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Construction Industry Federation

Construction Industry Federation. VAT Current Pitfalls and The New Proposals Dara Burke John Ward 6 March 2007.

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Construction Industry Federation

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  1. Construction Industry Federation VAT Current Pitfalls and The New Proposals Dara Burke John Ward 6 March 2007

  2. 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 therange 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.

  3. VAT ON PROPERTY – THE NEED FOR CHANGE • Current system is too complex And • It gives rise to trapped VAT.

  4. 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.

  5. 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!!

  6. 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.

  7. 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.

  8. REVERSIONTRAPPED 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.

  9. 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.

  10. WAIVER OF EXEMPTIONVAT 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 non-VATable persons. • Once letting is exempt subsequent lettings with waiver do not result in recovery of VAT on acquisition.

  11. RE-DEVELOPMENT VAT TRAP • 10% Rule • Expenditure incurred on “ relatively minor” extensions, alterations or demolitions. • If not - VAT must be charged on sale.

  12. 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.

  13. THE NEW SYSTEMRATIONALE • Allows for input VAT over 20 year life of developed or redevelopedproperty 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.

  14. 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).

  15. 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.

  16. 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.

  17. 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.

  18. KEY CHANGES – LEASESEXAMPLE • 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.

  19. 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.

  20. 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

  21. KEY CHANGES – CGSEXAMPLE 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 Inv Co has full input VAT recovery.

  22. KEY CHANGES – CGSEXAMPLE II (CONT’D) • Inv Co sells the offices for €2m in 2013 to Trade Co • 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.

  23. KEY CHANGES – CGSEXAMPLE III • In 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.

  24. 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 non-VATable. • 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.

  25. 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.

  26. 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.

  27. 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.

  28. 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.

  29. 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.

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