Vat on property

The New Rules

When buying, selling or leasing commercial properties, it is essential that before any contracts are exchanged or leases signed, that a full due diligence enquiry is carried out in relation to the VAT status of the property. It is important that each party to a property transaction fully understands and appreciates how the transaction will be treated from a VAT perspective. This is crucial, as the failure to investigate the VAT status of a property could have hidden or significant financial consequences for a purchaser or a lessee of a property.

The VAT Rules on property were substantially changed on 1 July 2008 and a new system for the charging or imposition of VAT on property was introduced. Henceforth, if a property, and generally we are referring to a commercial property, was developed within the last twenty years then it is likely that VAT will be charged on the sale or lease of the property. The 20 year period is referred to or known as the ‘adjustment period’. The freehold or an ownership lease (that is a freehold equivalent interest in a commercial property) will be treated as a Capital Good. The grant of an occupational lease of a commercial property is treated as a supply of a service.

Capital Goods Scheme

The Capital Goods scheme is a mechanism for the adjustment of VAT deductions over the VAT life of a Capital Good. Where VAT is charged on a Sale, the Purchaser can normally reclaim the VAT charged if they are VAT registered. Where taxable persons acquire property classified as a Capital Good, the deductibility for VAT purposes, which the taxable person has claimed on the development or acquisition of that property (the initial deduction), is used as a benchmark against which VAT adjustments in each interval in the adjustment period will be made. This is based on any changes in the taxable use of the particular property. The main thrust of the current VAT regime is to ensure that, after the initial sale, the continued use of the building is reviewed so that it continues to be used for activities that attract VAT. If the building is put to a changed use which does not attract VAT, a clawback of the initial VAT deduction or part thereof may occur.

Development – Material Change of Use

A category of development known as refurbishment is recognised as constituting development. Refurbishment is the development of an existing building. However, in the case of refurbishment (such as fit out works to a building), the adjustment period is reduced to ten years.

A property is developed if it has undergone construction, demolition, extension, alteration, reconstruction or other operations to affect a material change of use.

Summary of the VAT Rules

The VAT Rules can be summarised as follows:-

• The sale of a developed property will be taxable only when the property is considered New. A property is considered New when it is first sold within five years post development. The sale of a property comprising an existing building that has been substantially refurbished, or has been the subject of works to effect a materially altered use, will also be considered a sale of New property.

• The sale of a previously sold property (nearly new) within five years of the completion of development will also be taxable. This does not apply when the property has been occupied for two years or more at the time of the sale.

• The sale of a developed property, which was developed either prior to or after 1 July 2008 and is not deemed New or nearly new, will be exempt from VAT. Whilst the property is still in the adjustment period, a claw back of VAT reclaimed on the acquisition or development of the property will normally apply. This is unless a joint option to tax the sale of the property is exercised by both the vendor and purchaser. When the joint option to tax the sale of the property is exercised by the parties, VAT will be charged at the rate of 13.5% on the consideration paid. VAT must then be accounted by the purchaser by way of his or her self supply. A joint option to tax can only be exercised if both the purchaser and vendor are VAT registered; they are both taxable persons in Ireland and this must be exercised by an agreement in writing between the parties. If a purchaser is not registered for VAT, then it is likely that they will incur an additional significant cost on the acquisition of the property, as they will have to discharge VAT on the sale price without the ability to recoup it from Revenue.

• The granting of an easement or a right of way is considered to be a supply of a service for VAT purposes and will be subject to VAT at the standard rate.

Leases

• The general rule is that leases are exempt from VAT. From 1 July 2008 the lease of a commercial property is exempt from VAT, subject to a landlord’s option to tax the rent at a rate of 23% as a supply of a service. If the landlord fails to exercise an option to tax the lease, any VAT reclaimed by the landlord on the acquisition and development of the property will be clawed back by Revenue for the relevant adjustment period.

• The position of legacy leases is complex and specific advice should be sought in this area. Revenue may seek to clawback the initial VAT charged on leases where the property is put to a use which is not subject to VAT. In practice, this has led to difficulty where records of the intervening use are incomplete as there was no previous obligation to retain VAT use records.

Maintaining VAT Records and VAT Due Diligence

• VAT records – It is essential to maintain proper VAT records setting out all dealings and VAT inputs claimed in relation to property. This is because, as along with the initial VAT deduction, the use of the property for VAT purposes is examined on an ongoing basis. These records are known as the Capital Good Records and invariably they are sought by a purchaser or lessee before they enter into a contractual commitment in relation to commercial property.

• It is essential therefore to carry out VAT due diligence enquiries before a vendor or purchaser enters into a sale of property, or prior to a tenant signing a commercial lease. Failure to do so may have hidden and significant costs for an unwitting purchaser or lessee. I would recommend these form part of the pre-contract enquiries as the VAT implications of property transactions can lead to significant costs which may result in the transaction not proceeding or delaying transactions with further negotiations.

For further information on this topic, please contact Tom Marren at tmarren@reddycharlton.ie