CT OR NUCS T ION
Contents 3 Welcome to our
Winter 2021 edition of Construction
Developers: a new tax
4 Boom and bust in the construction sector
12 Construction Brief: new VAT regime
14 Check your
6 VAT on residential development
8 Clifftown Shore
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Welcome to our Winter 2021 edition of Construction
We are excited to welcome you to the Winter edition of our Construction newsletter. Our team at Scrutton Bland are here to help you navigate through the ever changing landscape, keep you informed about new regulations and assist you with all aspects of tax, accounting and insurance which relate to this sector. T he construction sector was initially one of the worst hit sectors when the pandemic first struck with only essential construction projects initially continuing. The sector shrunk by 40% at this time, and needless to say it has been trying to play catch up ever since with demand showing no indication of slowing down soon. The stamp duty holiday introduced to keep the economy moving in the 2020 budget resulted in an explosion of activity in the residential property market, and many took this as an
The shadow of the Grenfell tragedy looms large, and in October’s budget the government announced a new tax to be imposed on the largest property developers, with the amounts collected to be ringfenced in order to finance the removal and replacement of unsafe cladding. On page 10 we examine exactly what this means for developers, and who is going to be affected. We close this edition on page 8 with a focus on a stunning development recently completed on the Southend Sea Front which is not to be missed if you are ever in the area. We hope that you enjoy this edition of our Construction Newsletter, and if you want to discuss any of the points raised or alternatively if there are any specific topics you would like covered in future issues, please get in touch with your usual Scrutton Bland contact.
opportunity to delve into the world of property development. We detail on page 6 the complex rules around the VAT rates applicable when developing or constructing a new residential property, as well as a useful recap on the VAT reverse charge mechanism introduced to the sector back on 1 March 2021 on page 12. There is of course an element of risk with any construction and property development, so on page 14 we look at what insurance cover you might require, whether you are an existing business or embarking on your first venture into property development and include recommendations to help improve risk management.
Ask anybody within the sector and they’ll say that the common challenges that they are all facing are a shortage of labour, and the supply and rising costs of materials. In this edition we examine (on page 4) why it has never been more important for business owners and senior management to keep a handle on these rising costs and the potential pitfalls they can bring to the profitability of property schemes.
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Boom and bust in the construction sector Ben Cussons, Business Advisory Director, looks at the current state of the industry, and suggests some practical solutions for efficient financial management of building projects.
It may seem strange to be commenting on the troubles in the construction industry when the sector is booming and demand for supply is at unprecedented levels, but the past eighteen months have brought their own set of challenges and pitfalls that businesses should be aware of if they want to secure a successful outcome for their projects.
Anyone who has tried to organise building work or source some materials will tell you either: - Materials are extremely difficult to get hold of and if you’re lucky enough to get what you need to, the price has gone through the roof, or - Just simply getting a job booked in with a tradesman is very difficult and the wait times are significantly longer than was the case pre-Covid.
What effect is this having on the construction sector as a whole?
What does this mean for managers?
The nature of the construction business model requires a significant cash outlay at the start of a job which is then invoiced or applied for at various stages of completion. These staggered payments will include an element of profit which is used to fund the next job and with many projects simultaneously on the go, there will invariably be situations where cash from one job is borrowed to fund another as they progress. The result of all this is that when the margins are squeezed and the profit reduced there will be less of a cash buffer available to fund new or existing jobs.
Many large contracts that have started in the last six months will have been put to tender some time ago, and would have been quoted using the labour and material costs at that time, with a reasonable estimate for increases in the period from tender to commencement. In a competitive market where margins are already comparably low when compared to other sectors, many jobs are now being won with only a very modest profit margin factored in. As everyone is aware, the unprecedented price rises in the cost of labour and materials caused by supply chain issues, added to restricted production caused by social distancing in the workplace and, dare I say it Brexit, these already low margins are currently being squeezed even further.
