Construction Industry
Federation
VAT
Current Pitfalls
and
The New Proposals
Dara Burke
John Ward
6 March 2007
McAvoy & Associates is a specialist consulting firm that provides its clients with
leading-edge expertise in the fields of taxation, financial planning and business
consulting. Founded in 1997, continuing growth has been based on building long-term
relationships with our clients, delivering first-rate services tailored to their individual
needs. Our principals include specialists with national reputations. We advise a diverse
cross-section of clients, including multinationals, private companies, partnerships and
high net-worth individuals. Innovative and client-driven, we pride ourselves on
delivering a suite of services that is second-to-none.
Dara Burke [dara.burke@mcavoy.ie]
A Chartered Accountant and a member of the Institute of Taxation of Ireland, Dara
Burke is a principal of McAvoy and Associates. Dara achieved first place in Ireland in
the final Institute of Taxation examinations. She advises on tax minimisation and
compliance across the range of Irish taxes and has particular expertise in the areas of
VAT, estate planning, property transactions and tax-efficient employee packages and
pension arrangements. She has been a co-author of “Judge Irish Income Tax”, the
leading authority on Irish taxation, for several years and has contributed articles to
both professional journals and the popular press.
John Ward [john.ward@mcavoy.ie]
A Chartered Accountant and Fellow of the Irish Taxation Institute, John Ward is a
principal of McAvoy & Associates and has been actively involved in the firm since its
inception. John advises on tax minimisation and compliance across the range of Irish
taxes and has particular expertise in the areas of VAT, Capital Gains Tax planning, UK
Taxation and International Taxation. John has contributed articles to virtually all of
the major professional journals in the UK and Ireland. He is the principle author of
“Judge Irish Income Tax”, the leading authority on Irish taxation.
VAT ON PROPERTY –
THE NEED FOR CHANGE

Current system is too complex
And

It gives rise to trapped VAT.
POST-LETTING
TRAPPED VAT






Inv Co. acquires a freehold interest in 1985 as
investment.
Immediately grants a 35 year lease to Trade
Co.
In 2006 Inv Co. carries out significant
development work on the premises.
In 2007 Inv Co. sells the tenanted premises.
VAT is charged on the sales proceeds at 13.5%.
The purchaser cannot recover the VAT even
if VAT registered.
ECONOMIC VALUE TEST
TRAPPED VAT

The EVT is failed if the capitalised value
(CV) of the leasehold interest is less than
the economic value (EV).

CV of lease = valuation/ multiplier/ ¾ rent
x term of lease.

EV = Amount of expenditure on
acquisition of interest/ development on
which VAT is charged - including fees.

If EVT is failed the lease may be treated
as exempt and all input VAT must be
repaid!!
EVT
TRAPPED VAT

Inv Co buys a site for €500k (ex. VAT)

It develops the site at a cost of €300k (ex.
VAT).

Inv Co immediately grants a 21 year lease
in favour of Service Co. (VAT registered)
Rent under the lease is €35k p.a.
EVT
TRAPPED VAT
 CV
= €35k x 21.27 = €744,450.
 EV
= €800,000.
 CV
< EV. Therefore, EVT is not
satisfied.
 Inv
Co. cannot reclaim the VAT
charged on acquisition and
development. VAT is trapped.
REVERSION
TRAPPED VAT

Two supplies on creation of lease between
10 & 20 years:
supply of VATable leasehold interest,
and
self supply of reversionary interest.

Even where the lessor and lessee are both
VAT registered the VAT on the self supply
is irrecoverable.
REVERSION
TRAPPED VAT
Inv Co purchases a freehold property for
€1m plus VAT and immediately grants a
15 year lease at an annual rent of
€40,000.
 VAT charged on the capitalised value of
the lease (€850,800). The tenant can
recover the VAT.
 VAT charged on self supply of the
reversion (€149,200). Inv Co cannot
recover the VAT.

WAIVER OF EXEMPTION
VAT TRAP
Waiver
of exemption applies to all short
term lettings.
Therefore waiver on letting to VATable
person may not be feasible if a person
has other short term lettings to nonVATable persons.
Once letting is exempt subsequent
lettings with waiver do not result in
recovery of VAT on acquisition.
RE-DEVELOPMENT
VAT TRAP
10%
Rule
Expenditure
incurred on “ relatively
minor” extensions, alterations or
demolitions.
If
not - VAT must be charged on sale.
THE NEW SYSTEM:
A SEACHANGE LIES AHEAD






Assignments and surrenders - NOT covered
today.
Focus today on DEVELOPERS AND
INVESTORS.
Complexity should be reduced but by no means
eliminated.
Proposed new rules to be introduced in FA 2008.
Revenue proposals still open for consultation.
Expect ongoing anti-avoidance measures.
THE NEW SYSTEM
RATIONALE





Allows for input VAT over 20 year life of
developed or redeveloped property to be allocated
pro rata between exempt and non-exempt use on
annual basis.
Redeveloped property – i.e. where change of use or
cost = 25% or more of the sales proceeds.
Allows flow-through between VATable persons –
no blockages; EVT trap and reversionary interest
trap removed.
Waiver of exemption traps removed.
But now scope of waiver significantly reduced
while now relevant to all rental leases.
KEY CHANGES – FREEHOLD

