VAT Treatment of “Forced Sales” and similar situations involving a Mortgagee in Possession or an Asset Receiver.

Background

In the current property market there is an increasing number of “forced sales” occurring in situations where financial institutions exercise a power of sale or similar right in relation to a loan in default. There are various options available to a financial institution in such circumstances, depending on the wording of the loan agreement. Two of the more common options are –

• apply to the courts for a “Well Charging Order” or an “Order of Possession”- both of these scenarios will be described in this article as the financial institution becoming a “mortgagee in possession” (MIP), or
• where the financial institution has a charge on the property, appoint an “asset receiver” over the property.

This article is aimed at the accountant, solicitor or tax professional who already has some knowledge of the law on VAT on property and is intended to guide the reader through the transactions that may be presenting difficulty at present. VAT on property is a complex area and a guide is published on the Revenue website.

Mortgagee in Possession (“MIP”)

When an MIP takes possession of a property from a person who has defaulted on a loan agreement there are (depending on the clauses in the loan agreement) a number of options available to the MIP. For example, it can sell, rent or develop the property. The treatment of these scenarios is discussed below and the general situation in relation to deductibility for an MIP is also outlined. An MIP is obliged to register for VAT in respect of “forced sales” of a property. Revenue will not insist that a financial institution obtains a separate VAT registration in respect of each transaction.

Asset receiver

Generally, loan agreements (in addition to allowing the lender to secure possession) will allow the lender to appoint a receiver over the asset where the borrower has defaulted on the loan. In such cases, the loan agreements will usually state that the receiver is acting as agent of the borrower. The receiver is obliged to register for VAT if VAT liabilities will arise as described below. In strictness, as a receiver may be appointed over a number of assets involving potentially a number of borrowers, he/she would be expected to register separately for VAT in respect of each receivership. In practice, however, Revenue will accept that the same registration may be used by an asset receiver in respect of properties that are subject to loans given by the same mortgagee (lender) to the same mortgagor (borrower). For example, Mr Murphy is appointed asset receiver by the mortgagee, ABC Bank over seven properties for which ABC Bank has granted loans to the mortgagor, A Development Co. Mr Murphy may use one VAT registration for his receiverships of these seven properties. Depending on what is allowed by the loan agreement, when a receiver is appointed he/she will have the option of selling, renting or developing the property subject to the receivership, each of which is undertaken with a view to satisfying the debt to the lender.

MIP/asset receiver selling a property

Section 3(7) of the VAT Act 1972 (as amended), hereafter referred to as “the Act”, applies to property sales by an MIP / asset receiver. This section provides that the borrower (the person who has defaulted on the loan) is deemed to be the “accountable person” for VAT purposes in respect of the supply. However, Section 19(3)(b) of the Act provides that the MIP/asset receiver is the person liable to pay the “tax due in relation to that supply” to Revenue (that supply being the sale of the property by the MIP/asset receiver). This means that the MIP/asset receiver is responsible for accounting to Revenue for the VAT due in relation to a “forced sale”.

When is the sale of property subject to VAT?

The supply of freehold or freehold equivalent interests in ‘new’ properties in the course of an economic activity is subject to VAT. The five and two year rules determine if a property is ‘new’ -

• The first supply of a completed property within five years of its completion is subject to VAT.
• The second and subsequent supply of a property within five years of its completion is subject to VAT if it takes place within two years of occupation.

Generally, all sales of ‘old’ property (those outside the period when considered ‘new’) are exempt from VAT. The notable exception is the sale of residential properties by a developer/builder where the two and five-year rules do not apply. In such cases, the sale by the developer/builder is always taxable.

When an exempt supply occurs, a Capital Goods Scheme (CGS) adjustment arises which obliges the seller to pay VAT back to Revenue. The CGS Adjustment is based on the VAT deductibility taken on the acquisition or development of the property, reduced by the number of years that have elapsed in the CGS adjustment period for the property. However, a joint option for taxation is allowed whereby the vendor and the purchaser can jointly choose to apply VAT to the sale. In such cases the purchaser is liable to pay the VAT on the reverse charge basis and, because a taxable supply has occurred, there is no CGS adjustment for the vendor. See VAT on Property Guide for further details on these concepts.

What is the VAT treatment when an MIP/asset receiver sells a property?

In relation to “forced sales”, the same rules apply. If the sale of the property occurs when the property is “new”, the MIP/asset receiver will account for VAT on the supply and pay this VAT to Revenue. If the sale occurs outside this period, a CGS adjustment arises. The tax due under this adjustment (Section 12E(7)(b) of the Act refers) is payable by the MIP/asset receiver. This is because the wording of Section 19(3)(b) of the Act (as referred to above) provides that the MIP/asset receiver is liable to pay the “tax due in relation to that supply”. The tax due in relation to an exempt sale is the amount calculated in accordance with the formula in Section 12E(7)(b) of the Act.

Where an MIP/asset receiver has insufficient information to definitively decide if the transactions in any of the assets over which s/he was appointed would give rise to a VAT charge, then s/he may write to the Revenue District of the borrower setting out the confirmation sought. Where it is a possible to do so, the Revenue office will assist the MIP/asset receiver to enable him /her to meet his/her obligations under the VAT Acts.

