VAT treatment of property developers renting out residential properties

Introduction

New rules for VAT on property transactions came into effect on 1 July 2008. This article deals with situations where a property developer (or a person connected with a property developer) who was entitled to deduct the VAT incurred on the acquisition or development of residential property subsequently rents out that residential property on or after that date. There are two separate VAT rules for such scenarios depending on when the property was completed.

When is a property considered ‘completed’?

‘Completed’ is defined in legislation [1]. Generally speaking, a property is completed when it is ready to be used for the purposes for which it was designed. There are certain criteria that must be met before a property can be considered completed. For example, the utility services required for the purposes for which it was designed must be connected. However, the fact that the utility services are connected does not in itself necessarily mean that a property is completed. Revenue is prepared to accept, in cases to which this article applies, that a property may be regarded as not having been completed until it has been rented.

Properties completed before 1 July 2008 and rented on or after that date

Where a property developer develops a residential property, that property is completed before 1 July 2008, and that property is rented on or after 1 July 2008, then there is a full claw-back of the VAT deducted by the developer. This claw-back is triggered by Section 4C(3) VAT Act 1972 (as amended) and is effected at the time the letting of the residential property is created. Example 1 below illustrates how this operates.

Example 1

Developer D constructs a house for sale. The cost of constructing this house is €1,000,000 + VAT €135,000. D deducts all of this VAT. The development of the house is completed on 1 Feb 2008. D is unable to sell the house and instead rents it out. The letting is for two years and is created on 4 Aug 2008. This triggers an immediate claw-back under Section 4C(3) VAT Act 1972 (as amended) using the formula in Section 4(3)(ab) -

T × (Y - N)

Y

T = amount of tax deducted;
Y = 20
N = 0 (number of full years since development occurred)

135,000 × (20 - 0)

20

= €135,000 VAT payable by D in taxable period in which the letting is created (Jul/Aug 2008).

D must account for this amount in the VAT return for Jul/Aug.

It should be noted that the adjustment that Developer D makes in the above example as a result of letting the house from 4 August is the same that would have been required if the letting had commenced prior to 1 July 2008. The only difference is that, under the new rules, the formula in Section 4(3)(ab) is applied through the operation of the new Section 4C(3); prior to 1 July, Section 4(3)(ab) applied directly to such a transaction.

Properties completed on or after 1 July 2008 and rented on or after that date

Where a property developer develops a residential property, that property is completed on or after 1 July 2008, and that property is rented on or after 1 July 2008, no immediate claw-back occurs. Instead, the developer will be required to adjust the VAT deductibility at the end of the second capital goods scheme (CGS) interval [2]-and each subsequent interval-until the property is sold. Example 2 below illustrates how this operates.

Example 2

Developer E constructs a house for sale. The cost of constructing this house is €1,000,000 + VAT €135,000. E deducts all of this VAT. The development of the house is completed on 15 Jul 2008. E is unable to sell the house and instead rents it out. The letting is for two years and is created on 4 August 2008. There is no immediate claw-back of the VAT deducted. E’s accounting year ends on 31 December each year.

The CGS initial interval for E in respect of the property begins on 15 Jul 2008. It ends on 14 Jul 2009. The second interval ends on 31 December 2009 (end of accounting year). An adjustment arises at this point in accordance with Section 12E(5) VAT Act 1972 (as amended) as follows -

C - D
C = reference deduction amount
D = interval deductible amount (see VAT on property Guide for details)
6,750 - 0
= €6,750 payable as tax due by E for the taxable period following end of second interval:, that is, the tax is due for the Jan/Feb 2010 VAT period.

This payment essentially amounts to E paying back 1/20th of the VAT deducted in respect of the development of the property. At the end of each subsequent interval (in the taxable period following the end of each 31/12 financial year) the same amount (€6,750) will be payable by E for as long at the property is not used for a taxable purpose.

What is the position when a residential property - such as the properties in Examples 1 and 2 above - is subsequently sold after being rented?

In both cases, the sale is subject to VAT on the full consideration received regardless on of how long a period of time the properties have been let. However, there are two different treatments in relation to the deductibility that has been clawed back depending on the scenario. This is illustrated by example below.

Example 1 Continued

At the end of the lease (3 Aug 2010) D sells the property for €1,200,000. The sale is subject to VAT @ 13.5% = €162,000.

There is a VAT credit given to D for the VAT that was clawed back on the letting of the property, but this credit is reduced by the number of years that have elapsed since the property was completed -

E × N

T

E = non-deductible amount[3]
N = 18 (no of full intervals remaining in adjustment period + 1)
T = 20 (total number of intervals in adjustment period)

135,000 × 18

20

= €121,500 given as VAT credit for the taxable period in which sale occurs (Jul / Aug 2010). D must, however, also account for VAT of €162,000 for that period, being the VAT due on the sale of the property, for a net liability of €40,500.

Example 2 Continued

At the end of the lease (3 Aug 2010) E sells the property for €1,200,000. The sale is subject to VAT @ 13.5% = €162,000.

There is no VAT credit given as the claw-back of €6,750 that occurred in the Jan / Feb 2010 taxable period was in respect of the use to which the property was put during the second interval - i.e. an exempt use. No further claw-back of inputs arises as the taxable supply of the property in August 2010 constitutes a taxable use for the third and all subsequent intervals.

E must account for VAT of €162,000 for the Jul / Aug 2010 taxable period, being the VAT due on the sale of the property.

While the net amounts that Developers D and E will return in respect of their sales of the two houses differ greatly, this reflects the fact that Developer D, in making the deductibility adjustment in 2008 had already accounted for the potential exempt use of the property for the full remaining portion of its CGS adjustment period, and will therefore benefit from its diversion to taxable use via its taxable sale in 2010. Developer E, on the other hand, would have made adjustments for exempt use only on an interval by interval basis. In consequence, both developers have consistent entitlements to deductibility for the remaining intervals in the adjustment periods.

Treatment for Stamp Duty

Where an intended purchaser occupies a new house under ‘a rent with an option to buy scheme’ and the house is subsequently purchased by that person as part of the scheme, the property will be regarded as new for the purposes of reliefs that apply on the purchase of a new house.