Normally the supply of residential house building, and the supply of building materials, will be zero-rated. But, there is an exception allowing the recovery of the VAT for a person who lawfully builds residential housing, provided they do not carry out those works in the course of business.

The danger here is that the building works are carried out by someone who is not VAT registered, but who is subsequently held to be doing the building as a ‘business’. In that situation, the VAT will be irrecoverable. That is what happened in a recent case where an individual had a property letting business. That business was VAT exempt, and thus he was not VAT registered. However, he then agreed, as a favour, to build a house for a friend who had a disabled child. When he came to reclaim the input tax on the building material costs it was held that he had a ‘business’ and thus he could not recover the input tax. Although his business was property letting, and not building, the tribunal held that building activities were a ‘natural extension’ of the letting business and accordingly they were performed ‘in furtherance’ of that business. In the tribunal’s view, he had used his experience and contracting contacts, deriving from the letting business, in carrying out the building projects. In those circumstances, it was difficult to distance the building project from the letting business. Thus the case is a warning about taking care to avoid a ‘natural extension’ of a business.

It is a trap to avoid. However, one answer may lie in seeking voluntary registration (which can be backdated three years). Terry v HMRC [2009] UKFTT202 (TC). Source: (subscription service).