'Phased' construction work could create VAT problems for universities, expert says

The tribunal had to decide whether the second phase of construction of a new research building by York University Property Company Ltd, a subsidiary of York University, should be classed as a new building or was merely an extension to or enlargement of an existing building. Unfortunately for the university, the tribunal decided the latter - meaning that the university was liable for an irrecoverable 20% VAT cost on the works.

Universities are not able to recover VAT charged to them on supplies of goods and services which the university uses for its educational or 'non-business' activities, such as carrying out government-funded research for the public benefit. However, it is possible to 'zero-rate' supplies of construction to a university, and so prevent an irrecoverable VAT charge, where what is being constructed is a new building that is intended to be used only for a "relevant charitable purpose" or "relevant residential purpose". The former category largely comprises buildings that will be used for non-business activities, while the latter covers certain student accommodation buildings.

The rules for zero-rating such construction supplies are numerous and often technical in their application. One such rule is that zero-rating is only available for the construction of a new building and not for the enlargement of, or extension to, an existing building. In its decision in the York case, the VAT tribunal re-emphasised that whether or not works amount to construction of a new building or an enlargement or extension to an existing building is a question of fact and degree.

On the facts of the case, the result was perhaps not surprising and did not represent a departure from the existing legal tests. However, it was another reminder of the severe financial consequences of falling on the wrong side of the line in VAT terms, and of the need for universities to consider the VAT position of any proposed new developments at an early stage.

New building, or extension or enlargement?

The development in question was a two-phase chemistry department research building. Although planning permission was obtained for both phases at the outset, it was always intended that Phase 1 would be constructed and occupied with a "sacrificial wall" at one end, so that once funding had been obtained for Phase 2 the sacrificial wall could be removed and Phase 2 built.

There is no single factor that will conclusively dictate whether works amount to construction of a new building, or the enlargement or extension of an existing building. However, case law in this area has developed the tests that should be applied and the factors that should be considered as irrelevant. Broadly, the question must be answered as at the date the second works are carried out, based on an examination and comparison of the physical character of the building as it was before those works were carried out and as it would be after the works were completed. The courts will look at similarities and differences in appearance, the layout of the building or buildings and how they are equipped to function.

Although a single planning consent may be a helpful factor indicating that a later 'phase' is part of the construction of the original building, this is not a decisive factor and generally the terms of any particular planning consent should be ignored when answering the question. The subjective intentions of the taxpayer and the actual use of the building are also irrelevant: the tests should be applied on an objective basis looking at the physical characteristics of the building or buildings.

Finally, the tribunal confirmed after reviewing previous case law that there must be a sufficiently short period of time between the original works and the subsequent works for the latter to be considered part of the construction of the original building. Previous cases indicated that a period of several years between the two phases would mean the second works would be considered an enlargement or extension of the original building.

In this case, the crucial factors in deciding against the taxpayer were that:

• although the overall construction was double the original size once the Phase 2 works were completed, the building otherwise looked almost exactly the same in appearance, had a similar layout and functioned in the same way;
• Phase 1 was completed and occupied from September 2004, and the Phase 2 work did not begin until 2011;
• Phase 1 was fully functional as a research building throughout the period from 2004 to 2011 and the Phase 2 works were not critical to allowing this to take place, albeit that the overall 'vision' of the university was to bring research departments together in the completed development.

The university's subjective intentions for the building and the terms of the planning permission were not relevant to the enlargement or extension question.

Jon Robinson is a tax expert at Pinsent Masons, the law firm behind Out-Law.com.