Taxman to restrict VAT claims

Lennartz accounting

Nearly a decade ago a landmark European Court case changed the way UK businesses were allowed to claim back VAT on some goods and services they paid for. It’s known as the Lennartz case, and the Taxman hated it with a passion from the moment judgment was passed.

Full VAT recovery

The judgment said that where a business purchased something that would be used for both business and non-business purposes, it has the right to claim back the VAT it paid in full. This might apply for example to a business owner (director, sole trader or partner) who extended or converted part of their home to include an office or other space for business use, but also intended to occupy it as a part of their home.

Example - part 1. Jim is a director of Acom Ltd. He works a great deal from home and so decided to extend his home to add an office and sitting room. Acom paid £94,000 including VAT for the conversion. The Lennartz rule means that it could claim back the full £14,000 VAT it paid out. But unfortunately that’s not the end of the story.

Pay-back time

Acom doesn’t get away scot-free. Under the Lennartz rule it must pay VAT on Jim’s private use of the extension. Since late 2007 there has been a set formula for working this out. The first step is to assume, for VAT purposes only, that the extension will have a life of only ten years. It will be more in practice, but the Taxman’s rules don’t always reflect reality, as you probably already know! The VAT Acom must pay each quarter is worked out as follows:

Example - part 2. Divide the total cost of the extension which is £80,000 ex VAT by the deemed 120-month (ten-year) life: that’s £666; multiply this by the proportion of time Jim uses it privately in the VAT quarter, say, 50%: that equals £333; the VAT at 17.5% on this amount is £58.28. This is for a month, so in the VAT quarter concerned Acom must pay £174.84.

Interest-free loan

Using the Lennartz rule means Acom gets to use the Taxman’s money, i.e. the VAT it reclaimed, and pay it back interest-free over a period of ten years. Even better, if Jim sold his home three years after building the extension, the Lennartz charge stops. This means Acom can hang on to the remaining VAT it reclaimed at the time of purchase.

What’s changing

The Budget proposal is that from January 1 2011 you won’t be able to use the Lennartz method for immovable property purchases; essentially, anything to do with land and buildings. After that you’ll have to estimate future business use at the time you make the purchase and claim back VAT in proportion to that.

Tip 1. Use it while you can. The Taxman says that those businesses which are using the Lennartz rule can carry on doing so for any purchases made before January 1 2011.

Tip 2. The rule change only affects immovable land, boats and aircraft. So carry on using it for other purchases, or if you aren’t currently using Lennartz, start using it from now on.