Supplementary memorandum by the National
Housing Federation (DEC 21(a))
FURTHER TO NATIONAL HOUSING FEDERATION EVIDENCE
ON 28 JANUARY 2004
SUMMARY
The VAT Shelter incentive
— The ODPM's Disposals Levy Deduction
(England) Determination 2002 introduced the VAT Shelter arrangement
effective from 1 April 2002.
— The VAT Shelter allowed stock transfer
organisations to recover VAT on forward programmes of repairs.
— This meant many hundreds of millions
of pounds in extra investment for social housing.
Corporation Tax—adverse impact
— Towards the end of 2003 the Inland
Revenue began to make it clear that they intended to disallow
revenue repair costs in the tax assessment of non-charitable housing
associations.
— Consequently most of the financial
benefit of the VAT Shelter arrangement will be cancelled out by
liabilities for Corporation Tax— indeed in some cases the
liabilities faced on Corporation Tax far outweigh the savings
from VAT.
— For the sector as a whole, the under-investment
in social housing generally will run to hundreds of millions of
pounds. The Federation recently conducted a sample impact survey
of 11 of the 20 organisations using, or planning to use, the VAT
Shelter arrangement. Those organisations sampled own or manage
around 100,000 homes and in the long term they will be £170
million worse off as a result of additional Corporation Tax.
— For a number of associations the
necessary corrective action will place the achievement of Decent
Homes Standards seriously at risk.
Potential solution
— The Federation has written to ministers
urging their intervention to find a solution.
— We have supported or proposed a number
of solutions over the last five months but are now convinced that
the only way forward lies in gaining ministerial support for primary
legislation, retrospectively applied, in the Finance Bill.
— Two earlier suggestions (KPMG's alternative
interpretation of tax law/regulations and Treasury approval for
an Extra Statutory Concession) appear to have received unfavourable
consideration, although we await formal confirmation and explanation.
Background
The ODPM's Disposals Levy Deduction (England)
Determination 2002 introduced the VAT Shelter arrangement with
effect from 1 April 2002. This meant that from that date new stock
transfer housing associations using this arrangement were able
to reclaim VAT on their extensive catch-up repairs programmes.
This "VAT Shelter arrangement" was agreed between Customs
and Excise and the ODPM and put housing associations receiving
stock on a VAT-level playing field with local authorities. The
effect was to take many hundreds of millions of pounds of cost
out of associations' business plans—money to be used to
reinvest in social housing and to underpin programmes for bringing
stock up to government's Decent Homes Standards. It also signalled
a significant government commitment to the transfer programme.
The Inland Revenue's sudden and unexpected pronouncement
at the end of last year, that non-charitable[14]
RSLs using the VAT Shelter scheme would now be assessed for Corporation
Tax on all catch-up repairs, was confirmed in their letter to
KPMG of 24 October 2003. It signalled potentially major adverse
effects on a number of recent transfer organisations and immediately
undermined the on-going transfer process.
The effect of all of this is to neutralise the
impetus given by the VAT Shelter arrangement for non-charitable
organisations. If the current view stands, Corporation Tax liabilities
will wipe out the hundreds of millions of pounds that the VAT
Shelter arrangement released for social housing, including helping
to bring homes up to decent standard. There is already evidence
that a great deal of uncertainty has been created in the existing
transfer process and a number of our members are reporting that
they will face serious difficulties unless the balance is redressed.
Corrective action will be necessary and that means that investment
plans, including those focused on achieving Decent Homes Standards,
will have to be reviewed.
The accounting and tax principles
During the summer the Inland Revenue ruled,
in an individual housing association tax assessment, that no post-transfer
repairs expenditure could be used to offset against income for
Corporation Tax purposes. This decision not only applied to capital/improvement
expenditure, which the Revenue has always disallowed, but also
to revenue expenditure. Had the housing association in question
not operated a VAT shelter arrangement then the Revenue's normal
rules would have applied and the same revenue expenditure would
have been allowed to be offset for Corporation Tax purposes. The
same "allowance" would have applied had the identical
revenue expenditure been incurred by a traditional housing association.
KPMG, the accounting firm that had played a
major role in devising the VAT shelter scheme, subsequently met
the Inland Revenue and provided them with a detailed explanation
as to why they believed the Revenue's interpretation was incorrect,
or at least might be subject to an alternative interpretation.
The Revenue rejected KPMG's argument and expressed an opinion
that the entire "gross" amount paid by the housing association
to the local authority should be treated as an acquisition cost
of the properties. In this context no relief is allowed for the
revenue element of the refurbishment expenditure. Instead relief
is only available against any gain made on the sale of the property—if
it is sold.
Impact on the RSL sector
If the Inland Revenue's decision stands then
the implications for the sector are very far-reaching for both
existing and prospective stock transfer associations. In the longer
term, we have confirmation from members that the Revenue's decision
will result in many hundreds of millions of pounds being taken
out of the sector, effectively neutralising all the benefits of
the VAT shelter scheme. On that scale there will undoubtedly be
a major impact on the sector's ability to deliver Decent Homes
Standards, particularly where Corporation Tax liabilities exceed
VAT Shelter savings.
