Realty Insurances Limited
Guidance Note on including VAT in your Building Sum Insured
Introduction
Pool Re, the mutual reinsurer which facilitates the provision of terrorism insurance in the UK, has recently
highlighted that all non-recoverable Value Added Tax (VAT) must be included in setting building sums
insured.
This has premium cost repercussions for policyholders who purchase terrorism cover and previously
benefitted from insurance policies incorporating a ‘VAT Clause’ (which allowed sums insured to be set
without allowance for VAT).
As a consequence, the question of which building sum insured should and should not include VAT takes on
a new importance.
VAT Clauses in Insurance Policies
In order to correctly set building sums insured, property owners have to identify and confirm which
properties have been ‘opted to tax’ and how each property is used. This can be a significant and complex
task if a large, mixed use property portfolio is involved.
In order to make life easier for landlords, some specialist property owner insurance policies (including
Realty’s bespoke real estate policies) have up until now included a ‘VAT Clause’ that allows all sums
insured on buildings to be set without any allowance for VAT. If the insured suffers a loss then insurers will
still pay any VAT due. Hence, if there is a total loss, insurers’ maximum liability would amount to 120% of
the sum insured based on the current 20% rate of VAT.
Other, more standard, policies may have no VAT Clause or a less generous VAT Clause operating on a more
‘contingent’ basis, designed to pick up changes in VAT rates and inadvertent errors by an insured where
VAT is accidentally omitted from a sum insured (acknowledging the complexity of the VAT rules).
Pool Re Changes – 1 October 2015
Pool Re insures £2 trillion of UK terrorism risk through its members (who consist of the vast majority of UK
commercial insurers) and it provides policyholders with many advantages in terms of availability and
breadth of cover.
In the event of a large terrorism attack, each insurer would pay the first part of any claim before drawing
down on reserves built up by Pool Re – which currently stand at over £5 billion. Should the reserves
become exhausted, Pool Re can access government funds to meet its obligations.
During 2015 Pool Re has announced a series of changes in the way it will operate, many of which will
come into effect on 1 October. Pool Re has specifically highlighted that all non-recoverable VAT must be
included in buildings sums insured declared to the Pool and therefore charged for, irrespective of whether
a VAT Clause exists on the underlying material damage policy. This means that terrorism premiums will
increase in cases where VAT now has to be incorporated in sums insured.
As Pool Re has now stated explicitly that the wider, more generous VAT Clause is no longer recognised with
respect to terrorism cover, the same applies to the underlying policy (because the Pool Re cover follows the
underlying policy’s terms and conditions). Although this appears to be a case of ‘the tail wagging the dog’,
insurers appear united in their stance that the only VAT Clause to be allowed after 1 October 2015 will be
the less generous version covering inadvertent errors and omissions.
Whilst there is little we can do about the additional terrorism premiums that this will create, please rest
assured that we will do our best to negotiate premium rate reductions on underlying policies which
previously featured the wide VAT Clause, in order to negate the impact of having to incorporate higher
sums insured to accommodate VAT (which the insurer was previously covering for free).
Notwithstanding this, the change will undoubtedly involve additional administration for many property
owners in determining which building sums insured should and should not include VAT.
The following flow chart provides a simplistic overview of when to include VAT. The HMRC rules are,
however, highly complex and this chart should not be relied on in isolation as there are many exceptions
and intricacies. We therefore recommend that you seek professional advice if in doubt.
NOTES TO THE CHART
Are you VAT registered?
In essence:
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Businesses registered for VAT can recover the VAT they have paid out on goods and services that
they have purchased.
Private individuals or other VAT exempt businesses or persons cannot recover VAT they have paid
out on goods and services purchased.
Partial exempt businesses or persons fall into a half way category and can partially recover VAT.
Do you charge VAT on rent from your tenants?
The default position is that rents are exempt from VAT, but since 1989 VAT registered property owners
have been able to opt to charge VAT on rents (known as ‘option to tax’ or ‘election to waive exemption’) as
it provides them with the opportunity to claim back VAT on the costs they incur in building maintenance
(e.g. capital expenditure and service charge expenditure).
If they have opted to tax, they will be able to claim back VAT on insured rebuild and repair costs and hence
do not have to include VAT in the sums insured.
Conversely, if they have not opted to tax (and hence don’t charge VAT on rents), there will be no right to
reclaim VAT on rebuilding bills. Hence VAT should be included in sums insured where VAT is not charged on
the rent and the property owner is responsible for insuring the building under the terms of the lease.
Premises Occupied for Commercial Use
Building works relating to non domestic (i.e. commercial) properties are standard rated for VAT, whether
new builds or repairs, maintenance, refurbishments, extensions, etc.
Hence if the property owner is not VAT registered or has not opted to tax (i.e. charge VAT on rents), VAT is
unrecoverable and should be included in the sum insured (which is based on the rebuild cost valuation of
the property).
Premises Occupied for Residential Use
Domestic new builds (i.e. residential property including new dwellings and communal residential buildings,
as well as conversions of non-residential buildings) are zero rated for VAT (as are some other new builds
like churches and buildings for charitable use).
In accordance with HMRC VAT Notice 708, this zero rating does rely on the existing residential building
being demolished completely to ground level and being rebuilt from scratch (although Notice 708 allows
for basements, cellars, foundation slabs and single or corner facades kept explicitly for statutory planning
consent to be retained). Roads, boundary fences and garages also qualify for zero rating.
Certain other costs such as fees (e.g. legal and architects), demolition costs, landscaping and rebuilding
detached swimming pools are not zero rated however. VAT will therefore need to be added to these
aspects of the total cost of rebuilding.
Premises Occupied part domestic/part commercial (e.g. blocks of flats with shops on the
ground floor)
Mixed use new builds are zero rated on the residential parts but VAT taxable on the commercial portion.
Hence if the property owner is not VAT registered or has not opted to tax, VAT needs to be included in the
sum insured on the commercial portion and on the fees, demolition costs, etc of the residential parts.
Partial Damage / Repairs
It should be noted that some of the above may not hold true in the event of damage. For example, although
domestic new builds are VAT exempt, repairs are standard rated for VAT purposes. In other words, a sum
insured based on the cost of a residential new build would exclude VAT. Significant damage requiring
extensive repairs, however, would incur VAT.
In reality, if a residential building is severely damaged (80% or more destroyed), not a lot will remain. In
practice it will therefore be more cost effective to demolish and rebuild the property rather than repair it.
Hence it will be zero rated for VAT purposes.
Based on the above, most insurers accept that VAT does not need to be added to the rebuild cost in
calculating sums insured, even for repair situations (i.e. in terms of residential repaired damage, most
insurers will pay the VAT element up to the sum insured, a figure based on the total rebuild as opposed to
the repair cost).
Disclaimer: This article is for guidance only and does not constitute VAT advice. Always take professional advice with
regard to VAT matters.