Penalties for not delivering on time
But what happens when the budget and time margins have been squeezed to such an extent that your available resources run dry? We see this scenario quite often and eventually - inevitably - something has to give. The result is often an upset to the end customer, the sub- contractors and suppliers, and others along the supply chain where a bad debt running into a few thousand pounds can cause significant cash flow issues, a strain on personal relationships and, in the worse case scenario, the cessation of their business.
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How can this be avoided? Good cash and project management is key and will ultimately be the difference between success and failure. Here are some practical ways to manage your financial processes:
1 Allocate a cost…. for everything! Each and every job and process needs to be costed and a budget plan drawn up. Use historic expenditure patterns and check for appropriate benchmarks that may have been identified for budgeting purposes. Look forward and use your commercial knowledge to identify future changes which might impact on costs, such as legislative changes or exchange rates. 2 Allow for change If the past eighteen months have taught us anything it is that there will always be variances in costs, so don’t be tempted to draw up a budget fixed on the lowest figures. For example, labour costs need to take into account holidays and sickness pay, and overhead costs soon mount up. Bear in mind that a job may at first appear to have a healthy profit margin, but that may quickly erode once all the overhead costs have been incurred. 3 Set up control mechanisms Define who will control your project finances, how frequently they will report, and to whom. Ensure that your finance manager has access to the appropriate systems to allow them to collect timely and relevant information, and minimise the need for duplication of input.
4 Don’t overstretch your cash resources When preparing and implementing a project, look at the working capital you have and ensure you have enough to keep the project moving. Be honest about what expenditure will turn into cash promptly, and which costs will take longer to recoup, and negotiate with financiers if necessary. 5 Capture your costs Set up a regular review system to capture costs and separate recoverable costs from non-recoverable costs. Make sure you know how the costs are made up and question what they include. For example: do the labour rates include a percentage for overheads and profit? 6 Keep your lines of communication open Communication is essential to every phase of a project. Positive and negative news are equally important, so you need to establish a flow of communication with everyone involved. This transparency will make the process smoother and reduce stress whenever a problem arises. 7 Check your work in progress As costs build up in work in progress make sure they are subject to regular review and can be supported. Identify work in progress which is represented by irrecoverable costs and make sure it is accounted for correctly and understood by all those involved in the project.
8 Ask questions Every good financial project manager becomes an integral part of the project, working alongside others on the project and sense checking their figures. Financial project management on construction jobs requires particular care, because field elements can drastically affect the workflow of projects. It’s a good idea to develop a system of people who review others’ work in progress and who can challenge the data when required. For example, how are costs shared between projects dealt with? 9 Use tools to monitor costs and budgets Good financial project management requires all direct and indirect costs to be recorded. Even relatively small construction projects contain hundreds of individual costs, so to remain effective you need to use software that can track and monitor all costs, and alleviate the need to coordinate with every member of the team in order to allocate them against budgets. 10 Be honest about the profitability of the project Most of us are optimists, so make sure you build in contingencies for extra costs and time. Work-in-progress can distort figures especially on large projects covering a number of months. If you haven’t dealt with it before, your accountant will be able to advise you on how to factor it in. If you are embarking on a construction or property project, or need some help with your financial project management please get in touch with one of our business advisers for an initial chat.
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VAT on Residential Development For property developers, it is important that the VAT issues arising from a build project are ironed out as part of any initial financial appraisal.
The VAT rules can be complex as there are different VAT rate which apply to building works depending upon the circumstances in which the works are carried out and the nature of those works. There are also different VAT rates which can apply on the sale or leasing of buildings.
These differences are highlighted below:-
Construction related services in relation to a conversion of a non-residential building into a dwelling or a number of dwellings or a building which has a residential purpose should be charged at the reduced rate of 5%. This would include plumbing works, building works, electrical works, drainage and other works undertaken to the fabric of the building. Other costs in connection with a conversion project will incur VAT at 20%. •
The first sale or first grant of a long lease (>21 years) over a property by the person who has constructed or converted the building into dwelling(s) or for a residential purpose will be subject to a 0% VAT rate. However, the sale of a newly completed commercial unit would be subject to a 20% VAT rate. It is worth noting that where the supply consists of the grant of a first long lease over a newly completed residential property, only the initial lease premium (or first rental payment) will be zero-rated. Subsequent rental payments will be exempt for VAT purposes.
