By Orla Begley, Solicitor, Property Department
On the 1st of July 2008, the Finance Act 2008 introduced a new VAT regime with respect to all property transactions. The changes are designed to “simplify” the rules for VAT and it is imperative that this new VAT regime is carefully considered by all clients prior to entering into an agreement for lease or contract for sale/purchaser of a property.
The new rules will apply to both residential and commercial property and aim to rationalise the VAT treatment of property transactions.
Sale of property
The sale of residential property remains the same with VAT always chargeable on the supply of residential property by a builder/developer.
With respect to the sale of new commercial property the VAT rules are as follows:-
A sale of a new commercial freehold interest in a property or a freehold equivalent (e.g. lease for 99 years) is liable to VAT. Two rules, the two and five year rules, determine if a property is “new”-
The first supply of a completed property within five years of its completion is considered to be the supply of new property and is subject to VAT; and
The second and subsequent supply of property is considered to be the supply of a new property and subject to VAT but only if it takes place within two years of occupation.
Accordingly, any commercial freehold interest which falls into either of the above two criteria will be liable to VAT.
Sale of property with contract to develop
The sale of undeveloped property in connection with an agreement to develop the property is Vatable
Letting of commercial property
The letting of commercial property is now exempt from VAT irrespective of the term of the lease. However a landlord may opt to charge VAT at a rate of 21% on rents from a letting. It is important to note that a landlord may opt to charge VAT at any time during the lease and not just at the commencement of the term. From a tenants perspective this is potentially serious especially if the tenant is not VAT registered and the lease is free of VAT at the commencement of the term. Special attention needs to be given to VAT in negotiating the terms of the lease so that it is clear, from the outset, whether of not the rent is VAT inclusive. Unlike the old waiver of exemptions, these new options to tax can be made on a lease by lease basis.
A landlord's option to tax is curtailed in the following circumstances:-
A letting of a residential dwelling; and
A letting between connected persons. Connected persons has a wide interpretation and includes relatives, business partners and their spouses etc. There is one exception to this second letting and where connected persons are entitled to an input deduction of 90% or more then the Landlord can opt to tax.
Capital Goods Scheme
Section 91 of the Finance Act 2008 introduces, for property, a new concept known as the Capital Goods Scheme (CGS). Essentially, the capital goods scheme provides for an adjustment of the VAT deductibility on the acquisition or development of a property over the VAT life of a property (usually 20 years).
When does CGS apply?
CGS applies to all freehold and to freehold equivalent interests;
CGS applies to capital expenditure i.e. refurbishment; and
CGS applies to old leases of 10 years or more which were capitalised under the old regime when they were granted.
When does CGS not apply?
CGS does not apply to any person acquiring property on which VAT is not chargeable;
CGS does not apply to persons not engaged in economic activities; and
CGS does not apply to taxable persons who acquires/develops property in a non-business capacity.
To summarise, the key implications of the CGS are:-
The VAT life of a property is generally 20 years but is reduced to 10 years with respect to refurbishments.
Under the CGS, a business will be required to review, on an annual basis, the amount of VAT they initially recovered on the acquisition of a property over a twenty year period. Under the scheme either additional VAT can be deducted or a clawback can occur during the 20 year adjustment period e.g. a clawback can occur where the option to tax a letting is terminated or where property is sold and VAT is not charged/ paid in sale.
Finally businesses are required to keep and maintain a “capital good record” to account for the VAT history of a property.
Transitional rules apply to transactions involving commercial properties acquired or developed before 1 July 2008. In short, the transitional rules apply to freehold properties which are taxable under the old rules in Section 4 of the VAT Act 1972 (as amended) and which are supplied on or after 1 July 2008. These rules mirror the new rules for sale of freehold property i.e. the two and five year rules. With respect to leasehold properties, where an assignment or surrender of a leasehold interest occurs after 1 July 2008, it is subject to VAT on a reverse charge basis. The taxable amount is calculated by reference to the number of years remaining in the CGS life of the property.
Overall, the new VAT system aims to simplify and regularise our current Vat regime and it is hoped the new rules will move our system closer to the common system of VAT.
The new VAT regime opens the door to negotiation to both landlords/vendors and tenants/purchasers. Vendors and purchasers will have scope to negotiate different prices depending in whether the vendor chooses to charge VAT. Tenants will have opportunities to negotiate more favourable lease terms, in particular if non-vat registered.