We are aware that HM Revenue and Customs (HMRC) has recently withdrawn statutory clearances provided to several contractors in relation to the zero rating of remediation works. Whilst the withdrawal of the clearances is from a current date and the zero rating of the projects concerned may therefore be unaffected, this will impact those projects where a specific clearance has not been obtained and the works have been completed in the last four years. It also throws into doubt whether zero rating can be applied to future projects.
In June 2019 following tragic fire at Grenfell Tower, HMRC provided guidance as to when remediation works could qualify to be taxed at the zero rate. This was in the form of a memo from the VAT Policy Reliefs Team to the Joint VAT Consultative Committee. This stated the following:
“Prerequisite for VAT relief on building work done as snagging
HMRC have advised that their approach to this matter has not changed, and that the guidance provided is still extant.
What is interesting is that during a recent Land and Property Advisor Group meeting there was a clear difference of opinion between HMRC and several of the advisors regarding what clauses within the construction agreement were required to meet criteria 2 above. HMRC believed the works needed to be delivered under an obligation to rectify a defect/problem via an appropriate retention clause. Whereas some of the advisors in the room believed businesses should be able to rely upon clauses relating to the rectification of latent defects.
Retention clauses provide for usually up to 3-5% of the contract sum of each payment made under a construction contract to be withheld to ensure that works under the construction contract are completed to the required standard, and where this is not the case for any problems that are identified to be rectified as quickly as possible. This is also commonly known as Snagging.
Once these defects have been rectified then the sums retained are released. The defects liability period is a period following practical completion during which a contractor remains liable under the building contract for dealing with any defects which become apparent. Depending on the form of contract, it may also be referred to as a rectification period or defects correction period. A defects liability period is usually a period of around six or 12 months, but it can vary depending on the contract used. Any defects or faults which arise during this period (for example – due to defective materials or workmanship) must be put right by the contractor at its own expense.
It is worth noting that a defect which is not discovered until after the defects liability period has expired is still a breach of contract for which the contractor is liable (subject to limitation arguments). In these circumstances, the contractor has no right to return to the site to repair the defect but is liable to the customer for damages. Latent defect clauses usually provide protection for the customer should a defect arise after practical completion and typically provide protection for 10 -12 years.
What is clear is that HMRC sought to limit VAT relief to only those situations where the works could be viewed as snagging.
The rational for the recent withdrawal of the statutory clearances appears to be that:
We recommend that all housing associations who have procured replacement cladding or other fire remediation services in the last four years where zero rating has been applied review the fact pattern to determine if the circumstances are aligned with HMRC’s guidance.
The key questions to ask are:
Depending on the answers, the organisation will then need to consider what actions (if any) are required to manage, and if applicable, mitigate the associated tax risk. Specialist tax advice may be required.
For those about to embark on such projects in the future, if the works relate to the installation of replacement cladding or replacement cavity wall/roof insulation, and the primary function of the materials being installed is to improve the insulation of the building, the works should qualify for zero rating in their own right – installation of qualifying energy saving materials, provided the installation takes place during the period 1 April 2022 to 31 March 2027. If, however, the remediation works relate to resolving another type of defect, for example the improvement or installation of fire breaks within party walls, roof voids etc, then the fact pattern needs to be in line with the afore mentioned guidance for zero rating to apply.
In the meantime, the NHF together with support from RSM will seek to clarify with HMRC whether they will only accept that zero rating applies if the works are undertaken as a requirement of retention clause provisions, or if they are prepared to accept that protections afforded via latent defect clauses are also sufficient.
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