5].
Is the deemed sale a real tax charge with no cash?
Yes. Trading stock taken out of the trade other than in the course of the trade is treated as sold at market value[3]. The profit is taxed even though nothing was sold.
Does the partial exemption de minimis rule save the restricted VAT?
Only if exempt input tax is no more than £625 a month on average and no more than half of total input tax[2]. On a scheme of any size, it usually isn't.
What shows that units were meant to be kept from the start?
Contemporary evidence: board minutes, finance terms and appraisals. HMRC looks at intention through the badges of trade. See our guide to property trading vs investment.
Sources
- HMRC VAT Notice 742: land and property (paragraph 3.1). www.gov.uk/guidance/vat-on-land-and-property-notice-742
- HMRC VAT Notice 706: partial exemption (paragraphs 3.4, 11.2 and 13.7 to 13.10). www.gov.uk/guidance/partial-exemption-vat-notice-706
- HMRC Business Income Manual BIM33630: non-trading transactions in stock. www.gov.uk/hmrc-internal-manuals/business-income-manual/bim33630
- HMRC Capital Gains Manual CG67920: appropriations from stock in trade. www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg67920
- HMRC VAT Notice 708: buildings and construction (paragraphs 3.1, 4.1, 4.2.1 and 4.6). www.gov.uk/guidance/buildings-and-construction-vat-notice-708
- GOV.UK: VAT rates. www.gov.uk/vat-rates
- GOV.UK: Corporation Tax rates and allowances. www.gov.uk/corporation-tax-rates
- Taxation of Chargeable Gains Act 1992, section 161. www.legislation.gov.uk/ukpga/1992/12/section/161
- GOV.UK: SDLT rates for non-residential and mixed-use land and property. www.gov.uk/stamp-duty-land-tax/nonresidential-and-mixed-rates
Kieran Holsgrove is a Director and Co-Founder of Grafene Accounting, the property tax specialist firm based in Liverpool. He advises property developers, investors and landlords across Merseyside, Greater Manchester, Lancashire and Cheshire on tax structuring, developer VAT, SDLT and the long-view decisions that compound over the life of a portfolio.
This article is general information, not personal tax advice, and tax rules change. Your own position depends on facts we cannot see from here. Please take advice before acting on anything above.