Do you want to access the full text of articles?

Please see our digital edition archive for the full text of articles.

Alternatively:

If you are a Chartered Accountants Ireland member, please visit the RIS service where Accountancy Ireland is available free of charge via the EBSCO databases.

If you are an Accountancy Ireland subscriber (i.e. you pay each year to receive your copy of Accountancy Ireland) please contact our Subscriptions Department quoting your subscription number and include details of the article you want.

All other users should enquire from their local public or college library about accessing full text Accountancy Ireland articles.

Home / ... / VAT and Property Transactions - The Quagmire

Our former Minister for Finance, Mr Charlie McCreevy, put it succinctly a couple of years back when he said that Irish VAT and property rules had got so complicated that only a few people in the country could understand them. Hardly a basis for imposing a tax on one of the largest and most important sectors of the Irish economy. Remarkably, however, the reaction by the Department of Finance and the Revenue Commissioners has been to add further unnecessary complication to the rules over the past two years.

Added to a serious lack of resources within Revenue, the net result is a part of the Irish taxation system which is not comprehensible by the average tax practitioner / accountant nor by others charged with implementing the rules such as the lawyers, Revenue officials and property industry representatives.

While those involved are asking themselves how we have got ourselves into the position, the real question is how we are going to get ourselves out of it.

In recent months, the Revenue Commissioners have acknowledged the issue by announcing a review of the rules with a view to implementing changes in Finance Act 2007. While the seeds of a new regime may have been sown, there is a lot of work to be done to ensure that any new rules meet the needs of practitioners, industry and Revenue alike.

THE MOVE TOWARDS COMPLEXITY From 1972 to 1997, VAT on property transactions was a relatively straightforward affair. While the rules were always somewhat complex due to the complex nature of property transactions themselves, there seemed to be a general understanding as to what the rules were trying to achieve.

The current complexity and confusion can however be traced back to two events which occurred in or around 1997.

1. Finance Act 1997 Firstly, the Finance Act 1997 saw the first in a series of significant anti-avoidance measures brought forward by Revenue. In Revenue's view, these measures were necessary to counteract what they saw as an increasing trend towards the implementation of VAT planning arrangements by taxpayers in the VAT exempt / partially exempt sectors (including local authorities and other State entities).

Most years since 1997 have seen some further anti-avoidance measures plus additional tinkering with measures introduced in previous years.

It is not surprising, of course, that Revenue have focused on anti-avoidance measures as it is certainly the case that taxpayers have been looking at ways of minimising the cost of VAT on many property transactions. This is because VAT has now become a very substantial potential cost in property transactions, driven by the rapid increase in property values and the increase in the VAT rates applicable to property transactions.

A transaction which once might have attracted a VAT rate of 3% on a value of say €1m a number of years ago (i.e. €30,000), could now attract a liability of 13.5% on a figure of €10m (i.e. €1.35m). It's no wonder that taxpayers have been looking at ways of reducing that cost and that the Revenue have felt the need to intervene and implement a range of anti-avoidance measures.

2. Supreme Court Secondly, many of the rules which had applied in the period 1972 to 1997 were turned on their head by the decision in the Supreme Court case involving the Erin Executor & Trustee Company. This decision, which ruled against Revenue in the practice of disallowing VAT recovery on post letting expenses to a pension fund, caused a fundamental rethink in relation to many of the previously established principles of VAT and property. While Revenue sought to limit the impact of the case and restore the old order by introducing further legislative amendments, many of these amendments have caused more confusion. A classic example is the case of the sale of property which is subject to long lease. Prior to 1997 it was accepted by all parties that such a sale would generally not be subject to VAT. While it would have been very easy to ensure that this position was preserved following the Erin case, a series of legislative changes and Revenue policy pronouncements have resulted in the current position where there is still unnecessary uncertainty in relation to the VAT treatment applicable to the sale / purchase of investment property.

PRACTICAL ISSUES AND DIFFICULTIES To understand the challenge which lies ahead in terms of restoring some clarity to the VAT and property rules, it is worth noting the nature and range of situations where the current rules lead to genuine difficulties in practice.

In addition, until such time as changes are introduced, practitioners and taxpayers in the property sector need to know the potential ‘landmines’ which are now inherent in the system. An added element of stress for taxpayers is introduced into the analysis by means of the fact that the cost of getting any of these matters wrong can be seriously expensive. In addition to the fact that an unexpected VAT cost could turn a property transaction into a financial disaster, the Revenue Commissioners can add further pain by assessing heavy interest and penalty charges on any taxpayer who gets it wrong.

While interest and penalties are valid instruments for Revenue to use in the battle against tax fraud and tax evasion, to use them against otherwise compliant taxpayers who incorrectly interpret a highly complex set of legislation appears to be an indiscriminate and dis-proportionate use of Revenue's powers.

