Tax and VAT implications of remediation work: what you need to know

Remediation works required to replace defective cladding give rise to several tax questions, whether that work is undertaken by a contractor on behalf of a freeholder or management company, or by the developer itself. We explore the tax and VAT implications for developers undertaking remediation work under the DLUHC Self-Remediation Terms or the Welsh Pact, and outline the key tax-related questions stakeholders should be asking.

Who has ownership of remediation works once a freehold is sold?

When a freehold of a property is sold, the original developer no longer has an interest in the land. Although a developer may choose to carry out the remediation works, it is more likely that it will provide funding for the freehold’s owner or management company to carry out the works instead. In either scenario, cladding materials and services will need to be purchased and acquired. The first consideration for any party, therefore, will be whether VAT can be chargeable and, if so, at what rate.

What VAT-related issues should developers consider?

Whether a developer is carrying out the works itself or supplying/ funding others to do so, it is not receiving consideration for remedying the defective works. As such, developers will need to consider: 

• what the VAT treatment of its supplies and funding will be; 
• if any works it carries out itself will be treated as zero-rated; and 
• whether it can recover the VAT on materials and services attributable to those supplies.

Can freeholders or management companies recover VAT on supplies and services?

Where the developer funds the freeholder or management company, said entities will enter a contract for remediation works with the building contractor. If the contractor then charges VAT for the services and materials, the freeholder and management company are unlikely to recover the VAT, to the extent that the building is residential. As the supply is not made to the developer, it cannot recover VAT as input tax. Therefore, the funding provided by the developer must cover the VAT.

What if a change of law made remediation works zero-rated or exempt?

A change of law in future to the VAT treatment of remediation works or a change of law allowing the freeholder or management company to recover the VAT should be considered. If this occurred, all parties would need to consider whether the funding agreement should include a provision that requires the freeholder or management company to repay the part of the funding that was attributable to what was considered standard rated and irrecoverable VAT. Where a supply from the contractor were to be considered zero-rated, the funding agreement would need to require the contract between the contractor and the freeholder or management company to include a clause giving the latter the right to unwind the VAT payment made to the contractor. The agreement would then need to require the freeholder or management company to repay the sum recovered to the developer once it was repaid by the contractor.

Does the developer receive a supply from the freeholders/ management companies?

Where the remediation is undertaken by the freeholder or management company pursuant to a funding agreement with the developer, the freeholder or management company must consider if they are supplying a service to the developer. If they are, they will then need to explore: 

• the value of that service and whether they can charge VAT; 
• whether the contractor should supply its services to the developer and, therefore, issue VAT invoices to it; and 
• if that VAT is directly attributable to a taxable supply by the developer, and what proportion of VAT could be recovered under the developer’s partial exemption method.

When might the sub-contractor’s tax deduction scheme (CIS) be relevant?

If the freeholder or management company is treated as supplying the developer, they will need to consider whether their services fall within the sub-contractor’s tax deduction scheme (CIS). This will raise the question of whether a developer is considered a contractor and the freeholder or management company a sub-contractor for the purposes of the CIS, and what implications this may have.

Can a developer claim a corporation tax deduction?

From a corporation tax perspective, the developer will need to be sure that its expenditure – whether directly to the contractor or via a funding agreement with the freeholder/ management company – is deductible for corporation tax purposes. This requires the expenditure – whatever it may be – to be incurred wholly or exclusively for the purposes of the trade. Certain issues may arise here, such as whether the developer has a contractual obligation to make such payments, or whether it is making such payments to protect its reputation, brand, or share price and if this will be sufficient to attract the deduction. A contract may also be at pains to say that the developer is under no obligation to make such payments and will not admit liability for defective work. As such, the line between protecting a developer from legal recourse and ensuring a corporation tax deduction is often a delicate and complex one to navigate.