Tax LawNew VAT rules for property, which will take effect from July 1st, do not make the system any simpler or user-friendly, writes John McGlone

When the Revenue Commissioners announced in 2006 that they were going to reform the VAT rules for property, there was widespread support for the idea.

The old VAT rules had built up over successive finance acts and had become a patchwork of concepts that were difficult to apply in practice. What should have been straightforward transactions were becoming bogged down in the detail of VAT rules that few understood and in many cases bore little relationship to the underlying commercial reality of the transaction.

Following an initial consultation process, the Revenue Commissioners set out to completely rewrite the VAT rules with a stated objective of having a simpler VAT system which also protected Exchequer revenue.

The legislation detailing the new rules was published on Thursday last as part of the Finance Bill 2008. The new rules will take effect from July 1st, 2008 and will take time to digest. However at first sight, the promise of simplicity does not appear to have materialised.

Under the new VAT system for commercial property there will be two sets of rules, one for sales and another for lettings. The rules for residential sales and lettings are broadly as before - although with a possible cost for residential landlords who had previously elected to pay VAT on residential lettings.

From July 1st, 2008, the first sale of commercial property within five years of its completion will be subject to VAT at 13.5 per cent. The second and subsequent sales of a property will only be subject to VAT if the sale takes place within five years of completion and the property has been occupied for less than two years. The sale of other commercial property will be exempt from VAT, although the vendor and purchaser can jointly elect to have VAT chargeable on the transaction. The old rules relating to the development history of the property will no longer apply, although the concept of redevelopment has been retained in the new rules in determining when a property is new or old.

Lettings of commercial property will be exempt from VAT although the landlord can opt to have VAT apply to the rents.

The Revenue Commissioners has dropped the proposal to limit the ability of a landlord to opt to apply VAT to a commercial letting to cases where the tenant can fully reclaim that VAT. The previous rules which sought to apply VAT upfront on the full capitalised value of the lease will no longer apply.

In theory, this system of VAT rules for property should be straightforward. However, apart from what are hopefully just teething problems in terms of incomplete definitions and a need for the legislation to be tied in a little more tightly, there are a number of general problems with how the new rules are to be applied.

One difficulty is that the transitional rules seem to have gotten as much attention as the main rules themselves. In fact, one reading of the legislation is that the so-called "transitional rules" will be with us a very long time if, as is suggested, they apply to all properties currently held under a long lease.

The transitional regime is very "rules-based" rather than based on principles of how VAT should apply. This would be fine if the transitional regime was only going to apply for the first 12 months, but it will not assist the general understanding of the new VAT rules if it is difficult to extract general principles for a new regime because of transitional rules with a very long shelf life.

There is also a focus in the legislation on the previous use of "waiver of exemption", where a landlord had elected to apply VAT on rents at 21 per cent. Applying a waiver would have given the landlord an ability to reclaim VAT on acquisition and development costs.

As part of the new system Revenue has sought to shut down waivers and it seems that for residential lettings they will, in most cases, be phased out within 12 months of the new system. Again, the legislation introduced to deal with this area is complicated and will be difficult to easily apply in practice.

More than half of the legislation on the new system is related to what is known as a Capital Goods Scheme (CGS). The Bill devotes 11 pages of the legislation to a highly complex mechanism under which users of commercial property will have to adjust (over 20 years) the amount of VAT originally reclaimed when the building was first acquired.

Inevitably, things will become more clear-cut over the coming months as Revenue explains how they see the new legislation applying in practice. However, the initial impression is that the opportunity to introduce a simpler and user-friendly VAT system may have been missed.

John McGlone is a partner at KPMG and advises domestic and international clients on the VAT aspects of their business. He has extensive experience in dealing with VAT on property transactions