VAT on Developer’s Biodiversity net gain (BNG) costs

Planning permission granted for almost all Living Sector projects in England now includes an obligation to deliver at least a 10% biodiversity net gain (BNG). Before development can begin, a Biodiversity Gain Plan must be submitted to the Local Planning Authority and approved. This sets out how the BNG will be realised.

Developers can achieve BNG by creating biodiversity themselves either on-site or on land outside the development site. Alternatively, developers can buy off-site biodiversity units on the open market or buy statutory biodiversity credits from the government.

In addition to the environmental requirements, the costs and VAT treatment should also be considered. Residential developers usually structure their sales so as to make a “zero-rated” sale of the completed homes or residential property. By ensuring that the sale is zero-rated, the developer can recover VAT incurred on the cost of the new homes from HMRC. However, other zero-rating rules can apply with the effect that there is no VAT cost on the construction of new dwellings and certain other living sector buildings such as student accommodation.   

Creating and maintaining biodiversity

Green spaces and natural habitats can enhance residential developments making them more attractive to potential buyers. Accordingly, living sector developers may look to include features such as new ponds, or have areas planted with wildflowers or trees within their development sites. These features make completed development sites more desirable places to live for occupiers and increase biodiversity. That increased biodiversity can meet the developer’s BNG obligations for development in the immediate area or elsewhere in England.

Creating biodiversity may require up front capital costs for works such as creating ponds, planting trees or wildflowers. In addition to any upfront cost during the construction period, there will be ongoing costs of maintaining the biodiversity. Biodiversity created or enhanced by developers on or offsite must be maintained for thirty years. Developers who choose to create or enhance biodiversity on the development site or on other land, will enter into a legal agreement either within a section 106 planning obligation or as a conservation covenant. The legal agreement will set out who is responsible for maintaining and monitoring the habitat.

Upfront costs of creating biodiversity

Residential developers will incur VAT at 20% on the upfront capital costs of improving biodiversity. The zero-rating rules that apply to the cost of constructing buildings intended for use as dwellings or certain residential accommodation (such as student accommodation or care homes), do not extend to the landscaping, planting and other costs of increasing biodiversity. However, the VAT incurred on these upfront capital costs should be a cash flow cost only. Provided the developer makes a zero-rated supply of the new homes or residential accommodation, the VAT incurred on the BNG under the Biodiversity Gain Plan for the development should be recoverable.

Ongoing costs of maintaining BNG sites for thirty years

For residential developments, the VAT on the long term maintenance costs may not be recoverable where the costs are incurred after the zero-rated supply of dwellings or residential accommodation has been made. HMRC are considering this point and whether VAT on these ongoing costs should be treated as a cost component of the original zero-rated supply and so recoverable. While HMRC’s guidance is awaited, developers should plan around the potential VAT cost.

The upkeep obligations for BNG sites last thirty years, and could be approached in three ways:

• The Developer could undertake the upkeep work or employ a Habitat Bank Operator to undertake the necessary work paying the costs as they arise. Commercially, these ongoing costs and the long-term obligation would be unattractive to the developer. Without helpful guidance from HMRC, VAT would be an additional cost.
• The Developer could pay a Habitat Bank Operator a lump sum to undertake the necessary work for the full thirty-year period. This additional cost may be unattractive to the developer, but it removes the long-term management responsibility and when the payments have been made and the credits are secured, this ought to satisfy the developer’s obligations. The VAT costs should be recoverable if the Habitat Bank Operator is paid before the residential accommodation is sold as a zero-rated supply (which we would ordinarily expect to be the case).
• The Developer could pass the cost to the new owners of the development e.g. private house/flat owners through a management company or a Living Sector purchaser such as a BTR or student accommodation operator. The management company or Living Sector operator would then incur the upkeep costs, say annually, and pass the VAT inclusive cost on to the residents/occupiers. Commercially, this is a good outcome for the developer. However, the ongoing VAT cost would remain, unless HMRC provide very helpful guidance. There are also ongoing management issues: the question is whether the management company (which often faces other administrative and financing issues) is the best vehicle to be delivering long-term BNG management commitments. 

Purchasing units or credits

Including green spaces and habitats to enhance biodiversity on the site of a development is not always possible. Town or city centre developments often would not have available space (and brown-field sites can be very biodiverse, which requires additional credits to mitigate the loss). Developers who do not have spare BNG capacity on other development sites, must satisfy their BNG obligations by buying bio-diversity units from other landowners or Habitat Bank Operators or statutory biodiversity credits from the government. Given the argument that nature recovery works better “at scale” there may be sound ecological reasons for looking to deal with this issue off-site.  This may also mean that a site can accommodate more developable land, with the increased returns that may generate.   The statutory credits, sold by Natural England on behalf of DEFRA, are intended to be a last resort for developers (and are priced accordingly).

Following the introduction of BNG units and credits there was a period of uncertainty over their VAT treatment. HMRC initially suggested that they were outside the scope of VAT whereas DEFRA announced that they were subject to VAT at 20%. Although HMRC has not yet published formal guidance, the view that VAT applies to credits and units has prevailed with effect from 1 September 2024. This VAT cost should be a cash flow cost only for the developer if it is attributable to zero-rated sales of dwellings or residential accommodation.

Conclusion

Although formal guidance from HMRC on the treatment of the costs associated with BNG would be very welcome, the VAT treatment of costs has become clearer. Developers know to expect VAT on the costs of creating and maintaining BNG habitat or purchasing BNG units or statutory credits. Accordingly, planning can be put in place to ensure that those VAT costs are either recoverable or in taken account in appraisals for new residential developments.