The new VAT on Property system was introduced on 1 July 2008 to simplify the complex area of VAT on Property which had become unwieldy and to some extent nearly unmanageable. It was clear from the outset that it would take time for all parties involved to come to terms with the new system.
Although we are nearly 4 years into the new system, the whole property market has changed dramatically and the level of transactions has been low.
In this article, we will deal with the system and approach to dealing with VAT on Property transactions, the Capital Goods Scheme, the transitional rules and finally some items to be considered.
The System & Approach The VAT on Property rules can be divided in to four distinct categories;
o Sale of Property
o Letting of Property
o Capital Goods Scheme (CGS)
o Transitional Rules
When dealing with VAT on Property, the following approach is useful:
1. Determine the type of transaction – Sale; Letting; Assignment/Surrender;
2. Standard / Transitional rules;
3. Review Capital Goods Scheme considerations;
4. Consider Anti Avoidance provisions.
In order to understand the operation of the new system, it is imperative that you firstly understand the CGS.
Capital Goods Scheme (CGS) – The CGS is a system for ensuring that the VAT deductibility for a property reflects the use to which the property is put over the VAT-life (or adjustment period) of the property. The adjustment period is 20 years in the case of a new development, or 10 years in the case of a refurbishment.
The CGS allows the taxpayer to initially recover VAT based on an estimate of how the taxpayer expects to use the property with subsequent adjustments based on the actual usage. In year 1, the full VAT is adjusted, while in subsequent intervals the adjustment is 1/20 other than in the case of a big swing adjustment, which only arises if there is greater than 50% change in usage.
We have outlined below the steps involved in the CGS:
CGS Step Plan
Step 1 Recover the VAT upfront – Based on how the taxpayer intends to use the property
Step 2 Year 1 Adjustment – 12 months after the property acquired/developed – Adjustment on the entire VAT amount based on actual Year 1 usage
Step 3 Annual Adjustments – Annual adjustments are at the end of the accounting period and not related to purchase date – The base year is Year 1 and each interval adjustment is 1/20
Step 4 Property Sold/Let – When a property is sold/let within the adjustment period, a CGS adjustment may be required.
Example ABC Limited acquired a new building on 1 May 2010, on which it was charged €200,000 VAT. At the time ABC Limited estimated that the building would be used for 70% Vatable activities and therefore recovered €140,000 VAT in its’ May/June VAT return. At the end of the first year, it transpired that the property was actually used for 60% Vatable activities and therefore an adjustment was required. As it was the first interval adjustment, the adjustment was based on the entire VAT amount. The actual VAT that should have been recovered was €120,000 (60%) and therefore €20,000 has to be returned in its May/June 2011 VAT return. For each subsequent interval, the adjustment will occur at the end of the accounting period and only be based on that interval (e.g. 1/20). ABC Limited year end is 31 December and therefore the second interval is 1 May to 31 December 2011. If it transpired that the property was used for 70% Vatable activities in the interval period the adjustment would be €1,000 [(€140,000 – €120,000)/20)].
The key point is that the benchmark for all future interval adjustments is the VAT recovered based on Year 1 actual usage and not the original VAT recovered.
In Practice – Where a taxpayer has full recoverability throughout the adjustment period, then there is no adjustment required. If the property is sold during the adjustment period, then an adjustment will be required where the sale of the property is exempt and the option to tax has not been exercised.
Where a taxpayer has partial VAT recoverability, it is necessary to review at the end of each interval and an adjustment will be required if there is a change in the Vatable usage of the property.
Sale/Lettings of Property – This area has been comprehensively dealt with in the two articles by Vincent McCullagh in 2009. The sale of a property is exempt unless it is a ‘new’ property when VAT is chargeable. The letting of property is also exempt.
Option to Tax – The new rules introduce the ability to ‘opt to tax’ certain exempt sales/lettings of property. This reflects the fact that a large proportion of property transaction will be exempt and is designed to counteract any potential claw-back of VAT (under the CGS) as a result of making an exempt supply. In order to opt to tax a transaction, it must be between taxpayers in the course of their businesses and it must be exercised in writing. It is not possible to opt to tax residential lettings. Also, it is not possible to opt to tax a letting to ‘connected’ tenants or where the landlord and occupant are ‘connected’ unless the tenant/occupant is entitled to recover at least 90% of the VAT charged on the rent.
