On an office block converted into flats for sale, the tax sits in four places. SDLT at non-residential rates on the purchase. VAT at 5% on the works and 0% on the flat sales, so the developer recovers its VAT. Corporation tax on the profit. The purchase contract fixes more of the bill than most developers expect.
Key facts
- SDLT on a non-residential purchase is 0% up to £150,000, 2% on the next £100,000 and 5% above £250,000[1].
- SDLT is charged on the VAT-inclusive price, so VAT on the purchase increases the SDLT bill[2].
- A VAT1614D certificate, given before the price is legally fixed, stops the seller's option to tax applying to a building you will convert into dwellings[3].
- Builders' services converting an office block into dwellings qualify for the 5% reduced rate of VAT[4].
- The person converting can zero-rate the first sale or long lease of each new flat, provided no part was lived in during the previous 10 years[5].
What does the scheme look like?
This scheme is invented to show where the tax sits. A new development company buys a vacant four-storey office block on the edge of a North West town centre for £1.2m. The seller opted to tax the building years ago. The company converts it into 14 flats and sells each one on a long lease.
The company has no other companies under common control. It prepares 12-month accounts. Every figure below is illustrative.
How much SDLT does the developer pay on the purchase?
At completion the building is an office. So non-residential rates apply, whatever the planning consent says. The rates are 0% up to £150,000, 2% on the next £100,000 and 5% on the rest[1]. On £1.2m that's £49,500.
The residential surcharges don't touch this purchase. We cover the timing risk on permitted development schemes in our post on PD conversions.
One point people miss. SDLT is charged on the price including any VAT[2]. If VAT lands on the purchase, the SDLT goes up with it.
Why does the seller's option to tax matter before exchange?
The seller opted to tax, so by default the sale carries 20% VAT. That's £240,000 on £1.2m.
The fix is a VAT1614D certificate. The buyer confirms it intends to convert the building into dwellings. If the seller receives it before the price is legally fixed, the option to tax does not apply to the sale[3].
Without it, the developer pays £1.44m. The VAT is usually recoverable because the flats will be zero-rated. But the SDLT is now worked out on £1.44m, which gives £61,500. That extra £12,000 is a pure cost. The cash flow hit on the £240,000 comes on top.
What VAT applies to the works and to the flat sales?
Converting an office block into flats is a qualifying conversion. The contractor should charge 5% on its conversion services[4].
On the sale side, the first grant of a major interest in a dwelling created from a non-residential building is zero-rated when made by the person converting[5]. The relief sits in Group 5 of Schedule 8 to the VAT Act 1994[6]. A long lease counts as a major interest[5].
Zero-rated sales are taxable supplies. So the company recovers the 5% VAT on the works and the 20% VAT on professional fees. The condition to watch: the building, or the part in question, must not have been used as a dwelling in the 10 years before the sale[5].
How is the development profit taxed?
The company is building flats to sell. That's a trade, and the flats are trading stock. The profit is charged to corporation tax.
The main rate is 25%. The small profits rate is 19% for profits up to £50,000, with marginal relief between £50,000 and £250,000[7]. Those thresholds are divided between associated companies. A developer with four other trading SPVs under common control will hit the main rate much sooner. We explain that in our post on associated companies.
Residential Property Developer Tax adds 4% on residential development profits above a £25m annual allowance[8]. A scheme this size is nowhere near it.
What changes the result?
No VAT1614D. £12,000 more SDLT and £240,000 of cash out until the VAT return is repaid.
A flat that was lived in. A caretaker's flat on the top floor, used as a home in the last 10 years, fails the non-residential test[5]. The sale of that unit isn't zero-rated, and the VAT on its share of the costs gets harder to recover.
Keeping flats to let. Letting a flat is normally exempt from VAT[9]. If the company keeps 4 of the 14 flats, roughly 4/14 of the VAT on costs relates to exempt supplies. Here that's about £28,600 that may not be recoverable.
The builder charges 20%. On £1.4m of works that's £280,000 of VAT instead of £70,000. HMRC treats VAT charged at the wrong rate as not recoverable, so you can reclaim only 5% and must recover the rest from the contractor.
Associated companies. They shrink the marginal relief band and move more profit into the 25% rate[7].
All figures are invented.
Purchase: £1,200,000, VAT1614D served in time, so no VAT.
SDLT: £0 on the first £150,000, £2,000 on the next £100,000, £47,500 on the remaining £950,000. Total £49,500[1].
Conversion works: £1,400,000 plus 5% VAT of £70,000, recovered.
Professional fees: £150,000 plus 20% VAT of £30,000, recovered.
Finance costs: £180,000.
Sales: 14 flats at £235,000 each, zero-rated. Total £3,290,000.
Profit: £3,290,000 less £1,200,000, £49,500, £1,400,000, £150,000 and £180,000 gives £310,500.
Corporation tax: the profit is above £250,000, so the main rate of 25% applies to all of it[7]. Tax is £77,625.
Same scheme, no certificate: the price becomes £1,440,000 with VAT. SDLT rises to £61,500. Profit falls to £298,500 and the company waits for £240,000 of VAT to come back.
On office conversions, the numbers are mostly set at heads of terms. Ask the seller whether it has opted to tax. Serve the VAT1614D before the price is fixed. Confirm in writing that no part of the building has been lived in for 10 years. Then agree the 5% rate with the contractor before the first valuation.
If you might keep some flats to let, decide early. The VAT recovery depends on what you intend when you incur the costs, and changing your mind halfway through is expensive.
Common questions
Does an office bought for conversion pay residential SDLT?
Not if it is still an office at completion. SDLT follows the building's use on the effective date, so non-residential rates of 0%, 2% and 5% apply[1].
When must the VAT1614D be given?
Before the price for the sale is legally fixed, which in practice means before exchange[3]. A certificate handed over at completion is too late.
Can the builder zero-rate an office conversion?
No. The builder's conversion services are reduced-rated at 5%[4]. Zero-rating applies to the developer's first sale or long lease of each flat[5].
What if part of the building was a flat before?
That part only counts as non-residential if nobody lived in it as a dwelling in the 10 years before the sale[5]. Check the history of every floor before you buy.
Sources
- GOV.UK: SDLT rates for non-residential and mixed-use land and property. www.gov.uk/stamp-duty-land-tax/nonresidential-and-mixed-rates
- HMRC Stamp Duty Land Tax Manual SDLTM03800: interaction with VAT. www.gov.uk/hmrc-internal-manuals/stamp-duty-land-tax-manual/sdltm03800
- HMRC VAT Notice 742A, paragraph 3.4: buildings for conversion into dwellings and form VAT1614D. www.gov.uk/guidance/opting-to-tax-land-and-buildings-notice-742a#buildings-for-conversion-into-dwellings
- HMRC VAT Notice 708, section 7: reduced rate for residential conversions. www.gov.uk/guidance/buildings-and-construction-vat-notice-708#section7
- HMRC VAT Notice 708, section 5: zero rating conversions of non-residential buildings. www.gov.uk/guidance/buildings-and-construction-vat-notice-708#section5
- Value Added Tax Act 1994, Schedule 8, Group 5. www.legislation.gov.uk/ukpga/1994/23/schedule/8
- GOV.UK: Corporation Tax rates and allowances. www.gov.uk/corporation-tax-rates
- HMRC Residential Property Developer Tax Manual RPDT01100. www.gov.uk/hmrc-internal-manuals/residential-property-developer-tax-manual/rpdt01100
- HMRC VAT Notice 742, paragraph 3.1: exempt supplies of land and property. www.gov.uk/guidance/vat-on-land-and-property-notice-742
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.