Business Brief - 23/06

22 Dec 2006 01:15 PM

Contents:
1. Excise Duty: Expiry of UK Derogations from the Energy Products Directive
2. VAT: Cash Accounting Scheme -Renewal of UK Derogation 3. VAT: First grant of a major interest in residential property - attribution of input tax and the Capital Goods Scheme
4. Final Business Brief

1. EXPIRY OF UK DEROGATIONS FROM THE ENERGY PRODUCTS DIRECTIVE Under the EU Energy Products Directive (EPD), the UK holds derogations to allow reduced or exempt rates of duty on: - fuel used by private pleasure craft;
- fuel used by private aircraft; and
- waste oils reused as fuel.

All three derogations are due to expire on 31 December 2006. In October, the UK applied to the European Commission for these derogations to be extended. The Commission has now turned down the request from the UK (and other member states) for renewal of the derogations for fuel used in private pleasure craft and fuel used in private aircraft.

This means that the derogations will lapse on 31 December 2006, but in practice there will be no immediate change from 1st January 2007. We will be exploring the options for the most appropriate implementation, including timing, in the New Year. We shall be consulting stakeholders in both the boating and aviation sectors. Primary legislation will be needed to implement the new regime, and, until the law changes, the current arrangements will continue.

The Commission has not yet taken a decision on the derogation regarding waste oils.

2. VAT: CASH ACCOUNTING SCHEME - RENEWAL OF UK DEROGATION This Business Brief article explains the position regarding continued operation of the Cash Accounting Scheme after the 31 December 2006, pending renewal of the derogation on which the scheme rests.

Despite a late renewal of the derogation, the VAT Cash Accounting Scheme will continue to operate as normal. Businesses with a taxable turnover not exceeding £660,000 may continue to operate the scheme in the normal way pending the renewed derogation.

The current derogation expires on 31 December 2006 and, despite applying for renewal in 2005, the new derogation will not have been finalised by the end of this year. However, member states have agreed that the new derogation will be retroactive to 1 January 2007, meaning there is no break in the legal cover for the scheme. The expectation is that the new derogation will be approved by the Council in late January and the decision will appear in the Official Journal in February.

The VAT Cash Accounting Scheme (CAS) helps business by allowing users to account for VAT when they receive payment from their customers, rather than when they issue a VAT invoice. The scheme rules also mean that VAT on purchases (input tax) can only be recovered when a CAS user pays his supplier and this rule requires derogation from the Sixth VAT Directive.

3. VAT: FIRST GRANT OF A MAJOR INTEREST IN RESIDENTIAL PROPERTY - ATTRIBUTION OF INPUT TAX AND THE CAPITAL GOODS SCHEME

This Business Brief article confirms and explains HMRC policy regarding input tax incurred on the construction of residential property where the developer sells a long leasehold interest separately from the freehold interest.

Background
The first grant of a major interest (freehold sale or lease exceeding 21 years) in residential property by its developer is zero-rated, under VAT Act 1994, Schedule 8, Group 5. However, all subsequent grants in the property are VAT exempt. VAT on costs relating to zero-rated supplies is fully recoverable whereas VAT relating to exempt supplies is not normally recoverable.

Detailed rules on the liability of supplies of buildings are in Notice 708, on partial exemption in Notice 706 and on the capital goods scheme in Notice 706/2.

Attribution of input tax
When a residential property is constructed or results from the conversion of a non-residential property and the developer makes a first grant of a major interest in that property, any input tax incurred is recoverable in full. This is because the input tax is wholly attributed to that taxable first grant.

This is the case even where the value of the first grant does not represent full equity in the property, such as in shared ownership schemes run by housing associations.

Application of the Capital Goods Scheme (CGS)
Regulations 112(2) and 113 of the VAT Regulations 1995 set out when a building will be a capital item for the purposes of the CGS.

If a developer constructs a residential property and the first grant of a major interest in the building is a long lease, he is using the building for a business purpose other than solely for the purpose of selling the building. As a result, the developer will have to treat the building as a capital item. The input tax incurred on the construction of the building and wholly attributed to the zero-rated long lease will have to be adjusted through the CGS should a subsequent exempt grant be made of the building.

