Student Accommodation – Tax Update

The taxation of property in the UK is ever evolving and new announcements at the Autumn Budget 2017 will result in further significant changes to the landscape from April 2019. The changes, which we explore further in this update, will affect many offshore property owners, including those in the student accommodation sector. In brighter news, we also take a look at a recent taxpayer court victory in the sector (although the benefit of the case may be short lived as HMRC are appealing the decision).

Extending the scope of capital gains tax for non-residents

One of the most significant aspects of the UK tax regime for property investors has historically been that capital gains are not subject to UK tax for non-residents. In recent years the scope of capital gains tax has been extended to apply to residential property investments held by non-residents and it has now been announced, at the Autumn Budget in November, that from April 2019 capital gains tax will be extended further to non-residents investing in UK commercial property. However, there will be an automatic "rebasing" to April 2019, which effectively means that gains accruing prior to April 2019 will not be subject to tax for non-residents.

The new rules are intended not only to apply to direct disposals of UK commercial property but also indirect disposals (i.e. exits via the sale of shares or comparable interests). Indirect disposals will be subject to "property richness" and "ownership" conditions that broadly mean CGT will only apply if the entity disposed of derives 75% or more of its value from UK property and only then to investors with holdings of 25% or more. The charge to tax on indirect disposals will also be subject to the provisions of any applicable double tax treaty (although anti-forestalling rules will be introduced, with effect from 22 November 2017 to counteract any arrangements that seek a tax advantage under a treaty where that advantage is contrary to the object and purpose of the treaty).

This will be a major change in the nature of taxation for non-residents and will affect owners of student accommodation that hold assets through offshore vehicles. The non-resident capital gains tax rules on UK residential property that were introduced in April 2015 include a specific carve out for purpose built student accommodation based on the number of bedrooms in the building and the number of days they are occupied by students. It is not expected that there will be any similar carve out for student accommodation with these rules – the stated aim is to establish a level playing field for taxation of non-residents and residents alike investing in UK property.

Draft legislation is expected later in the year, where further detail and clarification, in particular on the indirect disposal rules and anti-forestalling measures, will be welcomed.

Tribunal decision results in VAT cash flow savings for contractors

The 2017 decision of the First Tier Tribunal in Summit Electrical Installations Limited v HMRC may result in cash flow savings for many student accommodation contractors who may find it more likely that they will be able to avoid paying VAT on sub-contractor's charges.

In summary, the decision is useful as it confirms that a planning permission condition stating that a building has to be used for student accommodation does not nonetheless preclude a building from being 'designed as a dwelling' for VAT purposes. Where a building is designed as a dwelling (or a number of dwellings) this broadly allows sub-contractors to zero rate their supplies for VAT purposes.

The tribunal also determined that if a relevant residential purpose certificate has been issued by the end user to a contractor (which only allows a contractor to zero rate supplies) this does not prevent a sub-contractor from being able to treat the building as designed as a dwelling and hence zero rating its supplies on that basis.

Dwelling vs RRP

In greater detail, the case looked at the interaction between constructing a building designed as a dwelling and a building designed for a relevant residential purpose ("RRP"). The VAT treatment of supplies made by sub-contractors to contractors is slightly different in the two scenarios.

• Broadly, where a building is "designed as a dwelling", sub-contractors can zero rate their supplies to contractors (i.e. charge VAT at 0% on their invoices). By contrast, where a building is designed for a RRP a certificate would generally be issued by the developer to the contractor, which allows the contractor to zero rate its supplies to the developer, but would not extend to permitting any sub-contractors to zero-rate their supplies to the contractor (as the certificate has not been issued to them). This results in a cash flow issue for the contractor, who would be obliged to recover VAT charged by sub-contractors via their usual periodic VAT return. HMRC guidance currently states that where a building may constitute both a dwelling or dwellings and a building for a RRP, it is for the customer of the main contractor to decide on which provision to rely on.
• It is broadly preferable for VAT purposes to be able to treat a building under construction as being designed as a dwelling or number of dwellings. There are specific restrictions on subsequent use that apply to buildings for a RRP that can lead to adverse VAT consequences in some circumstances. The VAT legislation states that residential accommodation for students is a building being used for a RRP. However, whether student accommodation may also class as a dwelling or dwellings for VAT purposes is more complicated. Student accommodation that consists of self-contained living accommodation with no internal access between dwellings, i.e. studio flats or cluster flats, may be considered a dwelling for VAT purposes – but to be a dwelling there is also a condition that the separate use or disposal of the dwelling is not prohibited by the terms of any covenant, statutory planning consent or similar provision. This means that where there is a prohibition on sale or use of individual flats due to an agreement, for example, to let only to students of a particular university, this can prevent the building from being a dwelling.

Prohibition on use?

In the Summit Electrical case the tribunal held that a condition in the planning permission that a minimum of 126 (out of 140) of the flats in the relevant building constructed had to be used for student accommodation was not a prohibition that stopped the building from being a dwelling. The tribunal relied on the fact that there were around 30,000 students in Leicester; narrowing use to such a large class of people could not represent a prohibition on separate use.

Deficiencies in HMRC guidance

This means that the building could be treated either as having a RRP or as a dwelling and the tribunal agreed with Summit Electricals that HMRC's policy to deny zero rating for sub-contractor costs because an RRP certificate had been issued was wrong. The issue of a certificate of RRP between the developer and the contractor was a matter for them and should not affect the appraisal by other suppliers down the chain of their VAT position.

This meant that Summit Electricals (as a sub-contractor) could zero rate its supplies to the contractor as relating to services in relation to construction of a building designed as dwellings, resulting in cash flow savings for that contractor.

Ostensibly, this is a welcome decision that will afford flexibility to sub-contractors and deliver the prospect of cash flow savings to contractors. However, HMRC's guidance in the area has not yet changed (paragraph 15.8 of VAT notice 708 still states sub-contractors VAT liability is dependent on the VAT treatment of supplies up the chain) and HMRC are in the process of appealing the decision (with the appeal scheduled to be heard in mid-May). Hence, the decision should be read with a degree of caution.