VAT in Prodev

Prodev has the capability to account for the effect of VAT (Value Added Tax) which applies to most development related financial transactions. This tax exists in most European Union countries and comes under various different names although its principles and application are similar.

In the UK, prior to the 1990’s most property development activity was zero rated, meaning that no VAT applied. There were some exceptions to this rule notably certain types of residential refurbishment, but in the main VAT was not an issue for the development industry until the rules were changed under European law. Nowadays VAT is applied but because it is almost always recoverable (in the UK at least) the additional interest costs are generally minimal so it is not often needed or used at this broad level of analysis.

By default VAT in Prodev is switched off. This is indicated by the VAT codes (the letters in the grey column to the right of the numeric entries in the Data List). You will notice that normally these are set to ‘z’ for zero-rated.

Virtually all cost headings within an appraisal are potentially subject to VAT, the notable exceptions (at the time of writing) being insurance premiums. Site Value is another item which may or may not be subject to VAT. Prodev allows you to apply VAT globally (for all items) or individually where you wish to treat certain items differently (e.g. insurance).

As far as revenues are concerned, whilst residential sales are normally VAT exempt, commercial transactions are potentially subject to VAT but are covered by such additional rules such as ‘sale as a going concern’ which provide exemption from VAT. There is no VAT on rents at the development analysis level as this is the responsibility of the tenant.

We strongly recommend you become conversant with how VAT should be applied before using it in Prodev. VAT is a very complex subject and we have included these notes merely as a guide. We recommend that you consult your own financial advisers as to how VAT should be applied within your own development appraisals.

The principal effect of recoverable VAT on costs is that it marginally increases the debt interest because of the additional interest charges applicable to the VAT element for the time period between its expenditure and recovery. It can also increase the point of maximum financial exposure within your cashflow.

For instance if you have Site Legal fees of £10,000, the actual sum paid will be £11,750 (assuming 17.5% VAT). The developer will pay over this total sum then recover the VAT element (£1,750) from the tax authority 1 - 3 months later. Although the VAT element is recovered there is a small additional cost being the finance charges applicable to the VAT element.

As far as revenue items are concerned, whilst residential sales are normally VAT exempt, commercial transactions are potentially subject to VAT but are covered by such additional rules such as ‘sale as a going concern’ which provide exemption from VAT. The principle is the same as VAT on costs but in reverse. A sale of £1,000,000 subject to VAT is received as a VAT inclusive sum of £1,175,000 (assuming 17.5% VAT) and the £175,000 VAT element is later paid back to the tax authority. Be aware that many sales transactions may have different ways of processing VAT and repayable VAT of this kind may not apply.

In certain situations VAT cannot be recovered, this is rare in the United Kingdom but does exist elsewhere and can make a substantial difference to your appraisal. As with recoverable VAT, it is charged at source but not repaid. Prodev can apply VAT in this way if required.

These are found as a separate section within the Data List in between the costs and sales categories. You can use the Sections List Box located to the bottom right of the main Data List to display these items.

Note: Even though VAT rates are present, they are not used until VAT has been ‘switched on’ by setting the VAT codes.

There are four rates of VAT which are all set as default in the UK/European version of Prodev to 17.5%. Certain countries have a dual rate system where there is a higher rate of tax applied to luxury goods and this is why there is a VAT Rate 1 and a VAT Rate 2 so that separate rates can be applied to separate items in the Data List.

In addition, other countries have differing rates on costs and sales which is why there are an additional two items allowing you to split VAT between outgoings and revenues. For the United Kingdom ensure that all these rates are set to the standard rate (17.5% at the time of writing).

These are the letters in the grey column to the right of the numeric entries in the Data List which indicate the VAT status of each Data List item. You will notice that by default these are set to ‘z’ for zero rated, in other words VAT is switched off by default.

You can change the status of these VAT Codes using the VAT menu on the Data List, which allows you to change them either globally by choosing VAT-All (all costs and/or all sales at once) or individually using VAT-Item (useful for specific items like insurance premiums). Note: The VAT-All and VAT-Item commands can also be accessed directly using the keyboard by using Ctrl-L and Ctrl-I respectively (holding down the Ctrl key and press either ‘L’ or ‘I’).

Depending on the option chosen either the ‘ALL VAT’ or ‘ITEM VAT’ selection boxes will display in the top right hand corner of the Data List. Select the appropriate option either by double-clicking on it, or select it with the cursor keys then press the Enter key.

When using the ‘ALL VAT’ selection box note that all VAT subject items (both costs and sales) will be set if you use the ‘All Zero-Rated/Recoverable’ options and all VAT subject costs will be set if you use the ‘Recovery/Non-Rec. on Cost’ settings.

Generally if VAT is used it will apply to most items in your project so the easiest way to implement VAT is to first use the ‘ALL VAT’ facility to apply VAT generally then, if necessary use the ‘ITEM VAT’ facility to exclude VAT from those items that do not apply.

Having set VAT codes in this way the VAT status is indicated by the VAT Code in the grey column to the right of the numeric entries. The 5 available settings and their effect on costs and sales is as follows.

You will notice that not all Data List items have a VAT code (e.g. areas) as they only apply to financial entries.

