If residential units are created from existing residential then the onward sale is exempt as there cannot be a zero-rated initial grant, because it had been subject to a grant previously as residential.

However, HMRC had agreed that some of the flats were zero-rated as they were converted from areas of the property that had not been previously used for residential purposes in the 10 years prior to conversion.  This zero-rating is available under Group 5 of Schedule 8 of the VAT Act 1994.

Another section of the law (Group 6 Item 1 of Schedule 8 of the VAT Act 1994) enables zero-rating where the property is a protected building and that the person making the grant has been involved in  ‘substantially reconstructing’ the property.

The issue was whether the property had been substantially reconstructed, so that sale of the long leases of the remaining flats could also be zero-rated (with VAT recovery) rather than exempt (with no VAT recoverable).

HMRC said that the retention of the main staircase, marble lined corridors, a chapel and most floor slabs meant that the property had not been substantially reconstructed. The tax payer contended that due to the construction method, the retention of the floor slabs was necessary to stabilise the outer walls.

The Tribunal also considered the issue of fiscal neutrality (see our DIY article here ) – that is if the supply of the flats was exempt they would have a different VAT treatment (and potentially pricing) to that of a zero-rated newly constructed flat. The Tribunal noted neither party raised the issue of differing VAT treatments within the same property.

The Tribunal took it no further as the issue of fiscal neutrality should be only envisaged between competing traders and here all the flats were being supplied by one business.

The Tribunal agreed with HMRC that the supply of the majority of the “new” flats were exempt so the associated input tax could not be reclaimed. Creating a potentially substantial cost for the taxpayer.

This again shows the complexities of the interaction of VAT and property; should you have any questions about property projects please talk to the RL VAT team.