What is vat for building work?

In the case of builder services subject to 5% VAT, there is an extra ‘win’ because the reduced rate also applies to any materials provided by builders as part of their work. So, if a plumber supplies labour and materials to fit a new bathroom suite, the entire job will be subject to 5% VAT if the labour charge qualifies for the lower rate.

Materials purchased on a stand-alone basis from, say, builder merchants are always standard rated. It is therefore logical for property owners to buy materials through their chosen builders and save 15% VAT, as long as the builder doesn’t wipe out the VAT saving by applying a mark-up of 16% or more for the materials in question.

I recently read that a stone-built church is being sold in Scotland, and it was described as having ‘potential for development or conversion’. The logical outcome is that the church will be purchased by a property developer and converted into flats which will then be rented out or sold when they are complete.

This is the first situation when builder services will qualify for 5% VAT, when a non-residential building is converted into either dwellings or a building that will be used for a ‘relevant residential purpose’. Dwellings include houses, bungalows, apartments and bedsits (see VAT Notice 708 para 14.4 for the conditions of a ‘dwelling’). Buildings to be used for a relevant residential purpose include homes for elderly people, and student and nursing accommodation. In the case of relevant residential purpose work, the builder must be given a certificate by the property owner (see VAT Notice 708 para 18.1).

Residential conversions are very common in our big cities; for example, the Northern Quarter in Manchester has many apartments that used to be factories and warehouses. Barn and office conversions are also popular (see Office converted into flats).

Imagine that you have purchased a detached house, and intend to convert it into two semi-detached houses and hopefully sell them for a profit. The sale of the houses will be exempt from VAT, which means there is no scope to reclaim input tax, even if you are VAT registered. However, the work carried out by builders will again be subject to 5% VAT because the project is producing a change in the number of dwellings; i.e. from one to two.

My emphasis of the word ‘change’ is deliberate. The 5% rate also applies if the number of residential units is reduced with a project; e.g. two semi-detached houses are converted into one detached house. This is perhaps surprising because the purpose of the 5% rate has always been to increase the number of habitable dwellings on our shores. But it is the change in number that attracts the lower rate of VAT (see VAT Notice 708 para 7.3).

If a project involves building work being carried out on a block of apartments, the number of units is always considered on a floor-by-floor basis. So, if a block consists of 12 apartments before a project starts – four on each of three different floors – and ends with the same number but two on the ground floor, six on the first floor and four on the second floor, the building work will be subject to 5% VAT in relation to work on the ground and first floors. However, work on the second floor will be standard rated because the number of units is unchanged (see VAT Notice 708 para 7.3.1).

The third situation when building work will qualify for 5% VAT is when a residential property has been empty for at least two years; i.e. not lived in during that period of time. However, there is an extra hurdle: the builder(s) carrying out the work will need proof of the empty period, such as council tax information, electoral register data, housing office records, and so on. The evidence must be from a third-party source. It would not be acceptable for the property owner to sign a statement stating the property has not been lived in for at least two years, or ask his accountant or solicitor to write a letter on his behalf.

As an amusing aside, HMRC helpfully confirms in its guidance that illegal occupation of a property by squatters is ignored for the purpose of the two-year window. Was this ever in doubt? Hopefully not (see VAT Notice 708 para 8.3.3).

Professional fees are always subject to 20% VAT; e.g. the services of architects, surveyors and project managers. A potential VAT planning solution is for the professionals to provide their services directly to the builder in cases where a 5% project applies to building work; and then the builder’s contract to the property owner is for a ‘design and build’ service, which attracts a 5% VAT rate on the entire fee, including materials and professional fees (see HMRC VAT Manual VCONST02720). See VAT saving on professional fees: design and build.

Builders often know some basic rules about VAT but struggle with the finer points of the legislation, similar to a teenager on holiday in Paris trying to get by with a bit of half-remembered GCSE French. Here are four important facts that are often misunderstood:

If a builder is working for a property owner and the building will be used for either a ‘relevant charitable purpose’ or a ‘relevant residential purpose’, the owner must issue a certificate to the contractor confirming the intended use of the building to support any 0% or 5% rates of VAT. But certificates are not necessary for any work carried out on dwellings (see VAT Notice 708 para 17.1).

With work carried out on dwellings, if the project qualifies for the reduced rate of VAT, the same rate is charged by all builders carrying out work; i.e. subcontractors working for other builders, as well as the main contractor working for the owner.

