This note sets out the VAT treatment of construction work and the UK's discretion in setting VAT rates under EU law, before looking at the debate on harmonising VAT rates on all types of construction work.Jump to full report >>
One of the more complicated areas of VAT law, as well as one of the more contentious, is the treatment of construction work. The construction of new buildings is charged a zero rate of VAT, provided the supply in question is for a social purpose: in effect, this means that only the construction of new houses, dwellings and buildings with a charitable purpose is zero-rated. Generally VAT is charged at the standard rate - currently 20% - on repair, renovation and maintenance work whatever the status of the building concerned.
The case for setting a uniform rate of VAT across all types of construction work has been made quite often, usually on the grounds that this would be an effective tool to encourage urban regeneration, removing an important disincentive for developers to refurbish empty properties.
The UK’s discretion in determining the structure of VAT, as with all Member States, is limited by European VAT law. The harmonisation of VAT systems across the EU has been seen as an important part of achieving a Single European Market for many years. In October 1992 the European Council agreed Directive 92/77/EEC which established new rules regarding VAT rates. In brief, Member States are required to apply a standard VAT rate of 15% or more and have the option of applying one or two reduced rates, no lower than 5%, to certain specified goods and services. One item on this list is the “provision, construction, renovation and alteration of housing, as part of a social policy.” Member States may continue to charge any lower rates, including zero rates, that were in place on 1 January 1991, though they cannot introduce any new rate under 5%.
In 2001 the Labour Government introduced some changes to the VAT liability of construction work. First, a new reduced rate of 5% was introduced for conversion or renovation work on some types of residential building from 12 May 2001. Second, the coverage of the existing zero rate on the construction of new buildings was extended to the sale of a renovated house empty for 10 years or more from 1 August 2001. Despite these reforms, the Labour Government opposed the introduction of a wider VAT relief for construction work arguing that it would be relatively costly and poorly targeted, and successive administrations have shown no interest in extending the scope of the 5% rate.
In January 2018 the European Commission published proposals to overhaul the EU rules on VAT rates – in effect, to reverse the current approach:
There is no firm timetable for these proposals to be agreed, and there is considerable uncertainty as to their relevance for the UK’s discretion in setting VAT rates, given the outcome of the EU referendum and the Government’s decision in March 2017 to trigger Article 50 – the two-year period for the UK to leave the EU.
To date the Government have not published any specific details as to the UK’s post-Brexit relationship with the EU on VAT, beyond stating its ambition for an agreement on “common processes and procedures” to avoid the need for any new VAT-related border controls on goods moving between the UK and the EU. Previously it had confirmed that, under the draft Withdrawal Agreement concluded in November 2018, the UK would remain compliant with EU law, including VAT law, during the ‘transition period’ prior to the implementation of the new, yet to be negotiated, UK-EU partnership arrangements.
Although Brexit could provide the UK with full discretion to set VAT rates on individual goods and services, there are several reasons why Ministers may be reluctant to introduce new VAT reliefs in the future. First, VAT reliefs are not means-tested, so there is an argument for targeting them quite narrowly. Second, extending the scope of relief carries with it the risk that individuals might seek to exploit it, or that the boundary between what is eligible for relief and what is not becomes legally contentious. Third, there may be many candidates for VAT relief, and a risk to undermining the tax base if Ministers find that agreeing to one relief makes it hard not to agree to others. Clearly any extension in VAT reliefs would mean that the rate of VAT on everything else would have to rise, to ensure the tax still raised as much money as it does.
 The range of eligible conversions and renovations was extended from 1 June 2002.
 European Commission press notice, VAT: More flexibility on VAT rates, less red tape for small businesses, 18 January 2018. Full details are on the Commission’s site.
 This deadline is now set at 31 October 2019, following agreement between the UK and the EU27 in April 2019 on an extension; for details see, Brexit timeline: events leading to the UK’s exit from the European Union, Commons Briefing paper CBP7960, 25 September 2019.