VAT on Construction: What You Need to Know

VAT is one of the most complex areas of tax in the UK, and it significantly impacts the construction sector. There are multiple VAT rates that can be applied, depending on the type of project being worked on and the specific details of the work. Applying the wrong VAT treatment can result in serious consequences, including financial penalties and unexpected bills.  

At Contractwise, we specialise in CIS compliance and also have a thorough understanding of VAT on construction. In this article, we’ll provide a comprehensive overview of VAT rules in the construction industry, explaining how different rates apply and the most common challenges businesses face.

Read on for more information…  

What are the rates of VAT on construction?

Construction work in the UK falls under three main VAT rates. These are as follows:

• Standard rate
• Reduced rate
• Zero rate

Which rate applies depends on the type of work, the nature of the project and how it will be used. Let’s look at each rate in more detail to properly understand VAT on building construction.

Standard Rate VAT (20%)

The standard rate applies a 20% VAT charge on construction work by default. This includes:

• Most domestic construction work and maintenance work
• Repairs to existing buildings
• New building extensions
• Alterations that do not qualify for reduced rates
• Work carried out on commercial buildings

For example, if a builder is hired to repair or replace a bathroom or kitchen in a domestic property. This is a standard service, so the usual 20% rate will apply. This may be different if the property is empty or a new build.

Reduced rate VAT (5%)

A reduced VAT rate of 5% is applied to specific types of residential construction work. This tends to be applied due to the fact that the UK government want to encourage house building or energy efficiency projects. Some common examples when the reduced rate applies include:

• Renovating a residential property that has been empty for at least two years
• Converting a single dwelling into multiple flats
• Energy saving projects (it’s worth noting that the installation of insulation, solar panels, heat pumps and other energy-saving materials will have a reduced rate of 5% applied until 31st March 2027)

A practical example of the reduced rate is if a contractor is carrying out renovation work on a house that has been unoccupied for more than two years. In this instance, 5% will be charged instead of the usual 20%.

Zero rate VAT (0%)

Zero-rated VAT primarily applies to new build projects. Again, this is an incentive for developers to build new houses, which the UK desperately needs. For these projects, VAT can be charged at 0% while also reclaiming material costs. This 0% rate applies when:

• Constructing new dwellings
• New buildings that will be used for residential dwellings, like care homes or student accommodation
• New charity buildings

The main example of the 0% rate is when a new house is being built from the ground up.

Why is applying the right VAT rate important?

It is extremely important that the correct VAT rate is applied. The benefits of doing this include:

• Ensuring you are complying with HMRC rules
• Avoiding financial penalties or retrospective VAT bills
• Protecting cash flow
• Producing accurate and professional invoices
• Reduce the risk of disputes with HMRC
• Making VAT returns simpler

If you get VAT wrong, HMRC will take action, and in some cases, this can mean being hit with fines or bills years in the future.  

VAT for different building projects

As mentioned above, VAT rules vary significantly depending on the type of construction work that is undertaken. This includes:

New builds

New residential builds are usually zero-rated when it comes to VAT. This includes the construction of new houses, flats and other buildings that qualify as dwellings. However, this criterion is very strict, so it is important that you are sure to avoid mistakes. If a project fails to meet HMRC’s criteria as a dwelling, the standard 20% rate will be applied.  

Renovations

Renovation work is often subject to the standard VAT rate, but there are some important exceptions. Some residential projects may qualify for the reduced 5% rate, especially when it comes to installing energy-efficiency materials and if it has been empty for more than two years. Each project will need to be assessed individually to check whether it is eligible for the reduced rate.

Commercial building projects

In most cases, a commercial construction project will be charged the standard 20% VAT rate. This includes offices, retail units, warehouses and industrial buildings. It is unlikely VAT relief can be applied to these projects, but there might be exceptions in special circumstances.

VAT registration in construction

VAT registration is a legal requirement for construction businesses that have a taxable turnover of more than £85,000 in a 12 month period. If your organisation exceeds this amount, your business must register for VAT with HMRC.

Failing to register for VAT with HMRC can result in backdated VAT bills that can be significant. This is particularly costly in the construction industry, where contracts might have already been completed, and payments have been made.

With this in mind, carefully monitoring turnover is essential.  

VAT challenges in construction

Construction businesses face several challenges when it comes to VAT. This includes the following issues:

• Determining the correct VAT rate for complex projects
• VAT on cross-border transactions, especially between the UK and the European Union  
• Partial exemption and capital goods scheme, which affect VAT recovery  
• Reverse rate VAT, which changes invoices and cash flow
• Mixed rate projects where different VAT rates may apply within one contract
• Having the right evidence to justify VAT treatment during HMRC checks

Specialist support is important when it comes to tax compliance, and this includes the Construction Industry Scheme. By partnering with Contractwise, construction businesses can focus on delivering projects while knowing all their tax affairs are compliant. We offer a range of services, including payroll audits, which protect contractors and subcontractors and eliminate the risk of HMRC reclassification - simply get in touch to find out more.