Works to construct a new, qualifying building such as a new-build home or a building which has a residential purpose such as a care home should be invoiced to you at a VAT 0% rate where the services are made in the course of constructing the building (ie building works, electrical works etc). Any other costs will need to be invoiced at the standard 20% VAT rate (eg management fees, hire of goods, professional fees).
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Any VAT which is incurred by the developer can be reclaimed by the developer if the developer intends to make “taxable” supplies. These are supplies upon which VAT is charged at either a 20% VAT rate, 5% VAT rate or 0% VAT rate. However, no VAT can be reclaimed if the developer intends to make VAT exempt supplies in relation to the building such as:-
VAT exempt supplies should be differentiated from supplies which carry a 0% VAT rate.
A key conclusion arising from the VAT rules is that VAT has the potential to cause either cash-flow issues or unexpected VAT costs unless these are planned for and anticipated at the outset of a project. Our property tax advisory team at Scrutton Bland is able to steer you through the maze of VAT rules to optimise the financial success of your project. Please contact us on SBTaxPlus@scruttonbland.co.uk if you need any assistance or advice.
Consequently, the intended use of the building will govern the extent of the VAT which can be reclaimed on the project costs. In cases where there is an intention to make a mixture of “taxable” and VAT exempt supplies (which could be the case in the context of a mixed-use building held for investment purposes such as a ground floor commercial unit and residential uppers), the costs attributable to the relevant parts of the building will need to be identified and separated if possible to accurately determine the amount of the VAT reclaim. If such costs cannot be separated then the VAT will need to be reclaimed in accordance with a partial exemption method which is agreeable to HMRC.
the letting of existing dwellings; or
the letting of commercial units where no VAT Option to Tax has been made; or
the sale of a commercial unit which is not “new” where no VAT Option to Tax has been made.
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Case Study Clifftown Shore Developments Ltd
Images provided by Clifftown Shore Developments Ltd
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Key highlights / the challenge / risks faced This property development took place at a challenging time, with Covid-19, Brexit and general economic uncertainty influencing every aspect of the project, from structuring the finances to construction work. We were able to assist Simon and his colleagues with a number of issues, particularly in tax and financial structuring, as well as implementing Xero cloud accounting technology to help them access high quality management information.
Clifftown Shore Developments Ltd is a company set up to deliver a £125 million project to develop an iconic seafront building in Southend into 51 luxury apartments. The development, which includes a restaurant and cocktail bar, is close to completion after four years of work on the project. The distinctive Art Deco design of the building has made it an immediate architectural landmark, as well as evoking an age of elegance and sophistication. Several apartments have already been completed and the remainder are selling fast. The development was led by three entrepreneurs who had not worked together before: Simon Talbot, an entrepreneur who had recently sold his IT business and wanted to try something new; James Struth, a trained surveyor with significant experience of property development, and Chris Swainsbury, a building professional with his own construction business. The team was almost immediately faced with a number of matters, not least the engineering issues involved in developing a building on the side of a cliff. The site needed to be pieced together, which meant buying the neighbouring café, and even after these problems had been resolved, there was the small matter of Covid which struck soon after construction had begun. Simon commented: “Although we always had a vision for the development, this was a large and complex project which threw up a number of challenges, not least in tax and financial structuring. Our lawyers put us in touch with Scrutton Bland and from the outset we were reassured by their knowledgeable approach, expertise across a number of disciplines and the ongoing help and support they delivered to our team.”
