Building a New Community Centre? A VAT Worked Example for Councils

I've worked either for local authorities or with them for over 40 years. I joined East Hertfordshire District Council straight after my A-levels in the mid-80s, as a clerical assistant in the accountancy section, having found the job in the local paper. For the past 30 years or so I've specialised in VAT, and I'm also the author of the Town and Parish Council VAT Guide.

Recently, I had the pleasure of speaking at a webinar about VAT on capital projects, focusing on community facilities. Whether your council is building a brand new centre, or refurbishing a building it has just taken on, the same question applies: can you recover the VAT on the works? In this post I walk through a worked example, a new community centre, starting with a plan that ticks every box and then changing it, as projects so often do.

A Quick Recap

How VAT works for councils

Non-business activities (outside the scope of VAT): councils can recover the related VAT without limit, whether or not they're registered.
Exempt business activities, such as most lettings of land and buildings: the related VAT is only recoverable within the partial exemption limit, the higher of 5% of the council's total input VAT for the year or £7,500, with seven-year averaging where needed. Breach it and the whole amount is repayable to HMRC.
Taxable business activities: the related VAT is recoverable, but only if the council is registered for VAT.
To claim VAT back, the council must place the order, receive the goods or services, hold a VAT invoice addressed to it, and pay from its own funds.

The Worked Example

Alongside the governance and funding questions, the first question on any capital project should be: can we claim back the VAT? At 20%, that's a significant chunk of the budget, and the danger is assuming you can recover it without ever considering that you might not. The answer depends on how the project is arranged. Here's a project that starts off ticking every box, and then changes, as projects so often do.

The original plan

The council will build a community centre on land it already owns.
Construction, including design, will cost an estimated £1 million plus VAT.
The council will arrange the building contract and pay, in full, from its reserves and precept.
When it's complete, an operator will take a 25-year lease at a peppercorn rent.
The operator will hire the centre out to the public and use that income to cover the day-to-day running and maintenance costs.

Can the council recover the VAT? Yes. A peppercorn rent means no payment, so granting the lease is a non-business activity, and councils can recover VAT on non-business activities without limit, whether or not they're registered. The council also meets the remaining conditions: it places the order, receives the building work, holds the VAT invoices from the builder and the architects, and pays from its own funds.

A word on "peppercorn". We take it to mean not just a peppercorn annual or quarterly rent, but no other consideration at all: no lease premium, no service charges, and no other benefit to the landlord, such as using rooms for free or at a discount. You're effectively giving the asset away.

Change 1: More Than a Peppercorn Rent

Now the lease changes. The operator is asked to repay the council's legal costs, or its building insurance if the council keeps insuring the building. Or the council reserves the right to review the rent after ten years, so it could charge more in future.

Any of those means the peppercorn is no longer the only consideration. The lease becomes a business transaction, and because it's a supply of land, an exempt one.

Why does that matter? Because VAT linked to exempt activities is only recoverable within the partial exemption limit. 20% of £1 million is £200,000. That takes the council over the limit, on the single-year basis and, in this example, on the seven-year average too. The £200,000 becomes repayable to HMRC: an extra cost to a budget that may not have allowed for it.

Could Opting to Tax Avoid the £200,000 Cost?

The first thing that comes to mind is the option to tax. You tell HMRC that from a certain date you will treat all supplies of the building as taxable rather than exempt. In practice:

Opting to tax, step by step

The council makes a formal decision to opt to tax the site.
The council notifies HMRC. (If it hasn't already, the council will also register for VAT.)
It charges VAT on payments under the lease, including the operator's contributions to legal and insurance costs, and any future rent.

In return, the council secures the recovery of the £200,000 of construction VAT. The operator may not be able to recover the VAT it pays, though it can also opt to tax and charge VAT when it lets the building to community groups. Either way, the VAT you're securing is far, far greater than the VAT the operator would suffer.

Our general advice is: think about the council's own VAT recovery first, and the third party's position second.

For the rest of the example, assume the council opts to tax.

Change 2: The Project Needs Outside Funding

Construction costs rise, and the estimate is now £1.5 million plus VAT. The council needs more funding: perhaps contributions from local businesses, the district council or the future operator, or grants. Having opted to tax, this shouldn't affect the council's ability to recover VAT, but it might affect who you charge VAT to. For each funder, ask: what do they get in return?

A local business

It may expect publicity: advertising, sponsorship, perhaps naming rights over the building. That's a supply of marketing services, a taxable supply by the council. If the business is VAT-registered it may be happy to pay VAT on top, so agree a price that's plus VAT, rather than suffering the VAT out of the money they've given you.

The district council

It may provide funding in return for use of the building. Because of the option to tax, that's taxable, so you'd charge VAT on top, which they may well be able to recover depending on their use.

The operator

Its contribution may count as another payment for the lease, so you'd charge VAT on it. But depending on their status, the option to tax can be disapplied: for example, where the tenant is a charity using the building for non-business purposes. Be careful managing contributions from someone who will occupy the building.

Grants

Who receives the money matters. If the council applies, its name is on the application and the money is paid to it, it's the council's money, just like the precept and reserves. Funding conditions that simply make sure the money is used for its intended purpose don't create a supply in return.

But some funders won't give money to public authorities and prefer charities. If the grant goes via a charity, ask what the charity gets in return. If it passes the money to the council, the same publicity and use-of-building questions arise. If it uses the money to commission building work itself, you may have a barter, and the VAT position becomes much more complicated.

