VAT Zero-rating: Dwellings or RRP – which is best for student accommodation?

Introduction

When developing new student accommodation a key tax consideration is the VAT zero-rating rules for both developers and providers of student homes (e.g. commercial developers or universities). Where zero-rating applies, it benefits both developers and providers of student homes.

• For developers, it allows VAT recovery on most costs that they incur on the project. This is because a zero-rated supply is still treated as a “taxable” supply for VAT purposes (in contrast to a VAT exempt supply). The eligible costs are recovered as input VAT on the developer’s VAT return.
• For providers of student homes, it ensures that there is no VAT cost on the purchase of new build student homes. Otherwise, if VAT is incurred by student homes providers it would be an irrecoverable cost given the VAT treatment of student rentals. Also, zero-rating helps reduce stamp duty land tax payable on the purchase.

The zero-rating rules make a distinction between student accommodation that is a “dwelling” and accommodation to be used for a “relevant residential purpose” (“RRP”). This distinction may be important both at the time of the zero-rated supply and later. Please see ¹ and ² for the definitions of dwelling and RRP.

Zero-rating applies to the first freehold sale of a building (or grant of a lease with a term of 21 years) by a person constructing, where the building is “designed as a dwelling or a number of dwellings; or intended solely for use for a relevant residential purpose” (Schedule 8, Group 5 Value Added Tax Act 1994). Although zero-rating can also apply to supplies of construction services and materials and to certain conversions of existing buildings, this article considers sales of newly built student accommodation only.

What does “designed as a dwelling or a number of dwellings” mean?

Student accommodation designed as flats (or houses) with a kitchen/living area, bathroom(s) and bedroom(s) behind their own front door, could be treated as dwellings for zero-rating purposes. The same facilities could be present in a student hall of residence but arranged in corridors or blocks with internal access. The hall of residence design would not count as a dwelling. To qualify as a dwelling there must be no internal access to other dwellings, although HMRC accept that a fire escape door that remains locked except in the event of fire or a fire test does not amount to internal access.

The size of each dwelling must be considered. Cluster flats are now a popular design for student housing. A cluster of six ensuite bedrooms with a central kitchen and living area is generally seen as a dwelling. Larger cluster flats – say with 30 bedrooms and five kitchens/communal areas – are unlikely to be treated as dwellings because they are more akin to a traditional student hall of residence. This leaves the question of how many bedrooms are too many for a “flat” or “house” to be a dwelling. There is no clear answer as to where the line is drawn and each design should be considered on the particular facts.

Also, to qualify for zero-rating as dwellings, the separate use, or disposal of the dwelling must not be prohibited by the term of any covenant, statutory planning consent or similar provision. Student flats are usually marketed to students attending a particular university or college. If the terms of any agreement limits the use of the accommodation to students of a particular institution, it would not be treated as a dwelling.

What is a “relevant residential purpose” or RRP?

Use of a building as residential accommodation for students or pupils is RRP use, which would include traditional halls of residence and student flats or houses. The design may include some additional facilities such as laundries, dining rooms, or common rooms. Space used for teaching, or as shops or bars within a student complex would not qualify as RRP.

To qualify for zero-rating the new building must be intended solely for RRP use. HMRC’s interpretation of the word “solely” is that 95% or more of the use of the property must be for RRP use. The solely requirement must be met for ten years or more. Clawback provisions apply in the ten years following the zero-rated supply, which may result in a VAT cost for the provider if the “solely” requirement is not met or the building is sold.  

For example, the “solely” rule limits the student accommodation provider’s ability to let the accommodation during holiday periods. Letting to non-students is severely restricted. It is helpful that HMRC’s definition of student includes those studying for professional qualifications and their continuing professional development; international students attending summer schools, and English as a Foreign Language students. Also, the rule prevents student accommodation providers entering into nominations agreements which would allow owners to let empty rooms to non-students.

The student accommodation purchaser must certify that the building is intended solely for RRP use. The certificate must be given to the developer that is supplying the building to keep with their VAT records. Without the certificate, the developer cannot make a zero-rated supply. HMRC provide a form of certificate that they would accept and expect the developer to take reasonable steps to check the validity of the certificate. If the student accommodation purchaser issues an incorrect certificate, HMRC can issue a penalty equal to the VAT that was not charged (unless there is a reasonable excuse). Accordingly, the student accommodation purchaser should carefully consider the requirement to use the building solely for student accommodation.

What are the advantages and disadvantages of dwellings or RRP accommodation?

One clear advantage of relying on the accommodation being a “dwelling” is that the criteria for dwellings do not require use of the accommodation by students only. The dwellings rules are as such more flexible on this point than the RRP rules. This is a particular advantage for private sector, as it allows for both lettings to non-students in the holiday periods and nominations agreements allowing letting to non-students if the accommodation has empty rooms.

Moreover, in the ten years following a zero-rated supply of RRP accommodation, there may be a VAT charge on a change of use or a sale of the student accommodation. The VAT charge would fall on the student accommodation provider that received of the zero-rated supply. It would apply where the student accommodation provider has changed their intention to use the building solely for student accommodation since receiving the zero-rated supply.

The change of use rule requires the recipient of the supply to monitor the use of the building. HMRC expect that the use of the building is reviewed every 12 months. Each review could create a charge, but there is no reclaim for an increase in RRP use. If the student accommodation provider lets the building to students only, this is straightforward. However, if the building is let to another operating company, that operating company’s use of the RRP building must also be monitored.

The ten-year clawback rule also bites on a sale of the building (ie a disposal of the freehold or assignment of the whole leasehold interest). If the student accommodation provider may consider selling the property within ten years of acquisition, it would be best to design the student accommodation as dwellings. If this is not possible, structuring should be considered to use a special purpose vehicle to hold the student accommodation. The vehicle could then be sold instead of the building.  

However, an RRP design may increase the extent to which costs are zero-rated. Facilities that do not form part of the dwellings, such as student dining halls or social areas would not qualify for zero-rating under the dwellings rule. They may be eligible for zero-rating as part of an RRP development.

Key take-away point

The design and layout of student accommodation and facilities can impact on the availability of zero-rating and the specific rules that apply. The immediate use of the buildings is relevant but longer-term use over the first ten years should also be considered. Planning at the outset as to whether to fall within the dwelling rules or the RRP rules is crucial.

For further information on how we can support you and your business, please contact Elizabeth Hughes, James Stewart or your regular contact at Charles Russell Speechlys.

¹ Dwellings are defined in Note 2 to Group 5 Schedule 8 Value Added Tax Act 1994

A building is designed as a dwelling or a number of dwellings where in relation to each dwelling the following conditions are satisfied—

(a) the dwelling consists of self-contained living accommodation;
(b) there is no provision for direct internal access from the dwelling to any other dwelling or part of a dwelling;
(c) the separate use, or disposal of the dwelling is not prohibited by the term of any covenant, statutory planning consent or similar provision; and
(d) statutory planning consent has been granted in respect of that dwelling and its construction or conversion has been carried out in accordance with that consent.    

² Use for an RRP is defined in Note 4 to Group 5 Schedule 8 Value Added Tax Act 1994

Use for a relevant residential purpose means use as—
…….
(d) residential accommodation for students or school pupils;
……..
except use as a hospital, prison or similar institution or an hotel, inn or similar establishment.