“The 2(c) test”
The construction of a new house is zero-rated for VAT purposes when the house falls within the statutory definition of a building “designed as a dwelling”. In particular, VAT Act 1994, Schedule 8, Group 5, Note 2(c) means there cannot be zero-rating unless “the separate use, or disposal of the dwelling is not prohibited by the term of any covenant, statutory planning consent or similar provision”.
The purpose of the test
Take the example of a farmer who wants to build a bungalow for his daughter and son-in-law close to his own farmhouse. Often the planning authority will require him to enter into a s106 agreement stipulating that the bungalow will only be occupied or sold in conjunction with the existing farmhouse. In those circumstances 2(c) is not met and the construction of the bungalow will be standard-rated. The rationale is easy to follow as the bungalow is in reality an extension of an existing building.
HMRC pushes the boundaries
A builder client of mine recently had direct experience of a Revenue policy that for some time has been successfully limiting the scope of zero-rating by invoking 2(c) in situations where I would doubt that it was ever meant to apply.
The client had a contract to build a new headmaster’s house for an independent school that I shall call Marygreen School, to protect the innocent. The planning permission included the following clause, referred to hereafter as the problem clause:
“The occupation of the dwelling shall be limited to a person solely or mainly working for Marygreen School, and to any resident dependants”.
A visiting officer assessed my client on the basis that the 2(c) test had not been met and its supply of construction services should have been standard-rated. While their contract enabled them to recoup the VAT from the school, they were left with a suspended penalty hanging over their head.
What did HMRC’s guidance say?
Having looked at Notice 708, the client found HMRC’s reaction confusing. The problem clause appeared to be an occupancy restriction of the kind that the Notice said was compatible with zero-rating. Asking whether an occupancy restriction failed the 2(c) test, the Notice says:
“It will depend on the wording but if all it does is restrict the occupancy of a building to a certain type of person such as persons working in agriculture or forestry or to persons over a specified age, the answer is No”.
A difficulty arises because Notice 708 also says that, on the other hand, there is a problem “if the wording of the restriction prevents the building from being used separately from another building or from being sold (or otherwise disposed of) separately from another building”.
But the problem clause did not impose such a restriction. What did case law say?
Cases in the Upper Tribunal
The leading cases are Roy Shields and Burton. Both concerned DIY builders’ claims but test 2(c) still applied.
Roy Shields turned on the planning permission for the construction of an equestrian facilities manager’s residence that limited the occupation of the dwelling to “a person solely employed by the equestrian business at 274 Bangor Road, Newtownards, and any resident dependants”.
The Upper Tribunal decided that a term that prohibited use for a particular activity or a general restriction based on the occupation of the occupant did not contravene 2(c). What did fail the 2(c) test was any condition prohibiting use or disposal that was separate from the use or disposal of other land (or buildings on that other land). The restriction in Roy Shields was not a general restriction but referred to employment in a specific business at a specific address. Therefore, it failed the 2(c) test and no DIY claim was possible.
In Burton, planning restricted the occupation of the dwelling to an employee or former employee of Park Hall Fishery, creating what the Upper Tribunal referred to as the “required link to specific land or premises” that meant that the 2(c) test was not met, and a D-I-Y claim was not available.
Application to Marygreen
Any school is an institution and not a building. Marygreen is an independent school with a name that does not tie it to its current location. Therefore, the Trustees could move the school to another site if they chose to do so. Such a move would not be unprecedented. For example, my own school moved from London to Godalming (albeit in 1872).
Nonetheless, the reviewing officer was satisfied that the “planning permission document’s mention of Marygreen School [did] link the restriction on the Headmaster’s house to the school building/site and therefore separate use [was] prohibited”.
While the officer had arguably used the correct test, this succinct decision overlooks the reality that a school is more than a building or its site.
Lessons to be learned
HMRC’s pursuit of cases like this one seems unnecessary and to miss the purpose of 2(c). The cost of litigation means that the published decisions are probably only the tip of the iceberg and HMRC may well be succeeding even more widely in this campaign to restrict zero-rating.
Builders must take care to review the VAT liability of their supplies whenever a project involves unusual planning conditions. Where their clients are institutions unable to recover VAT (such as schools or churches), those clients need to budget for an additional cost when building new houses or flats for their staff: if not the additional VAT, then the cost of litigation.