Housing Associations: Don’t forget tax if you are considering changing the tenure mix

Over the last few weeks, an already uncertain market for shared ownership and open market sales has become even more challenging. As a result many housing associations have been reassessing the tenure mix they were proposing for developments in progress. Changing the tenure mix can alter the tax treatment greatly, and an association may find itself facing a large, unexpected tax bill. It is essential that any tax adjustments are taken into account when plans are being reassessed.

Take an example where a housing association has paid £5 million plus £1 million of VAT for some land on which it was planning to construct 75 units for shared ownership and 25 units for rent.

The first-tranche sales of shared ownership units are zero-rated for VAT. Renting is exempt from VAT. This means that the development as a whole is intended to generate both zero-rated and exempt income and any VAT incurred on the development as a whole is partly recoverable.

Most associations in this position will have agreed a VAT recovery method with HMRC based on each development’s unit numbers or floor area. This means the association would have been faced with a VAT cost of around £250,000 on this scheme.

At this point, the association would probably have considered the options available to buy the land more VAT-efficiently.  However, these options usually mean paying elsewhere. There may be additional legal, SDLT, or financing costs, or a need to compensate the buyer for additional costs that they will suffer. Over the last few years, advising on similar schemes, we have found that the most efficient option has often been simply to stick to the original plan and suffer some VAT cost.

What if the current market conditions mean that the association has now concluded that it should change the tenure mix to 25 shared ownership and 75 for sale? This will come with a substantial VAT cost and it is essential that this is taken into account in any modelling.

How much of the VAT previously recovered will have to be repaid to HMRC will depend on a number of factors. If a property is moving from being all for sale to being partly or fully for rent, then potentially any VAT incurred in the last six years may have to be repaid to HMRC. This would include not only VAT recovered on buying the land but also on any professional fees incurred.

Where the property was always intended to be mixed tenure, but that mix is now changing, the effect should be less dramatic.  VAT incurred in the last ten years is now potentially repayable, but the effect tapers over time. In the above example, the VAT repayable to HMRC will probably not be as much as £500,000, but is still likely to be in six figures.

If some units were intended for open market sale there is further complication. In order to avoid non-primary purpose trading in a charitable housing association, the land for these units will often have been sold at an early stage to a non-charitable subsidiary.  If these units will now be for rent, they will be sitting in the wrong entity. Selling them back to the association may not be that straightforward, especially if the subsidiary would make a loss and has no reserves.

What strategies are available to mitigate this situation?

If an association has not yet acquired the land and is now getting nervous about its proposed tenure plans, it is worth looking again at the potential strategies to acquire land VAT-free. Recently we have seen sellers be a lot more open to these strategies without demanding an increase in the price.

If the group has a design-and-build company, use it for every new build project – even if this intended to be 100% for shared ownership. If a scheme then converts to rent, at least then you do not have to repay VAT recovered on professional fees. We see time and time again, groups not using their design-and-build company to its full capacity.

Commercial developers in this situation would often set-up a new company and sell any unsold units to this. The developer preserves its full VAT recovery. The new company acquires its units VAT-free and can rent these for a while until the market picks up.  Housing groups have traditionally been reluctant to do this. Loan covenants and other governance issues are unlikely to make this easy, and any strategy involving changing the ownership of a property needs to consider whether SDLT would be due. However, those facing a large VAT cost may need to look at this again.

For some, it may now be as stark a choice as sale or rent. Rent-to-buy models are providing popular in many areas. In our experience, these typically allow between 80 and 90% of VAT incurred to be recovered.

Tax should never be the driving factor for a housing association to make a decision on what properties it is developing. However, if financial models do not take account of the tax impacts of changing plans, they could lead to costly decisions being made. 

This article first appeared in Social Housing Magazine in July 2020.