| New regime for VAT on property |
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| The Revenue have published a white paper setting out proposals for a new VAT regime on property. The proposals are designed to simplify the current regime and draft legislation is to be published shortly. It remains to be seen whether simplification will be achieved. Some financial services businesses could be adversely impacted and it is important to plan now for deals maturing after the proposed implementation date (July 2008). The report is open to discussion with the Revenue, an opportunity not to be missed. |
The new regime
The key features of the proposed new system are:
• the first sale of a new building will be chargeable to VAT where it is supplied within five years of completion;
• any other sale within 5 years of completion of the building would be subject to VAT only where the building has been occupied for two years following completion. This is a radical change from the current system under which a developed property remains liable to VAT on a supply almost indefinetly - usually until after it is transferred to a non taxable person.
• a disposal outside these time limits but within 20 years of completion of the building can lead to a partial clawback of original VAT recovery
• a vendor and a purchaser of property which is being disposed of outside the time limits above may jointly elect to charge VAT on the supply. The amount of VAT chargeable will be based on calculations related to the amount of VAT initially paid by the vendor on acquisition or development and not on the sale price. This option to tax helps minimise the amount of VAT which is trapped as irrecoverable tax for the vendor.
• The VAT chargable on the supply of a property will be recoverable in full initially ( as at present) where the purchaser is fully VAT taxable. However the recovery is subject to adjustment in each subsequent year in the period of 20 years from the completion of the building , having regard to the purchaser's input credit recovery rate for each year.
• Where the purchaser is only partly taxable , the initial recovery of VAT will be determined by his recoverable p.c. for the initial year and will be subject to adjustment ( both upwards or downwards) in successive years over the 20 year adjustment period. The annual adjustment is computed in respect of 5p.c. of the total VAT cost in each year ( or in respect of 10p.c. in the case of a refurbished building). This regular annual adjustment of the initial recovery of VAT is known as a 'Capital Goods Scheme' and is widely applied within the EU.
• all rental of property will be VAT exempt but with the option to apply VAT to the rents (at 21p.c.) where both tenant and landlord agree and where the tenant is at least 90p.c. taxable. Again, this is a radical change which removes the current distinction between 'short' and 'long' leases. The existing rules which seek to apply an upfront VAT charge on the capitalised value of a VATable long lease will be abolished. The new 90p.c. test may cause difficulties (see below).
Financial services businesses
What will this mean for financial services companies? They are the most important VAT exempt sector of the economy at present and suffer heavy costs from the existing VAT regime in terms of irrecoverable VAT on the provision of premises.
The VAT cost on the sale of a building will not escalate indefinitely as the building increases in value after initial development. As indicated above, the VAT cost will be largely related to the amount of VAT chargable on the initial supply after development, and after 20 years ( 10 in the case of refurbishment expenditure) the building will be outside the VAT net.
Older properties may become more attractive because of the removal of the charge to VAT on properties more than 5 years old. However, this doesn't mean that no VAT cost will arise. Where the vendor has reclaimed VAT in the past, the vendor is likely to seek to opt to tax the sale or look for some type of compensation from the purchaser for the clawback of VAT suffered by the vendor.
The proportion of any VAT charged on acquisition will be under review for up to 20 years - something which can be an advantage to a business whose taxable proportion of turnover is increasing or a disadvantage in the opposite case. In the event of a later onward resale within 20 years of completion to a taxable person who agrees to it being taxed , the irrecoverable VAT on the original acquisition can be partly reversed.
Some financial businesses may find that they own a building on which they recovered some VAT on acquisition or development but which now would be outside the VAT net, being more than five years complete. They may find that the building may increase in value as a result, being attractive to other financial services companies which are largely exempt. Some input credit clawback may occur on a disposal within 20 years of original completion but it will usually be less than the VAT which would be chargeable under the existing system.
One aspect is unsatisfactory. Leases of property will be VAT exempt, with an option to tax only available where the tenant is at least 90p.c. taxable. This may cause considerable difficulty for businesses operating between 1p.c. and 89p.c. of VAT recovery. Where a landlord cannot opt to tax, the landlord will suffer a clawback of VAT and will seek to charge this to the tenant (either as a lump sum amount or as additional rent). Difficulties will arise as regards restrictions on tenant use where the 90p.c. limit is breached by the tenant.
The consultation
The impact of any new regime can only be sensibly understood by relating it to the actual position of real businesses. Although legislation has not yet been published, all businesses should engage in a review of the possible impact of these proposals and consider making representations in the consultation process where they believe the proposals can be improved. A review of current transactions is especially important as there may be a need to include special provisions in legal agreements to take account of the new system. |
Terry O'Neill is a partner in KPMG's indirect taxes division.
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| Article appeared in the February 2007 issue.
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