The sale of housing that has been converted from an existing non-residential building is currently exempt from VAT. That means that developers cannot reclaim the tax already paid on goods and construction services used in the conversion. The extra costs are therefore passed on to the buyer.
But sources at Customs and Excise said the Government is planning to treat conversions in the same way as new buildings, in which all construction services and the sale of the property are zero-rated, so all VAT can be reclaimed.
European Union regulations make it difficult to zero-rate any categories of spending that are not already zero-rated, so the change will probably involve a redefinition of what counts as a new building for VAT purposes.
The Government hopes the move will help the hard-pressed construction industry, which figures released on Friday showed had fallen deeper into recession in the third quarter of the year. It may also aid inner-city development and come as a boost to owners of properties suitable for conversion, such as British Rail.
Part of the cost of the move can be recouped by removing the need to employ civil servants to distinguish between new buildings and coversions for VAT purposes. Drawing a line between the two has become increasingly difficult, with Customs and Excise losing a number of important test cases on the issue.
Heritage groups are likely to object to the change. They fear it would lead to a large increase in unsightly barn conversions, which English Heritage regards as the least desirable use for farm buildings.
The Chancellor is also understood to be considering the abandonment of zero-rating for large alterations to listed buildings, which is available for changes that obtain the proper planning and listed building consents.
Zero-rating is thought anomalous when VAT at the full 17.5 per cent is charged on repairs to such buildings. Civil servants again have to be employed to distinguish between repairs and large renovations. Heritage groups are likely to press for more funding so that necessary large renovations to listing buildings still go ahead.
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