The following supplies of freehold and
freehold equivalent (long lease at
peppercorn rent) interests in immovable
goods will be VATable:
 First disposal of new buildings within
5 years of completion.
 Second and subsequent disposals of
new buildings within 5 years of
completion, unless occupied for more
than 2 years since completion by any
person(s).
KEY CHANGES –
FREEHOLD II
Certain
disposals free of stamp duty
may not be treated as “First Supplies”
Supplies
otherwise exempt subject to
joint option to tax- reverse charge
mechanism to apply- may not be
permitted where consideration is
artificially low. See FA 2007.
KEY CHANGES –
FREEHOLD EXAMPLE I
Date of completion by Devco.
1.01.09
Date of first occupation by Devco.1.01.09
Date of first supply by Devco
to Tradeco
1.02.11
Date of subsequent supply
by Tradeco
1.08.12
First supply is VATable as < 5 years since
completion. Second supply is exempt as
occupied for > 2 years since completion.
KEY CHANGES – LEASES
Concept
of capitalised value of long rental
leases abolished- rents thereunder will be
treated as supply of services.
Rents
classed as provision of services will
normally be exempt.
Rents
of commercial buildings subject to
joint option to tax- only where tenant 90%
VATable - liable at 21%- building by
building basis. Consider implications of
tenant taking on exempt activities.
KEY CHANGES – LEASES
EXAMPLE
Inv
Co. develops a commercial property at
a cost of €1.5m ex. VAT and lets it to Trade
Co. who is fully VATable under a 25 year
lease.
Rent of €70,000 p.a.
Inv Co and Trade Co opt to tax the rent.
VAT charged at 21% on rent.
Inv Co and Trade Co entitled to VAT input
credits.
KEY CHANGES – CAPITAL
GOODS SCHEME (CGS)
Capital
Goods Scheme is a mechanism which
adjusts the VAT claimed on acquisition when a
change from exempt to taxable use or vice versa
occurs.
CGS
applies to freehold and freehold equivalents.
Adjustments
over 20 years from time of
acquisition/10 years from the date of refurbishment
(new concept).
Input
VAT recoverable in first instance on basis of
exempt/ taxable use in whole of first year.
Adjusted
annually in subsequent years if ratio of
use changes; blanket adjustment on sale.
KEY CHANGES – CGS
EXAMPLE I
In 2008 Trade Co acquires offices for
€1m plus VAT of €135k.
 Trade Co is a fully taxable trader.
 Full recovery of €135,000 in 2008.
 In 2013 Trade Co lets out 30% of
property - unable to opt to tax rents.
 Recapture of input VAT under CGS in
2013 of €135,000 x 1/20 x 30%= €2,025

KEY CHANGES – CGS
EXAMPLE II
 In
2008 Inv Co acquires offices for
€1m plus VAT of €135k.
 Inv
Co enters into a 15 year lease
which is treated as a supply of
services.
 Joint
option to tax the rents.
 Therefore
recovery.
Inv Co has full input VAT
KEY CHANGES – CGS
EXAMPLE II (CONT’D)
Co sells the offices for €2m in
2013 to Trade Co
 Inv
 Parties
jointly opt to tax the sale. Trade
Co must reverse-charge the VAT of
€101,250
 Future
potential adjustments apply for
remaining 15 year VAT life of the
building.
KEY CHANGES – CGS
EXAMPLE III
2008 Inv Co acquires offices for €1m plus VAT of
€135k.
Service Co enters into a lease which is treated as a
supply of services.
Parties jointly opt to tax rents.
Therefore full input VAT recovery.
In 2013 the offices are sold to NewCo (exempt trader)
for €2m – sale is not opted to be taxed.
Recapture of VAT of €101,250 (135,000 X 15/20) from
Inv Co.
NewCo has no input VAT – so CGS no longer relevant
unless property redeveloped or refurbished.
In
TRANSITIONAL MEASURES:
FREEHOLDS
New rules will apply from the start date to all new
properties not yet sold. A lot of issues still require to
be addressed.
 All properties developed prior to 1988 and not since
redeveloped - exempt from VAT.
 Reversionary interests presumably will remain nonVATable.
 Freeholds and equivalents developed within prior 20
years:
- sales taxable if sold within 2 years of date of first
occupation
based on total price, as is currently
the case,
- thereafter disposals exempt unless the option to
tax is exercised.
TRANSITIONAL MEASURES:
FREEHOLDS

If no option exercised, CGS clawback based
on 20 year life from the date of acquisition.

If option exercised, VAT on sale as per new
rules.
TRANSITIONAL MEASURES:
LONG LEASEHOLDS

Interest created and property developed 20 years
or more prior to the start date and not since
redeveloped – exempt from VAT.

Otherwise supplies will be taxable under the
current valuation rules within 2 years of first
occupation; thereafter all such disposals exempt
unless the option to tax is exercised.

If no option exercised, CGS clawback based on 20
year life from date of acquisition.

If option exercised, VAT on disposal as per new
rules.
TRANSITIONAL MEASURES:
SHORT TERM LETTING

Existing waivers on commercial properties where tenant
has 90% VATable activities may continue.

Existing waivers – where the tenant does not meet 90%
test – landlord may:
 cancel
global waiver within one year under current
rules for these leases only – refunding surplus input
VAT (cancellation amount), or
 continue to charge VAT on the rent until the lease
expires. In the case of non-written/ residential leases =
1 year after the start date of the new system,
 Continue to charge VAT on the rent until the waiver in
respect of the individual property is cancelled.
TRANSITIONAL MEASURES:
SHORT TERM LETTING

On expiry of the lease/ cancellation of the waiver
the cancellation amount is payable over the
balance of the 20 year VAT life of the property.

Facility to waive exemption on residential
property withdrawn for properties developed or
acquired with effect from passing of FA 2007.
LOOKING AHEAD
 Delay
transactions if current VAT traps
apply and can’t be planned around.
 Leases
to partially exempt bodies may
be better treated under the old rules.
 Delay
sales of second hand buildings to
(partially) exempt purchasers until new
rules in force.