BACKGROUND AND HISTORY

COP 28 ended with a statement that there will be a transition from fossil fuels to renewables.

I pride myself on being able to add a VAT angle to any conversation but in respect of net zero and in particular the transition away from fossil fuels to renewables indirect tax can (and should) be used as a useful tool to encourage 'green' behaviours. Using a carrot and stick approach often produces the best results.

One example of the 'stick' to discourage 'bad' behaviour was the introduction of the fuel price escalator in March 1993. The aim was to increase fuel duty at a rate of 3% above inflation every year and increased to 6% above inflation in 1997.

However, this was frozen for several years and was replaced in 2011 by the fuel duty stabiliser. Successive budgets have generally seen fuel duty frozen partly because of high fuel prices and partly for political reasons.

The 'carrot' has a more successful history, particularly in relation to buildings. On 1 April 2000, the law was amended to include the supply and installation of energy-saving materials in all residential and charity buildings within the reduced rate schedule, which at the time was (and still is) 5%.

These include;

insulation for walls, floors, ceilings, roofs, lofts, water tanks, pipes and other plumbing fittings

  • draught stripping for windows and doors
  • central heating system controls
  • hot water system controls, and
  • solar panels.
  • ground and air source heat pumps,
  • micro combined heat and power units, and
  • wood-fuelled boilers

BREXIT

In 2013, the EU ruled that the reduced rate for energy-saving materials was incompatible with EU law and began infraction proceedings. In response, the UK reduced the scope of the rate for those most in need, which meant for many residents in the UK there was no relief for energy-saving materials. The UK was also unable to apply the zero-rate of VAT again because that was contrary to EU Law, indeed the zero-rate was seen a transitional rate when the UK applied for membership of the then Common Market and it was assumed that the UK would abolish the zero – rate as time passed.

When the UK left the single market in 2020 it was no longer bound by EU directives. Therefore, since 1 April 2022 the zero-rate has been applied to the installation of energy-saving materials within Great Britain and when the Windsor Framework is ratified it will also apply to Northern Ireland.

At the same time, in 2022, amendments to the EU Directive are likely to have allowed the above rules to apply if the UK had remained within the EU.

PREDOMINANT PURPOSE OF THE WORKS

Unfortunately, the practical application of services that could benefit from the zero-rate is not always simple.

In some cases, where a construction service contains two or more services that attract differing VAT rates, a 'fair and reasonable' apportionment can be applied. For example, this would be relevant where there is the construction of a new building comprising both commercial and residential elements. In this case if the commercial element was in respect of the ground floor with, for example four storey's of residential above, then VAT could be charged on one fifth of the contract.

This does not apply to energy-saving materials. Where the service of installing energy-saving materials is provided with other services a business would need to decide what the predominant purpose of that supply is. The VAT treatment would then follow the main supply. This means that if there was a large contract for the refurbishment of a dwelling, which happened to include some installation of energy-saving materials, VAT at the standard rate would apply to the entire contract. In the circumstances described above it would be worth considering whether building works could legitimately be carried out at different times, particularly if the supply was to a homeowner where VAT would be a cost. Conversely if the main element of any works are services subject to the relief, other incidental works carried out at the same time will also benefit from the zero-rate.

GRENFELL

It was hoped that the changes announced in 2022 is respect of energy-saving materials would assist with the issues regarding the installation of cladding to affected buildings post Grenfell. Initially HMRC did signal that the replacement of cladding to residential flats could be seen as zero-rated (albeit very late) snagging in respect of the original zerorated construction. As most remedial works are not carried out by the original building company HMRC have not allowed this as a blanket policy although it may be relevant in certain circumstances.

Cladding could also be seen as insulation meaning that it would attract VAT under energy-saving materials rules. Unfortunately, HMRC have stated that in most cases replacement cladding is seen as being for aesthetic rather than insulation purposes and therefore the zero-rate cannot apply. It is shame that a pragmatic solution could not be applied to works of this nature especially in the context of the tragedy.

CONSULTATION AND CHANGES

On a more positive note, HMRC has carried out a consultation exercise to extend the application of the relief. The relief will shortly be extended to charitable buildings, as it was in the past, but it is also expected that the scope of the relief will be extended to other newer technologies. The relief is likely to include certain ground works necessary for the installation of ground and water source heat pumps. One suggestion still being considered has been for the relief to extend to battery storage.

Normally, HMRC are slow in introducing new changes, but as the zero-rate for energy-saving materials has at present a short shelf life until 2027, the zero-rate fits in with the government's net zero plans. The new technologies that are likely to be brought within the zero-rate will be minimal and therefore it is likely the law will be amended early in 2024.

CONCLUSION

Clearly indirect tax is not the answer to all of life's problems, but it can encourage or discourage behaviour which in this instance could help toward meeting the UK's COP28 obligations and aspirations. That is surely a good thing.

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