A recent impact survey by the Federation of
actual and prospective stock transfer associations has revealed
the potential long-term impact for the sector. The survey of a
sample of 11 of the 20 organisations that have used or are planning
to use the VAT Shelter arrangement, revealed additional long-term
Corporation Tax liabilities of more than £170 million. Those
organisation own or manage around 100,000 homes.
For recent non-charitable transfer organisations
that have used the VAT shelter arrangement this decision seriously
undermines viability. All of these organisations have long-term
business plans based on projections at transfer and agreed with
the Housing Corporation in compliance with ODPM stock transfer
guidelines. This includes the assumption that the normal rules
for assessing Corporation Tax would apply. The Inland Revenue's
decision not to follow the "normal rules" means that
some of our members already face punitive current year tax assessments
that cannot be avoided. There have been some suggestions that:
— Housing associations affected by
this ruling should convert to charitable status. It is our belief
that this would be a perverse incentive and that organisational
structures should not, in any event, be driven by tax avoidance
policies.
— Some associations' business plans
are not dependent on the VAT Shelter savings to deliver promises
to tenants. That is true but takes no account of the fact that,
where Corporation Tax liabilities outweigh VAT Shelter savings
(see below), then business plans will be directly affected—indeed
the Housing Corporation have already taken steps to ensure that
associations re-compute their plans in order to balance their
books. That will in turn directly impact on decent homes spending
plans.
For those transfers currently being planned
by local authorities, most if not all of which will be using the
VAT shelter arrangement, there is already evidence of considerable
uncertainty and some questioning as to whether the neutralising
of the shelter arrangement will put the proposed transfer itself
in doubt.
The following examples illustrate the typical
impacts currently facing the boards of a number of housing associations:
Increased Corporation Tax liability v VAT shelter
saving
— One 6,500 unit housing association
where the increased Corporation Tax amounts to £29 million
against a VAT shelter savings of £11.7 million.
— a 16,000-unit association where Corporation
Tax liability jumps from £22.4 million to £42 million
compared with VAT shelter savings of £32 million.
— a delayed transfer caused directly
by this issue and where VAT shelter savings of £8 million
would be wiped out by Corporation Tax liabilities of £l5
million.
There is no way that the significant adjustments
necessary to maintain viability in these cases could possibly
avoid impacting on decent homes delivery.
Extended period and increased value of peak debt
— several examples where peak debt
increases significantly in value and is pushed back in time. Including
one association where peak debt originally planned at £62
million in year 11 moves to £88 million in year 16.
Failure to meet undertakings to lenders
— including several examples where
the undertakings to lenders to repay in 30 years will not be met
for a further 10 years.
Severe distortion of the intended neutral impact
of Right To Buy sales
— a common theme for a number of associations
where accelerated Corporation Tax liability will mean that income
from Right To Buy sales will no longer compensate for lost stock
revenue as it becomes almost immediately taxed at 30%. At least
one association is currently experiencing sales at four times
the rate initially expected and where corrective action will definitely
hit decent homes programmes.
All of these facts have already prompted a number
of associations to take urgent steps towards conversion to charitable
status—indeed some have already taken that irreversible
decision. Some prospective transfer organisations are similarly
exploring this option which, for the reasons previously stated,
we vigorously maintain is not the answer to this problem.
Action taken by the Federation
The Federation has to date:
— Attended meetings with officials
on 27 August and 1 December 2003. These meetings were convened
by KPMG and involved senior officials from the Inland Revenue,
HM Customs and Excise, the ODPM and the Housing Corporation. They
focused on possible solutions dependent upon alternative technical
interpretation of accounting principles and tax law.
— Written to the Treasury and Housing
ministers on 13 November and 3 December urging their intervention
and support.
— Encouraged affected housing associations
and prospective transfer organisations to seek the support of
their local MPs in making their own representations.
Conclusion
We have had no substantive response to our letters
to ministers or from our representations to the Inland Revenue.
We have now suggested three possible solutions:
1. We have supported KPMG in their attempts
to persuade the Inland Revenue that there might be an alternative
tax interpretation. However, whilst we are aware that the matter
has been with the Revenue's legal experts since we last met on
1 December 2003, we understand informally that the Revenue believe
that there can be no alternative interpretation.
2. We suggested to the Revenue that an Extra
Statutory Concession (ESC) might offer a way forward. Once again,
whilst we have had no formal response or explanation we understand
that the Revenue regard this as technically not possible. An ESC
would have had the benefit of allowing the Inland Revenue to ring-fence
these transactions for the RSL sector only and would thereby ensure
the closing-off of any wider application. An ESC would also only
have required approval at departmental level.
3. In the event that neither of the above
options is possible then we strongly urge that primary legislation
be enacted via the Finance Bill and that such provision should
be retrospective.
14 Charitable associations are not liable for Corporation
Tax. Back
| 