What we did we do to help/the support we can/do offer
• Implementing Xero cloud accounting technology and training/supporting the in- house finance person
Assisting with Stamp Duty Land Tax issues
• Helping to structure the project from a tax perspective
• Setting up and helping to manage the financial structuring of the property development
• Providing financial intelligence throughout the project from origination to completion
• Ensuring the business owners were kept informed of any changes to tax and accounting regulations which may affect the project
• Providing ongoing compliance work with year-end accounts and corporation tax
Delivering targeted reporting to lenders
• Making sure that Scrutton Bland was available and accessible all times to advise and support throughout
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Property Developers: A new tax The Government is set to introduce a new tax on residential property developer companies. This adds to the plethora of taxes which already affects such developers such as Stamp Duty Land Tax, VAT and corporation tax.
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The new tax (Residential Property Developers Tax or “RPDT”) will be a corporation tax charge imposed on profits of companies carrying out residential property development activities where the company:-
• holds or has held a beneficial interest in the land being developed; and
• the land represents trading stock in the hands of the company
A company will be deemed to hold a beneficial interest in the land if any related company (a related company will include a member of the same corporate group or a company which is connected by virtue of common interests in a joint venture company) holds such an interest in UK land. Residential property development activities will include anything done by the developer in connection with UK land and buildings for the purposes of the development of residential property. Consequently, the activities which are caught could include the obtaining of a residential planning permission, the conversion of commercial property into residential property as well as the development and sale of residential property. There are a number of exclusions from the scope of the new charge. These include profits arising from the development of residential care homes or student accommodation. Not for profit housing companies or wholly owned subsidiaries of such companies will also be specifically excluded from the scope of the charge. In determining the amount of residential property development profits which are attributable to a company, account will be taken of profits arising from a residential property development joint venture in which the developer has at least a 10% interest. In this scenario, the profits that would be available for distribution to the developer from the joint venture entity will form part of the company’s profits for the purposes of the RPDT. The new RPDT will apply to profits arising in the accounting periods of companies ending on or after 1 April 2022. For accounting periods which straddle this date, the part of an accounting period arising before 1 April 2022 will be treated as a separate accounting period to the period from 1 April 2022 to the end of the actual accounting period. The RPDT will only apply to profits calculated for the later period and the profits will be apportioned to the later period on a time apportionment basis. The Government’s stated aim of the new tax is to “ensure the largest developers make a fair contribution to help fund government cladding remediation costs”. To ensure that only the largest developers are targeted, the Government has proposed a £25 million allowance in which only residential developer profits above the allowance are subjected to tax. There will be various specific rules to determine how this allowance should be applied to companies within a corporate group. For example, the general rule is likely to be that the allowance available to a residential property developer within a group will be £x (ie the headline allowance) divided by the number of companies that are members of the group at the end of an accounting period. The RPDT will come into force on 1 April 2022. If you have any questions about the potential scope and cost of the new tax charge for your business operation, please get in touch with one of our construction tax specialists who will be glad to help.
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Construction Brief: New VAT regime Gavin Birchall, Tax Partner, looks at the new VAT reverse charge regime for the construction industry which finally became effective on the 1st March this year.
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It is clear that the new VAT reverse charge regime represents a major change to the way in which construction related businesses account for VAT. The change will affect both contractors and sub-contractors and will impact all the way through the construction chain. The change will in many cases shift the responsibility for collecting and accounting for VAT on to the customer rather than the supplier. Instead of the supplier collecting the VAT from the customer and paying this over to HMRC, the customer will pay over the VAT element to HMRC directly and will include it on their own VAT return as both ‘output’ and ‘input’ tax. This change is designed to combat VAT fraud which the Government perceives to be a major problem within the construction industry. In what circumstances will the new rules apply? The new rules will not apply in every case. They will be focused upon supplies of construction related services which would usually be subject to the Construction Industry Scheme and would ordinarily attract VAT at a 20% or 5% rate:-
In addition, the supply of VAT zero-rated construction services would not be subject to the VAT reverse charge procedure. Consequently, the VAT reverse charge regime would not apply to amounts invoiced in connection with the construction of new build houses. These should be invoiced in the same manner as was previously the case. There will be a deminimus threshold of £1,000 so if the total amount invoiced between the supplier and the customer during a particular month does not exceed £1,000, the VAT reverse charge will not operate on the amount invoiced. Supplies of construction services to customers who are not making onward construction related services themselves (ie an “end-user”) will not be affected by the VAT reverse charge rules. Timing of the new rules The new rules will apply if the tax point relating to the contract occurs on or after the 1 March 2021. This will generally mean that the new VAT reverse charge will apply to invoices raised on or after 1 March 2021. Consequently, the new rules are likely to impact upon new amounts invoiced under existing contracts. Any retentions may also be subject to the VAT reverse charge as the tax point for retentions under a contract is delayed until payment is received or a VAT invoice has been issued for it (whichever is earlier). What action needs to be taken? Businesses will need to ensure that they have procedures in place to determine whether the VAT reverse charge should be operated or whether the traditional method of VAT invoicing should be operated on a particular invoice.