If a builder invoices another builder, and the builder receiving the invoice is both registered for VAT and CIS, the reverse charge has applied to these invoices since 1 March 2021. In other words, the first builder does not charge VAT on his sales invoices, and his customer accounts for the VAT in Box 1 instead, also claiming input tax in Box 4. The reverse charge applies to construction services subject to 5% and 20% VAT but – quite logically – not zero-rated services.

Standard rate of VAT – 20%

Generally, plumbers charge VAT at 20% on:

Reduced rate of VAT – 5%

In some cases, plumbers can charge VAT at 5% on:

Zero rate – 0%

There will be 0% VAT for services such as:

You can check the details of any projects with the list on HMRC’s website to be sure you have invoiced the correct rate.

When do you need a certificate for 5% VAT on building work?

VAT for most work on houses and flats by builders and similar trades like plumbers, plasterers, and carpenters are charged at the standard rate of 20% – but there are some exceptions.

Building work can be charged at 5% in the following circumstances:

There is a VAT notice which has the exact details and whether or not the 5% rate can be used is a matter of fact, not opinion. HMRC will not give specific clearance, they will refer you to the rules and ask you to check the rules with your builder for your project. The property owner doesn’t issue a certificate (as would be needed for Zero Rating), it is for the builder/developer to determine whether and on what the 5% VAT rate can be applied.

The only exceptions (when a reduced rate certificate would be needed) are

The builder may not have to charge VAT on some types of work if it meets certain conditions, including building a new house or flat or carrying out building and related work for disabled people in their home.

For work on a new house or flat to be zero-rated for VAT, it must qualify as a genuinely new, self-contained house or flat. This means:

There may also be situations where you may not have to be charged VAT on alterations made to a disabled person’s home, or certain equipment supplied for their personal use. To be zero-rated for VAT, the work being done needs to be for someone with a:

Someone who’s temporarily disabled or incapacitated, or elderly and frail but not disabled, doesn’t qualify.

For more information and/or assistance, please do not hesitate to contact me at the email address below or phone our Tax Team

Buying an under construction flat is most taxing for any buyer. In my post on Resale Flat or Under Construction Flat, Which is better? i discussed pros and cons of under construction flat. Builders attract buyers with attractive offers of Rs 2999* psf or Rs 3999* psf only. The “star” next to price point makes all the difference. A buyer is caught unaware of miscellaneous charges attached to under construction flat. Though with the time, things have changed and now reputed builders disclose most of the charges associated with under construction flat. Still small and unorganized builders which contribute max inventory keep customers in dark. Dream of owning a house is still a dream for many and in order to bring affordability factor, most of the additional charges are not disclosed to the end user. One such monster is VAT (Value Added Tax) and Service Tax levied on the under construction flats. For many of my clients this is the only souring point with the builder for under construction flat.

As per ruling of Honorable Supreme Court of India, the sale of under construction flat / property is liable to pay VAT. State Govt’s are quite happy with this decision as VAT helps to generate additional revenue because VAT is a state subject. Service Tax is paid to the central government. VAT and Service Tax increase the total cost of under construction flat. Let me clarify that VAT and Service Tax are not applicable for “Constructed Property”. It is only applicable for under construction flat. Secondly, VAT may vary from state to state as it is state subject but service tax is uniform across country i.e. 12.36% as it is fixed by Govt of India.

Honestly speaking its a Grey area and no one knows how it is getting calculated. Recently i visited few builders and checked with them and they are also not aware :). Simple answer i received was that VAT and Service Tax is Rs X. One of them candidly told me that their finance team is calculating VAT and Service for under construction flat based on what is beneficial for him :)

Let me explain, There are 2 different methods of calculating VAT and Service Tax for under construction flat

Method 1

If total project cost is apportioned flat wise then there are 3 cost components of any under construction flat. These 3 cost heads are Land Cost (approx 35%), Material Cost (approx 40%) and Labour + Service Cost (approx 25%). Cost break up may vary from project to project but on an average cost break remains approximately the same as shared by me. You can get this break up from builder for an under construction flat though builders are reluctant to share. Some exceptions are like High Land cost in cities like Mumbai and Delhi or High Material Cost due to transportation in upcoming cities.

VAT is applicable only on Material cost @ 14.5% and ST is applicable only on Labour & Services Cost @ 12.36%. Please note that VAT may vary from state to state. In this post i have taken VAT as applicable in state of Karnataka for reference.