Option to tax and avoiding CGS adjustment on exempt “forced sales”

The CGS adjustment due on the exempt sale can be avoided by the MIP/asset receiver. The MIP / asset receiver and the purchaser (if s/he is a “taxable person”) can enter into an agreement to have VAT charged on an exempt supply in relation to any “forced sales” which occur on or after 3 April 2010. Section 4B(6A) of the Act allows this option provided the purchaser is not connected to the MIP/asset receiver or the person who has defaulted. Where the MIP/asset receiver and the purchaser have opted to have VAT charged on such a sale, the purchaser is liable to account for the VAT in relation to the sale on the reverse charge basis.

Special rules for the sale of residential properties by an MIP/asset receiver

Special rules apply where an MIP/asset receiver sells a residential property where the defaulter is a property developer who had intended to sell that property or a person connected with that person, within the meaning of section 7A of the Act. Section 4B(6A)(e) of the Act provides that the sale of a residential property is always liable to VAT (i.e. even where it is not “new”). The MIP/asset receiver is liable to account for VAT on the sale of such properties in accordance with Section 19(3)(b) of the Act.

What is the position where an MIP rents a property?

Some loan agreements will allow an MIP to rent the property. The letting of property is exempt from VAT. However, a landlord may choose to charge VAT on the rents by exercising the landlord’s option to tax (subject to certain restrictions [1]). Where the loan agreement allows an MIP to enter into a lease with a tenant, Revenue accepts that the MIP may exercise the “landlord’s option to tax” in accordance with Section 7A of the Act.

What is the position where an asset receiver rents property?

As the receiver is the agent of the borrower, s/he is entitled (subject to the normal restrictions in Section 7A of the Act [1]) to exercise the landlord’s option to tax in respect of a letting. In respect of properties where the borrower has waived his or her exemption (in relation to a short lease created prior to 1 July 2008) then as long as the waiver remains in place any new lettings of that property will be subject to VAT as a result of the waiver.

What is the position where an MIP/asset receiver “takes over” a rent roll?

Situations can also arise where an MIP/asset receiver “takes over” an existing letting from a borrower. In such cases the receiver will manage the property and be entitled to the rent roll. Where the MIP/asset receiver is entitled to the VAT inclusive rent [2] in respect of a letting, the MIP/asset receiver is obliged to pay the VAT on the rents over to Revenue.

What is the position when an MIP/asset receiver develops a property?

Some loan agreements allow an MIP/asset receiver to develop a property (either to completion or for improvement). In such cases, the MIP/asset receiver is likely to be considered a principal contractor for the purposes of Section 8(1B) of the Act and will be liable for VAT on the reverse charge basis on the receipt of construction services from sub-contractors. Further information on the operation of the reverse charge for construction services is available on the Revenue Website.

Deductibility for an MIP

The normal deductibility rules in Section 12 of the Act apply to an MIP. VAT is deductible where the costs incurred relate to an onward taxable supply. VAT is not deductible where the costs incurred related to an onward exempt supply.

Any VAT costs incurred in relation to securing possession of the property are not deductible, on the basis that such costs directly relate to the exempt lending business of the relevant financial institution.

VAT costs, including costs incurred in developing a property, in relation to an onward sale will be deductible if the sale is one on which VAT is chargeable. This includes sales that are automatically liable to VAT and situations where the MIP and the purchaser will enter into an agreement to apply VAT to an otherwise exempt sale in accordance with Section 4B(6A) of the Act. VAT costs incurred in relation to an onward sale will not be deductible if the sale is exempt from VAT.

VAT costs, including costs incurred in developing a property, in relation to a letting of a property will be deductible where the landlord’s option to tax is exercised. VAT costs incurred in relation to a letting will not be deductible if the letting is exempt from VAT (i.e. if the landlord’s option to tax is not or cannot be exercised).

Deductibility for asset receivers

In a similar way to an MIP, an asset receiver may deduct VAT costs incurred in relation to an onward supply which is subject to VAT (either a taxable sale or a letting where an option is exercised). VAT costs incurred in relation to an onward supply that is exempt from VAT (either sale or letting) will be not be deductible by the receiver.

What is the position for an MIP/asset receiver where a CGS adjustment is due in relation to a letting of residential property by a property developer?

Section 4B(7) of the Act provides for special rules for property developers who have developed residential properties since such sales are always subject to VAT, regardless of how long has elapsed since the completion of the development. In addition, there is a special rule in relation to situations where such a developer rents such a property [3] whereby the developer is not liable for a full CGS adjustment, but pays 1/20th of the VAT originally deducted to Revenue for each year for which the property is rented [4].

Where an MIP/asset receiver makes a new letting or “takes over” a letting from a borrower who is liable to pay this CGS adjustment, there is no obligation on the MIP / asset receiver in relation to this adjustment. The borrower is the person who is and remains liable to pay this adjustment. The borrower is also responsible for the CGS adjustment in the case of a new exempt non-residential letting.