In Practice – The decision whether to opt to tax the sale/letting of a property is critical and requires careful consideration. Where there is a potential CGS adjustment for the Vendor, the Vendor will wish to exercise the option; however the purchaser/tenant needs to give this careful consideration. Even where the purchaser has full VAT recovery, by agreeing to opt to tax, the 20 year CGS begins again and future potential CGS adjustment issues would then rest with the purchaser. It is not possible to backdate an option to tax and therefore it is imperative that due consideration is given to this decision.
Transitional Rules – The transitional rules will apply to a property which was acquired or developed by a taxable person before 1 July 2008 and which that person still owns on 1 July 2008. It is important to point out that the property will remain within the scope of the transitional rules until it is sold.
In Practice – The transitional rules will in the main apply to assignments and surrenders of Legacy Leases, which are leasehold interests created by a taxable person before 1 July 2008, for a period of 10 years or more and the tenant was entitled to recover VAT. Where the tenant was entitled to recover any VAT on acquiring the lease or developing the property, then the assignment/surrender is subject to VAT, based on a formula (T x N/Y). Where the tenant was not entitled to recover VAT, then the assignment/surrender is exempt with an option to tax.
In relation to lettings, the transitional rules only apply where the landlord had an entitlement to recover VAT. The transitional rules are very similar to the new rules in that the letting is exempt with an option to tax.
The key differences between the standard and transitional rules are if the landlord does not opt to tax the letting, then there is a deductibility adjustment and not a CGS adjustment (while you might think that these are the same the amount will not always be the same) and opting to tax a transitional letting does not give rise to any additional VAT recovery entitlement. The transitional rules only apply to the sale of a property where the property was acquired before 1 July 2008, there was no development since this date and there was no entitlement to recover VAT. The transitional rules provide the Vendor with the option to tax the sale, which could give rise to a VAT reclaim under the CGS.
Items to be considered – The new VAT on property system was never going to be straightforward and under each of the categories, there are specific intricacies and anti-avoidance provisions that need to be considered.
Below is a brief listing of the items that should be considered under the relevant headings.
VAT on Sales
– Transaction Exempt / Taxable (New Property)
o Undeveloped Land
o Old Property/Building – Completed (>5 years)
o Used Second Hand Property/Building – Occupied (>2 years)
– Option to Tax
o New Property (i.e. not within the exempt categories)
o Undeveloped Land connected with Development
o Partially Completed
o Sale by a Property Developer
VAT on Leases
– Residential / Commercial
– Option to Tax
– Connected Persons
– Term of Lease no longer relevant for VAT Capital Goods Scheme (CGS)
– CGS only applicable where charged VAT and in business
– Initial Interval and Subsequent Annual Interval adjustments
– Adjustment only arises where VAT recovery % changes
– Big Swing (>50% change in usage)
– Maintain CGS Records
– Development by Tenant
– subsequent assignment/surrender
– Impact on Capital Allowances / Compensation Payments (TB 03-2010)
Law Society Pre Contract VAT Enquiries
This document attempts to cover all eventualities and can appear cumbersome and difficult to understand for those not dealing with them often. However, the document is split into distinct sections and only the relevant section needs to be completed.
Even though, the new system has been with us almost four year on, the system is still very much in its infancy given the level of property transactions that have taken place to date.
It is vital that all parties involved in property transactions understand that the fundamental issue is the decision on whether to exercise the option to tax. The decision on whether to exercise the option to tax is totally dependent on the CGS.
Although most practitioners are quietly satisfied that the old system is no longer with us given its’ complexities (EVT, etc), many are still getting to grips with the new system and steer away from it. As the new system still has many definitions and peculiarities, it is likely to remain a complex topic where the transaction does not fall within the straightforward rules.
To date it would appear that the new system is preferable to the old but time will tell whether new provisions will be introduced which could further complicate matters.
Sean is Tax Director at Quintas.
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