The essence of Recoverable VAT is that there is a time period in between its expenditure and recovery (in the UK between 1 and 3 months). All matters relating to general timing in Prodev are contained in the Time/Finance section and within the Overall Timescales are the two timescale entries, recovery start date and frequency that are used for this purpose.

Note: If you do not set these timescales then recoverable VAT will have no effect because the recovery will take place in the same month that it is paid out (Prodev will warn you about this if you use recoverable VAT in the Data List without applying these timescales). The timescale factors for VAT are not relevant when dealing with non-recoverable VAT as there is no recovery to consider.

Sets the first date for VAT recovery and is timed from the commencement of the project. Generally speaking in the UK VAT is recoverable either monthly or three monthly so as a rule of thumb either use the figures 1 or 3 here. This can be used to offset the VAT recovery date into the correct month. For instance if the project starts in June and the first VAT recovery date is the beginning of August then set this figure to 3.

If set to zero then all VAT timings are switched off even if you have entered a value for the frequency setting (explained below). When set as zero any recoverable VAT applied is recovered in the same month and therefore the values will cancel each other out so there will be no impact on interest charges.

Specifies how often recovery occurs after the VAT recovery start date (explained above). In most cases development projects recover this tax on a periodic basis (monthly or three monthly in the UK). If the VAT recovery start month number is set to zero then this entry will be ignored altogether.

The VAT recovery frequency works in conjunction with the VAT recovery start date so that if the start date is set to 2 and the frequency is set to 3 then VAT would be recovered at the start of months 2, 5, 8, 11 and so on.

In the United Kingdom, Stamp Duty is often subject to non-recoverable VAT. Therefore if you have a land value of £1m and the Stamp duty is 4% then that figure will be £40,000. However as non-recoverable VAT at, say 17.5%, is payable on the Stamp duty element, the actual figure paid out is £47,000. This can be entered in two ways; either set the stamp duty as being subject to non-recoverable VAT at 17.5% or (far more simply) apply your Stamp duty rate at 4.7% rather than 4%. It is clearer if you use the former method as the appraisal will qualify where VAT has been used.

In most cases VAT is only applied to costs although in certain cases it needs to be applied to revenues as well. Residential sales will generally be zero rated, however commercial sales are often subject to VAT except where they are treated as a ‘sale as a going concern’ where separate arrangements may apply. Be aware that many sales transactions may have different ways of dealing with VAT so repayable VAT of this kind may not apply.

If Non-Recoverable VAT is applied to sales items it is assumed that the developer is paying the VAT on behalf of the purchaser. If a sale of £500,000 is subject to 17.5% Non-Recoverable VAT then the net proceeds are £412,500 once the VAT element of £87,500 (17.5% of £500,000) has been deducted.

First either enter or open an existing project that contains both cost and sale information for which VAT has not yet been applied. As you browse through the sections you will notice that all the VAT codes are initially set to ‘z’ for zero-rated.

•	Using the Sections List Box on the Data List click on ‘VAT rates’ to display the 4 VAT rate entries and ensure they are all set to the appropriate rate (currently 17.5% in the UK).

•	At the top of the Data List you will see the VAT menu. Click on it then click on ‘VAT-All’ and a dropdown box will display showing various VAT settings, double-click on the entry ‘Recovery on Cost – Rate 1’. This will apply recoverable VAT to all the cost items in the Data List.

•	When you change the VAT settings in this way you may be prompted with a message reminding you that you have not yet set timescales for VAT. Ignore this message for the moment and click the ‘OK’ button.

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Having set VAT for all the costs you may decide that certain categories are exempt from VAT. For instance, one of the Initial Payments may be an insurance premium or other type of payment which does not attract VAT. If so then you need to change this individually which is done by using the second item on the VAT menu: ‘VAT-Item’.

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If you want to do this then highlight the chosen item then select ‘VAT-Item’ on the VAT menu and a dropdown box will display the individual settings that you may wish to apply to this individual item. The entry you have chosen is probably now set to ‘R1’ because previously you applied Recoverable VAT to all your costs. What you will need to do here is select Zero-Rated which will remove the VAT status from the selected item.

•	When you change the VAT settings in this way you may be prompted with a message reminding you that you have not yet set timescales for VAT. Ignore this message for the moment and click the ‘OK’ button.

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Finally you need to tell Prodev the timescales for the recovery of VAT and this is done in the Time/Finance section where you will notice that the Overall Timescales entry box has two settings for VAT recovery, the start month and the frequency in months. If you are recovering VAT every month then set both the start month number and frequency in months to ‘1’; if it is three monthly then set both these values to ‘3’.

Having applied VAT to the majority of the costs and applied VAT timescales you will notice that your profit level has been reduced albeit by a small amount. To see how the VAT is applied you need to look at the appraisal and cashflow reports (use the ‘Print/Preview’ button).

The appraisal totals will not have changed as they still show the net figures but what will appear next to VAT-subject items is the VAT code (-R1). The cashflow however will show the relevant payments as being inclusive of VAT and on the revenue side there is an additional line showing the VAT recoveries for all VAT-subject cost items. If you had used VAT on revenue items then the revenue items would be gross of VAT and the VAT repayments will show as additional cost line.

From this you can see how the additional expenditure and delayed recovery is impacting, albeit in a small way, on the finance charges.