• where the supplier and the customer of such supplies are both VAT registered businesses; and
• the customer is not an “end user” or “intermediary”. In other words, businesses or individual consumers who make onward supplies of building and construction related services For example, a VAT registered plumber who invoices a VAT registered construction company for work performed will generally be subject to the new VAT reverse charge arrangement. The nature of the work carried out will be a construction related service and the construction company will not be an end user or intermediary because it will be making onward supplies of building and construction services. In this scenario, the VAT registered plumber will issue an invoice to the construction company without adding VAT and the construction company will pay over the VAT directly to HMRC (whilst reclaiming the VAT as input tax) via its VAT return. The supplier (ie the VAT registered plumber) will need to make a note on the invoice to make it clear that the domestic reverse charge applies and that the customer is required to account for the VAT. The supplier must also state how much VAT is due under the reverse charge but without adding this to the amount charged to the customer. There will be certain supplies which will be excepted from the new regime such as the installation of security systems, and the professional work of architects or surveyors or of building or engineering consultants. However, if any element of the work undertaken by a supplier includes work which would be caught by the new VAT reverse charge then the whole amount of the work invoiced will be subject to the new VAT reverse charge procedure.
These procedures should include:-
verifying the VAT registered status of the supplier/ customer (as applicable);
• checking the nature of the supplies made and the rate of VAT which applies; and
• obtaining confirmation from the customer that they are an end user/intermediary (if applicable)
Changes will also need to be made to the information included on invoices raised, and the way in which VAT returns are completed. For example, a customer which receives a service subject to the VAT reverse charge will need to account for the VAT in box 1 of the VAT return and recover it simultaneously on the same VAT return. Conversely, suppliers will not enter any output tax on sales to which the domestic reverse charge applies but will need to include the net value of the sale in their VAT return. Help and Support Please contact any member of the Scrutton Bland Tax Team if you would like help and support in steering you through these changes.
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Check your construction cover This year has seen rapidly escalating costs and a shortage of labour. Mark Wilby, commercial executive, looks at how current trading conditions are affecting insurance policies in the construction sector, and what businesses should be checking.
Material costs are increasing
Types of construction
Design and Construct Professional Indemnity
It is well known that the costs of materials have been rising at a rapid pace. While this has implications for many aspects of new construction projects, it also means that the costs of property rebuilding have risen commensurately. We recommend that you check property rebuild costs to ensure they remain adequate for existing structures, and also check contract values for new build works to ensure contracted ‘all risks’ values remain.
The concerns around cladding are well documented and insurers will require full disclosure. The increasing concerns around existing structures that contain external cladding or external wall insulation mean your insurer will require additional information if this applies to you. Failure to disclose will likely invalidate your policy in the event of a claim. It sounds obvious, but it’s vital to ensure your business description is accurate and fully describes all your business activities on every project. This will need to extend to include the types of properties being worked on and their methods of construction. Please ensure you check your insurance documents, paying particular attention to any exclusions that may restrict the types of properties you are covered to work on, and any restrictions relating to the types of construction method used. Insurers are increasingly looking to reduce their exposure, especially relating to timber-framed new- build sites, so check and review your existing arrangements to ensure you are correctly covered.