The following list of practical difficulties in dealing with property transactions is not exhaustive but demonstrates the challenge in navigating through the current complexity.

- The question as to whether a property has been ‘developed’ for VAT purposes is fundamental to the VAT treatment of many transactions. However, there is huge scope for differing interpretations regarding the meaning of "development" in different cases. In addition, the Revenue concession which allows development to be ignored where the amount of expenditure is less than 10% is often useless in practice as it is subject to a cap of €300,000, which is simply too low for most commercial property transactions.

- The treatment of certain property transactions can be dependant on events dating back to 1972. This information is often not available leaving taxpayers uncertain as to what treatment to apply.

- Long leases of between 10 and 20 years can give rise to an irrecoverable VAT charge for the lessor, even where the lessor and lessee are fully VAT registered entities. This illogical provision causes an un-necessary restriction on the property market.

- The VAT treatment of sales of investment property, as referred to above, has been the subject of much change and debate in the last few years. This has caused genuine uncertainty in the property market and has the potential to un-necessarily interfere with normal commercial transactions. While a very simple solution is available, it would appear that Revenue are reluctant to change as it could lead to VAT not being collected in certain relatively obscure situations. A golden opportunity to rectify the situation was missed in the most recent Finance Act when Revenue went some of the way towards a final solution but couldn't bring themselves to let go of their concerns concerning the impact of tenant development works.

- The so-called ‘economic value test’, which was introduced in 2002, is a perfect example of Revenue using a hammer to smash a nut. While its purpose is to deal with perceived VAT leakage to the Exchequer in certain situations involving leases of specialist buildings, it is actually applied to all commercial property leases. It causes an unnecessary complication of the system for the vast majority of leases and can actually result in a VAT cost for a lessor where there was no VAT advantage sought or obtained. It is a blunt instrument which does not take into account the realities of the commercial property market.

- Finally, valuation is a constant area of uncertainty. As many of the VAT charges assessed by legislation require notional valuations to be determined (e.g. valuations of rent receivable under long leases over the term of the lease), there is always scope for disagreement. As with many provisions in VAT and property law, much mental energy can be expended on dealing with questions of valuation where it really shouldn't matter (e.g. where the tenant is entitled to full recovery anyway). Get it wrong, however, and the aforementioned interest and penalty provisions can hit you like a ton of bricks.

A WAY-FORWARD Lest you think that it is all bad news, the good news is that there are some easy solutions to the problems which have been identified. For these solutions to be implemented, however, it will require a process of open negotiation between Revenue, practitioners and industry participants to arrive at a set of provisions which meets everybody's objectives.

Before entering into the negotiation process, it is critical that there are a number of guiding principles to set the context, otherwise little progress is likely to be made. A few suggestions on what the key principles should be are as follows:

Targeted The right of Revenue to introduce anti-avoidance measures must be respected. However, these provisions must be targeted at the specific circumstances where Revenue believe they are necessary rather than in a blanket fashion so as to un-necessarily complicate all transactions.

Commercial It is necessary for any VAT provisions to be understandable in the commercial context of property transactions. In so far as possible, they should not be artificial provisions which have no relevance to day-to-day property transactions. The economic value test is a perfect example of a provision which does not properly reflect the realities of the commercial marketplace.

Practical For any piece of legislation to work properly it must be reasonably practical. Provisions which require excessive levels of detail or are unrealistic stand little chance of being implemented properly. For example, the requirement to extract information from records dating back to 1972 is simply not practical (and is obviously becoming less so as time goes on).

Proportional The impact of any provision must be weighed against the net benefit to the Exchequer. For example, provisions which are unlikely to raise much in VAT revenues for the Exchequer but which cause significant complication for a large range of routine transactions should be avoided.

Accepting the above principles as the context for the review of current VAT and property rules would represent a very good start and would give all parties a reasonable chance of producing meaningful changes to the system by the time Finance Act 2007 is drafted.

CONCLUSION The years since 1997 have resulted in a steady progression towards complication of the VAT and property rules to the degree that they are now not understandable by the average accountant, tax practitioner or Revenue official. The decision by Revenue to launch a review of the rules must therefore be welcomed although it is clear that achieving the objectives of all interested parties will be easier said than done. By setting a few guiding principles, however, it should be possible for significant progress to be made. In the meantime, until such time as amendments are introduced, everybody working with the VAT and property rules should continue to exercise great caution in navigating their way through the rules as any mistake could prove very costly.

I bought a commercial unit in 1994 and there was no vat on the purchase price of €195-00. I am no selling it for €295-00. Can you please advise me if there is vat liable on the "sale" Regards, Donnacha Kendlin