We are aware that HM Revenue and Customs (HMRC) has recently withdrawn statutory clearances provided to several contractors in relation to the zero rating of remediation works.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.
Background
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
- Remedial work must have been part of the initial qualifying zero-rated construction or qualifying reduced rated conversion of a building.
- The remedial work must be connected to the original build, via a retention clause in the contract to carry out damages or an ongoing dispute advising that the works had not been completed.
- The person commissioning the remedial work must have a ‘person constructing status’ for the initial construction.
- The remedial work is done as soon as possible.”
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.
Recent HMRC correspondence
The rational for the recent withdrawal of the statutory clearances appears to be that:
- The building in question was no longer in the course of construction by virtue of the fact that a certificate of completion had been issued (the building was signed off by local authority building control as being compliant with the relevant Building Regulations in place at the time) and the building had been occupied in the intervening period.
- The remediation work was undertaken post completion and was not undertaken by the original contractor.
- The period of time between the completion of the building and the remedial works was such that it could not be evidenced that there was a temporal link between the services provided and the construction of the building which would ordinarily be the case in order for the services to be viewed as “snagging”.
Recommendations – historic and future projects
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:
- Did the housing association originally commission the construction and as such has “person constructing status”?
- Were the works part of the initial qualifying zero-rated construction or qualifying zero/reduced rated conversion of a building? For example, was the cladding part of the original building/conversion specification?
- Is the contractor rectifying the problem under the terms of a retention clause within the contract or under latent defect clauses?
- In relation to the problems identified, had they been known at the time that the certificate of completion was issued, would the local authority building control still have completed the certification process?
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.