The current market conditions have led to Professional Indemnity insurance becoming a very challenging policy to negotiate. Early engagement with your broker is vital to ensure that terms are obtained competitively and with established insurers. Certain trades are being hit with dramatic rate increases and significant exclusions which may have a serious impact on your business. Most notable exclusions relate to fire exposure. Those in the cladding industry and the fire protection industry should be well aware of these exclusions by now, but we are also finding these being applied to most trades involved in the construction industry. It is absolutely vital your broker fully understands your business, in particular to any past, present or future contracts which may involve any cladding or fire protection exposure and how any exclusions would impact your cover to ensure you are protected against any design exposure your business could be liable for.
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Labour-only subcontractors vs bona fide subcontractors
For smaller tradesman policies, you will very often find a ‘theft of tools’ clause which will exclude cover for the theft of tools from vehicles overnight, unless contained within a locked compound. Certain insurers will allow you to extend your policy to include overnight theft of tools, which we strongly recommend. Your broker should advise you of any plant security conditions which are contained within your policy and will also be able to recommend any additional plant security measures you could use to improve risk management. At Scrutton Bland this is something we’d advise our clients on as standard practice, so if your broker hasn’t suggested it – maybe it’s time you talked to us?
The construction sector is experiencing a rapid rise in the theft of construction plant and tools. To limit their exposure, insurers are looking to apply certain plant security conditions, which are often contained within the policy wording. These will typically require plant to be contained within a locked compound or fenced perimeters when left unattended. In addition to this, insurers are further requesting trackers and/or immobilisers be fitted to items of plant which exceed certain values. We would strongly recommend you check your policy and verify you are able to comply with any plant or tools security conditions to make sure your plant is covered correctly.
If you use subcontractors, you are probably already aware of the different classifications of ‘labour only’ and ‘bona fide’. This is an important distinction when it comes to your insurance, as bona fide subcontractors will usually need to have their own insurance whereas labour-only subcontractors are regarded as employees for the purposes of Employers Liability cover. Please speak to your broker who should be able to explain the difference between the two, as it’s important these are correctly disclosed to insurers.
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Meet the Team Our team of construction sector specialists regularly advise a wide range of corporate and owner managed businesses, from large civil engineering contractors to specialist craftspeople and have a thorough understanding of the opportunities and challenges facing the industry.
We seek to build long-term, trusted relationships with our clients. It is important to us that we understand our clients’ business and personal aims and objectives, in order that we can provide bespoke and personal advice.
Get in touch with a member of the team to see how they can help you.
Ben Cussons Business Advisory Director ben.cussons@ scruttonbland.co.uk 01379 773532
Sue Gull Audit Partner sue.gull@ scruttonbland.co.uk 01473 945854
Gavin Birchall Tax Advisory Partner gavin.birchall@ scruttonbland.co.uk 01206 417277 Mark Wilby Commercial Account Executive mark.wilby@ scruttonbland.co.uk 01379 773524 Ryan Whybrow Commercial Account Executive ryan. whybrow@ scruttonbland.co.uk 01206 417186 Jake Egner Tax Executive jake.egner@ scruttonbland.co.uk 01206 417278
Jason Fayers Managing Partner and Tax Partner jason.fayers@ scruttonbland.co.uk 01473 945817 Mark Smith Corporate Finance Director mark.smith@ scruttonbland.co.uk 01473 945732
Tim Bell Business Protection Consultant tim.bell@ scruttonbland.co.uk 01473 945753
0330 058 6559 scruttonbland.co.uk
Scrutton Bland Insurance Brokers Limited is authorised and regulated by the Financial Conduct Authority. Our FCA registered number is 828934. 0696/11/2021/MKTGPage 1 Page 2 Page 3 Page 4 Page 5 Page 6 Page 7 Page 8 Page 9 Page 10 Page 11 Page 12 Page 13 Page 14 Page 15 Page 16
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