UK HMRC changes its view on VAT recovery of cladding remediation works

The issue of unsafe cladding was brought into focus as a result of the Grenfell tragedy in 2019. In 2022 Michael Gove, the secretary of state for levelling up, housing and communities, announced a commitment (which was legislated in the Building Safety Act 2022) to make companies involved in unsafe cladding pay for its replacement. 

Whether VAT is chargeable on the remedial costs, at what rate, and whether developers can recover are key questions for many businesses and, up until now, there has been some controversy over the costs of cladding remediation and its input tax recovery.

Input tax recovery

VAT incurred on the costs of cladding remediation work would normally only be recoverable if either it was a cost component of an earlier supply or as overhead. However, as an overhead, there would need to be a direct and immediate link to the general business activity for it to be recoverable under the VAT legislation.

HMRC's previous position

Last autumn, HMRC indicated that it considered the expense of cladding remediation as an overhead cost only in cases where the work was required to be done, such as due to the Building Safely Act 2022. This suggested that such treatment would not apply to work done outside measures under the Buidling Safety Act, whether prior to its introduction or in the rest of the UK. HMRC said that this would be reflected in its guidance, which it was expecting to publish before Christmas (but which we are still awaiting).

The issue with HMRC's approach was that certain housebuilders had voluntarily remediated cladding, even when they were not contractually obliged to do so and before the enactment of the Building Safety Act. In many circumstances, that decision is likely to have been motivated by a desire to protect the reputation and brand of the housebuilder (which would appear to be VAT on business overheads with recovery determined in the normal way). 

HMRC's revised position

In welcome news, HMRC has reconsidered the position. When the guidance is published (which is expected soon) it is expected to explain that HMRC now accepts that businesses will be able to treat VAT incurred on cladding remediation as an overhead and so deductible in line with the normal overhead recovery, as long as the cost forms a cost component of the business’s future supplies.

Osborne Clarke comment

This is very welcome news for housebuilders and developers and levels the playing field between those housebuilders that voluntarily chose to replace defective cladding and those forced to be compliant through the Building Safely Act 2022 or other measures. Housebuilders with unfavourable partial exemption treatment may, however, continue to look for HMRC to treat the VAT incurred as a cost component of an earlier supply.

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