VAT: The change of use of an asset

Andrew Needham looks at how VAT recovery on an asset alters with a change in its use. Suppose that a business purchased an asset (e.g., a building) for a project expecting to use it in its taxable business, and recovers all the VAT on the purchase. However, circumstances change and it no longer needs to use the building and decides to sell it to a housing association for redevelopment. It cannot opt to tax and so the sale is an exempt supply. The change of intention takes place two years after buying the property.

Adjustment for change of use

If the intended use of an asset changes within six years from taxable to exempt or non-business instead, the law (SI 1995/2518, reg 108) requires the original attribution to be corrected. The correction must be made on the VAT return for the period in which the use occurs, or the intention changes. If the initial attribution or apportionment of tax on an asset proves inaccurate, it must be corrected.

It’s not all bad news. Regulation 109 provides for a similar correction if the use turns out to be taxable rather than exempt or non-business. An application for refund of the tax previously disallowed must be approved by HMRC before it is claimed on the VAT return. In Really Useful Group plc (LON/91/136 No 6578), VAT was incurred on a building intended as the company’s offices.

It was then realised that it would be inadequate, and an exempt sale resulted. There had not been any use for taxable purposes by the company, so the provisional attribution of the refurbishment costs to its taxable outputs had to be corrected, and the VAT repaid. In Cooper and Chapman (Builders) Ltd v C&E Comrs ([1993] STC 1), a house was converted into ten flats, which were advertised as holiday accommodation.

Holiday lettings were achieved for only four of them. All ten were then let for a year to a single tenant. Regulation 108 did not apply to those flats which had been let for holiday accommodation, because a taxable supply had occurred. However, it was held that an apportionment was required because the VAT attributable to the six that had remained empty before being let for an exempt rent had to be paid back to HMRC.

Bad news

However, in Royal and Sun Alliance Insurance Group plc (MAN/97/916 No 16148) it was held that regulation 109 (the right to recover more VAT) did not apply if a property has been vacant and available to let for some time. Opting to tax the lease did not create a right under regulation 109 to recover input tax incurred on rents and service charges paid to the superior landlord during the vacant quarters.

Such input tax was, therefore, treated as an overhead cost recoverable according to the partial exemption calculations for those quarters. In CHA v Revenue and Customs Comrs [2009] EWHC 455 (Ch), CHA was a housing association providing mainly residential renting, which is exempt from VAT. CHA incurred input tax related to the construction of new housing for use in its business.

CHA subsequently changed its operation by inserting a new subsidiary between itself and its suppliers. Then, having raised invoices to the subsidiary for the value of work undertaken on uncompleted projects prior to this change, CHA lodged a ‘payback’ claim. They argued that input tax on costs for part-completed projects incurred prior to the change were not used as originally intended and were now attributable to a taxable supply from CHA to the new subsidiary. HMRC rejected the claim on the grounds that there were no supplies of services between CHA and its subsidiary, but lost in the High Court.

Practical tip

If a business buys an asset and the intended use changes before it puts it to use, and within six years of purchase, an adjustment to the VAT reclaimed will be required.

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