If a developer constructs a residential property and the first grant of a major interest is the sale of the freehold, the developer is using the building solely for the purpose of selling the building and will not have to treat the building as a capital item.

Examples
There are essentially three ways a developer might grant all the leases and the reversionary interest in the freehold of a residential property (typically a block of flats): -
a) All flats sold followed by the freehold - The sale of each individual flat will be zero-rated as first grant of a major interest. While the developer will hold a capital item, when the freehold is sold, we consider that this will only be exempt to the extent that it relates to those areas of the building that were previously the subject of the zero-rated grants of individual flats. Most of the sale of the freehold will be zero-rated because it relates to the common parts that have not been subject to any previous supply.

These circumstances are part of the sale of new dwellings for which the zero-rating was designed. Furthermore any CGS adjustments would be negligible. Accordingly there is no need for CGS adjustments in this example.

b) Freehold sold before any flats are sold - The sale of the freehold will be a zero-rated grant and since no leases had been granted, would not be a capital item (by virtue of Reg 112(2), VAT Regulations 1995). Since the freehold is zero-rated, all input tax incurred on the construction costs will be fully deductible.

As the new freeholder, the purchaser will normally make any exempt grants of leases to buyers of flats. Even where the consideration for such sales accrues to the developer, so that VAT law treats the developer as the person supplying the flat, this will not impact on the initial deduction of input tax by the developer. It may, however, have implications for any input tax incurred on selling costs.

c) Freehold sold after some flats have been sold - The flats sold before the freehold has been supplied will each be a zero-rated first grant of a major interest. While the developer will hold a capital item, when the freehold is sold, we consider that this will only be exempt to the extent that it relates to those areas of the building that were previously the subject of the zero-rated grants of individual flats. Most of the supply of the freehold will be zero-rated relating to the common parts and unsold flats that haven't been subject to any previous supply. As per example a) above, no CGS adjustments are needed.

If, under the agreement for sale, the developer has retained the right to receive the monies from the sale of the remaining unsold flats, the considerations set out in example b) above apply.

Other residential property
The first grant of a major interest in a relevant residential property (e.g. a care home) is zero-rated. Under Reg 116(3), VAT Regulations 1995, in determining any CGS adjustments in subsequent years, the developer disregards any exempt supply arising directly from that grant (including all rents due under that lease). Even though the developer holds a capital item, providing he makes no exempt supplies other than those arising from that zero-rated grant, he will retain full deduction of the input tax on the construction of the development.

However, if the developer makes a new grant, like selling the freehold, this is the second grant in the building and will be exempt. In this situation CGS adjustments are likely to be required and CGS calculations must be carried out.

4. FINAL BUSINESS BRIEF
This is the last Business Brief that HMRC will issue.
There has been a substantial decrease in demand for a paper product in recent years. When we consulted subscribers earlier this year their feedback was that a move to an online only service was appropriate.
An online only service means that HMRC can get information published far more quickly.

Business Briefs were originally published by the former HM Customs & Excise and dealt with changes in indirect tax policy. In the former Inland Revenue a similar publication 'Tax Bulletin' covered direct tax matters.

HMRC are taking this opportunity to combine the two publications into a single online only bulletin - 'Revenue & Customs Brief' Revenue & Customs Brief will appear in the Library section of our website http://www.hmrc.gov.uk/library.htm, and will go live from 1 January 2007.

Further information
For further information and advice, please contact HM Revenue & Customs' National Advice Service on 0845 010 9000.
The views expressed in this Business Brief are those of HM Revenue & Customs.

GENERAL ENQUIRIES:
For general enquiries please contact HM Revenue & Customs' National Advice Service on 0845 010 9000.

This release and other information about HM Revenue & Customs can be found at our website: www.hmrc.gov.uk

Business Briefs are available by subscription from the News Distribution Service, Government News Network, Hercules Road, London, SE1 7DU