Renovations and the 5% VAT rate

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The most common misunderstanding about VAT and renovations is when the 5% rate applies, so I thought that I’d try to clear up the confusion.

In my previous blog, I explained the basic rule which is:

  • If you’re purchasing goods only, the supplier, whether a builder’s merchant or retailer, has to charge 20% VAT.
  • If you purchase the goods from a contractor who also installs the goods, he can charge 5% for the services and the goods.

The reason for this is that under the VAT law, the 5% rate only applies to services supplied in the course of qualifying renovations or restorations AND GOODS SUPPLIED IN CONNECTION WITH THOSE SERVICES.

So what difference does this make in practice?

Suppose you want to install a new boiler to supplement an existing wooden stove as part of the renovation. You know that you can only get the 5% rate if the boiler is supplied by and fitted by a VAT registered plumber/contractor.

But you know that you can get a better price if you shop round and buy the boiler direct and engage a plumber to install it for you. So how do you calculate whether this works out cheaper overall than the supply and fit option?

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Unfortunately there’s no simple formula to work this out, because each case is different and depends on a range of factors, including the size of your discount under Option A and how much mark-up the contractor adds under Option B.

Here’s an example:

Option A

I buy a boiler with a list price of £1,500 net of VAT and negotiate a 15% discount, so the VAT inclusive cost works out as follows:

• Discounted net price: £1,275.
• VAT at 20%: £255
• VAT inclusive price: £1,530.
• The cost of installation by a trader who is not registered for VAT is £800.

Total price: £1,530 + £800 = £2,330.

Option B

I engage a VAT registered contractor to supply and install the boiler.

Because he’s trade, he can get a much higher discount of 25% on the boiler. So the cost to him is discounted net price: £1,500 less 25% discount = £1,125 + VAT @20%: £225 = £1350.

Because he’s registered for VAT, he can claim the 20% VAT of £225 from HMRC on his VAT return.

Assume that I persuade the contractor to give me the same 15% discount that I would have got if I’d bought direct?
• The net price would be £1,275.
• Plus his labour: £800
• Total net cost: £1,275 + £800 = £2,075
• Plus VAT @ 5% = £103.75

Total price: £1,275 + £800 + £103.75 = £2,178.75.

In this case, it would be cheaper to engage the contractor under Option B:

Option B price: £2,178.75
Option A price: £2,330

I’d save £151.25 over the price if I bought directly and engaged labour directly.

Of course, this example only considers one relatively small piece of expenditure and the answer would be quite different if depending on a range of factors, for example, if the contractor charged me list price for the boiler. But there can be significant savings by engaging a single contractor to do the whole renovation at 5% VAT. If you were looking at a total spend in excess of £150,000, the saving from a supply and install contract could be several £1,000s.

Finally, I’m often asked if it matters whether you pay 20% rather than 5% if you can claim the VAT back from HMRC. The answer is most definitely YES, it does matter, for a number of reasons which I’ll discuss in more detail in my next blog.