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HMRC internal manual

VAT Partial Exemption Guidance

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HM Revenue & Customs
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Other Partial Exemption issues: changes in intention or use: property example

A property developer buys a building on which the seller has opted to tax. He intends to demolish the building and build houses on the land, which he proposes to sell. The sales will be taxable at the zero-rate, and he therefore recovers the input tax on the building and legal costs incurred in buying it.

In the event he is unable to obtain financing for the building programme and decides not to build the houses but to sell the building instead. If he has made no option to tax, the supply of the building will be exempt. If the decision not to build houses takes place within the same tax year as the initial deduction, the longer period adjustment at the year end will require the business to reconsider his input tax claims during the year and reattribute as a result of his change of mind.

If however at the year-end he still intends to build the houses, he will be entitled to the input tax at that time.

If the change of intention takes place after the year-end but within 6 years of the tax quarter in which he first made the input tax deduction then he will have to repay the input tax claimed. The repayment is due in the quarter that the change of intention takes place. The original deduction should remain untouched since at the time that it was deducted the attribution was correct. If, at the time of deduction, the business was partly exempt and using a partial exemption method that relied on the values of input tax to determine the deductible proportion of the residual input tax, the business would also have to rework the previous partial exemption calculation for the relevant annual adjustment replacing the original value for taxable input tax with the revised value. The result of any such adjustment should be entered on to the return covering the time at which the change in intention occurred. The business would also have to re-measure the annual adjustment for de minimis. Any resulting adjustment would be entered on the return in which the change in intention was made.

In addition to the need to revisit any VAT directly attributable to the intended supplies (usually on capital costs), anyone using an inputs or input tax-based method must also review the calculations carried out in the intervening tax periods and tax years since residual input tax apportioned in this fashion has been indirectly attributed to those intended supplies. This can be difficult to do in practise. [For some businesses, it may be appropriate when negotiating a method to agree whether retrospective adjustments should be carried out or not.]

Where a business recovers tax based on an intention to build houses and, in the event, is unable to sell the houses immediately he can be under some pressure from financing companies for some return on their investment. The situation in the Curtis Henderson case where the houses were rented out temporarily while a buyer was found occurs from time to time.

In such cases clawback will be triggered but will not require a complete reversal of the input tax claim if the business retains an underlying intention to sell the houses.

This means that at the time of the change of intention, (at least by the time that the first exempt supply of rent is made) the business will have to make some adjustment to his previous input tax deduction to reflect the change. You may come across cases where no adjustment has been made. The default for the adjustment is to apply the PE method applicable at the time the input tax was incurred, but this may not give a true reflection of the overall use and intended use of the property. Evaluation of the new intention can be difficult in that it is often not known how long the exempt supply of renting will continue.

Provided that you are satisfied that the overriding intention is genuine, and the method applicable at the time the input tax was incurred does not give a fair and reasonable reflection of the proportionate use of the property, you should invite the business to submit proposals as to how the adjustment should be made. Possibilities would include comparison on the basis of the time or value. On a practical basis this can be difficult to determine with any certainty. In such instances we would recommend a broad-brush approach agreeing the most practical basis of adjustment that you are able to secure. Any adjustment should be a one-off; any on going adjustment would in effect be a version of the Capital Goods Scheme, which is not appropriate for properties below the set limit of that scheme.