None of these changes is far-fetched. We've seen every one of them in council projects, and you can see how quickly it gets complex.

Change 3: The Council Runs the Centre Itself

Finally, the council decides to run the centre in-house rather than granting a lease, so it can keep the hire income to maintain the building.

If it has already opted to tax

Its VAT recovery is fine, but it will need to charge VAT on most hires. Not all hirers can recover VAT, so there may be a political decision about charging VAT to community groups. Some charities may also qualify for hires where the option to tax doesn't apply, bringing a share of the costs back into the partial exemption calculation. The council's own use, such as council meetings, and any free use will be non-business.

At these values, though, the option to tax may still be the best decision, and really the only comfortable way to secure the VAT recovery. If you want to protect your hirers, you can set lower charges and absorb the VAT within the income rather than adding it on top. You receive less income, but you've managed the prices your users pay.

If it hasn't opted to tax, or has withdrawn the option

Withdrawing is possible within the first six months if you haven't yet made any supplies of the building. In that case:

How hires are treated without the option to tax

Basic room hire will usually be exempt.
Hire with additional services, such as catering or staff hosting the event, is a package where the room is no longer the main thing, so HMRC sees it as a taxable supply in its own right.
Weddings are a good example. Providing wedding facilities is usually more than hiring a room, and court decisions suggest that the very fact a building is licensed for weddings means you must charge VAT on lettings for wedding purposes.

The council must divide construction and running costs fairly between these uses for its partial exemption calculation. Enough non-business and taxable use may keep VAT recovery within the limit using seven-year averaging, without opting to tax, but that leaves less room to use averaging for future projects.

Key Takeaways for Councils Taking On Community Facilities

Before you sign anything

Ask "can we claim back the VAT?" at the start, alongside the governance and funding questions. At 20%, it's a significant chunk of the budget.
A true peppercorn means nothing else in return. Recharged legal or insurance costs, or a future rent review, can turn a non-business lease into an exempt one.
Exempt lettings on a big project can breach the £7,500 limit, making all the related VAT repayable: £200,000 on a £1 million build.
Consider the option to tax, and put the council's own VAT recovery first. The third party's position is secondary.
For every funder, ask what they get in return, and agree prices "plus VAT" where a supply is involved.
Check who receives a grant, and whether a charity in the middle changes the picture.
Watch for packages. Catering, staffing and wedding licences can make a letting taxable.

Final Thoughts

This example covers only some of the issues that can change a project's VAT treatment. Projects grow arms and legs and get used in different ways, and every change raises new questions. None of these changes is far-fetched; we've seen every one of them. But there are lots of options for protecting your VAT recovery.

They tend to be decisions you need to take early, and if you take them early, they have less negative impact.

If you have a question, email helpline@pstax.co.uk with details of your project and we'll give you our initial thoughts on the VAT issues and risks, with a more detailed review available under consultancy terms if needed. If you're an SLCC member, VAT questions to the SLCC advice line come straight through to us as part of your subscription.

Watch the Full Session

This article is drawn from Richard's webinar on VAT and acquiring new community facilities. For the full case study and the audience Q&A, the recording, slides and podcast are available on demand.

VAT: Acquiring New Community Facilities (recording, slides and podcast)

About Richard Strevens

Richard is Associate Director and Divisional Lead for Indirect Taxes at PSTAX. He has worked for or with local authorities for over 40 years, specialising in VAT for the past 30, and is the author of the Town and Parish Council VAT Guide.

PSTAX is a specialist public sector tax consultancy, part of the Dains group: pstax.co.uk

A Note from John Fagan, Founder of Civic.ly

Richard's example shows how much of the VAT answer depends on how a building is actually used: who occupies it, who hires it, and what each party gives in return. Those facts change over the life of a building, and they are easy to lose when they live in a lease file, a bookings diary and someone's memory.

With Civic.ly, councils can:

Keep every building and community facility in one register, with its documents, leases and notes attached
Record how each building is used, and by whom, as that changes over time
Schedule inspections, maintenance and renewal dates so nothing quietly lapses
Give your VAT adviser and auditor a clear, dated record to work from

Book a Demo

Frequently Asked Questions

Can a parish or town council recover VAT on building a community centre?

It depends on how the building will be used. If the council builds it and grants a lease at a true peppercorn rent, the lease is a non-business activity and the council can recover the VAT without limit, whether or not it is VAT registered. If the building will earn exempt income, such as most lettings, the related VAT is only recoverable within the partial exemption limit.

What counts as a peppercorn rent for VAT?

A peppercorn means no other consideration at all: no lease premium, no service charges, no recharged legal or insurance costs, no rent review that could raise the rent later, and no other benefit to the landlord such as free or discounted use of rooms. Any of those can turn a non-business lease into an exempt business supply.

What is the partial exemption limit for councils?

VAT linked to exempt business activities is only recoverable if it stays within the higher of 5% of the council's total input VAT for the year or £7,500, with seven-year averaging available where needed. If the limit is breached, the whole amount of exempt-related VAT is repayable to HMRC.

What does the option to tax do for a council building project?

Opting to tax means the council treats supplies of the building as taxable rather than exempt. The council makes a formal decision, notifies HMRC, registers for VAT if it has not already, and charges VAT on payments under the lease or on hires. In return it secures recovery of the construction VAT, which on a large project is usually far greater than the VAT its tenant or hirers would bear.