Lets understand with an example:

Assuming Person A bought an under construction flat with base cost of 50 lakh i.e. excluding amenities, club house charges, PLC, deposits etc. In this case, builder will apportion 50 lakh under 3 heads for under construction flat i.e. Land Cost, Material cost and Labour + Service Cost. The break up for under construction flat is as follows

Land Cost: 15 Lakh

Material Cost: 23 Lakh

Labour + Service Cost: 12 Lakh

Material Cost + Labour + Service Cost is collectively referred as Construction Value

Now applicable VAT and Service Tax will be as follows for under construction flat in Karnataka

VAT = 14.5%  X  Rs 23,00,000 = Rs 3,33,500

Service Tax = 12.36%  X  Rs  12,00,000 = Rs 1,48,320

Total VAT and Service Tax will be Rs 481820

Method 2:

In 2nd method, instead of calculating head wise cost for under construction flat, VAT and Service Tax is calculated on Total contract value of the flat. This value is amount mentioned in agreement value or registration value / value for stamp duty purpose, Whichever is higher. Let’s check how it is done

VAT: In case of VAT, many states have launched composition scheme for real estate developers e.g. Haryana, Maharashtra etc. Under composition scheme, builders are free to pay VAT at X% on Total Contract Value. This X% is normally 1% (e.g. Haryana and Maharashtra) for most of the states.

Service Tax: Similarly Service Tax under composition scheme is 3.09% of Total Contract Value for under construction flat. It basically means that service tax of 12.36% will be charged on 25% of total contract value, if the total contract value is less than 1 Cr or flats are below 2000 sq ft. Therefore 25% of 12.36% is basically 3.09% of total contract value.

In case under construction flat is costing 1 Cr and more or under construction flat is more than 2000 sq ft in area then service tax applicable is 3.71%. For such cases, Service tax is charged at 30% of total contract value. Therefore 30% of 12.36% is 3.71% of total value. Only condition is that agreement is signed after March, 2013

In continuation of our example, VAT in Karnataka is 5.5%. For under construction flat costing less than 1 Cr in karnataka, VAT + ST = 8.59% of total cost (5.5% VAT + 3.09% ST). For 50 lakh flat, VAT and Service Tax will be Rs 429500

Method 2 is financially more beneficial in our example but not always. It depends on break up of cost. For states like Maharashtra, Haryana, AP etc where VAT is 1% under composition scheme Method 2 is financially more beneficial.

Million Dollar Question: Who will pay the VAT and Service Tax?

Unfortunately, NO one would like to bear this additional burden. There is no specific guidelines on this. Buyers say that as per court ruling it has to be paid by the builder for under construction flat. Let me clarify, responsibility of builder is to deposit the VAT and Service Tax with govt. It doesn’t mean he has to deposit from own pocket. Therefore it all boils down to what is being mentioned in the agreement between builder and the buyer. If you wish to avoid paying VAT and Service Tax kindly insist on mentioning the same in your agreement with the builder.

Important Points:

1. Land cost is exempted from both VAT and Service Tax

2. Total contract value include value of land under composition scheme. Some builder exclude value of land citing it is exempted from VAT and Service Tax. Please note VAT and Service Tax under composition scheme include value of land i.e. it is part of Total Contract Value.

3. VAT and Service Tax is not applicable on Ready to Occupy flats. You may postpone sale agreement to be signed after completion certificate is issued. In short, if completion certificate is issued then VAT and Service Tax is not applicable for so called “under construction flat”.

4. Builder will issue 2 separate payment receipts i.e. one each for VAT (with Tax Invoice no and TIN) and ST (with Tax Invoice No and ST registration no).

5. VAT & Service tax should be specifically mentioned in the sale agreement and which party will bear this cost

6. Service Tax is not applicable on single residential unit i.e. independent house, villa or bungalow

7. Service Tax is not applicable for low cost housing with carpet area of upto 60 sq. mt. per house in the housing complex but subject to approval from concerned authorities

8. Service Tax on Amount paid towards Amenities, PLC etc will be 12.36%. Service tax on these cost heads will not be calculated under composition scheme and Service Tax of 12.36% will be payable on actuals.

Work carried out by builders is sometimes subject to 5% VAT rather than 20%, a big saving for property owners who cannot claim input tax.