fbpx

Simplified Accounting: Using Composite VAT Rates

Simplified Accounting Using Composite VAT Rates

I t is quite common for building projects to attract more than one rate of VAT on different elements of the development. For example, a three-story property in London is purchased and consists of a retail unit on the ground floor and four residential apartments on the two floors above, two on each floor. The planned development will consist of the modernisation of the retail unit, the conversion of the four flats into two high-end apartments and the building of a new fourth floor containing a third new apartment. The VAT liability of this project will depend on the work being undertaken. The refurbishment of the existing retail unit will be subject to standard-rated VAT of 20%, the work of converting the existing four flats into two apartments will be subject to 5% VAT (change in the number of dwellings) and the construction of the new apartment would be zerorated.

 

Invoicing the Project

Invoicing for projects like this can be problematic for the contractor, as they will be billing as the project progresses, normally monthly.

Each invoice will consist of elements at different VAT rates, so the contractor will need to calculate the value of each element undertaken each month and bill accordingly, which can be an administrative nightmare.

 

Composite VAT Rate

The way around this is to use a composite VAT rate, taking into account the total value of the works undertaken on each part of the project.

Normally, as part of the process, a surveyor will calculate the values of each element of the project in order to calculate what to charge. This can be used as the basis for calculating a composite rate of VAT that can be applied uniformly to each invoice, simplifying the procedure.

 

Example: VAT on Split Development Costs

The total cost of the development is calculated as being £1.2m plus VAT. This is split between:

  • Refurbishment of the commercial unit – £200,000 x 20% = £40,000.
  • Conversion of four flats into two – £550,000 x 5% VAT = £27,500.
  • Construction of new 4th floor flat – £350,000 zero-rated.
  • General works to the building – £100,000 apportioned between the various elements.

Calculation:

VAT Rate        Value               VAT

20%                £200,000          £40,000

5%                  £550,000          £27,500

Zero                £350,000            Nil

Total    £1,100,000        £67,500

£67,500/£1,100,000 x 100 = 6.14%

The average rate of VAT on the project is 6.14% and so a composite rate of 6.14% VAT is applied to each invoice issued throughout the project. Composite rates are not just used in the construction industry. For example, certain computer hardware can be designed or adapted for use by disabled people and benefit from zero-rating, so when selling a package of equipment to a disabled customer, parts can be zero-rated and other parts standard-rated; so it is possible to agree on the use of a composite rate with HMRC. To keep HMRC happy, a business should carefully document the reasoning for applying a composite rate and keep copies of the calculation to show that it is a fair and reasonable apportionment. If a business is likely to undertake a number of these projects, they should write to HMRC telling them what they intend to do, enclosing a copy of the proposed calculation and asking for confirmation that it is acceptable to use on an ongoing basis.

 

Practical Tip

If a business is undertaking a building project with mixed rates of VAT applicable, the use of a composite VAT rate can simplify administration and invoicing. Keep detailed records of the apportionment calculation, or ask HMRC to confirm the principle used.