CHANGES IN IRISH REAL ESTATE LAW tend to be rare. However, the last six months of 2008 saw significant changes in the areas of landlord and tenant rights for business premises, VAT on property transactions and the introduction of a building energy rating scheme. In addition, legislation was passed immediately before Christmas that signals the abolition of most of the remaining stamp duty minimisation methods for real estate transactions. This article summarises these recent developments.
MAJOR CHANGE TO LANDLORD AND TENANT STATUTORY RENEWAL RIGHTS
One of the most far-reaching changes to commercial landlord and tenant law in the past 15 years has recently come into force.
Since 20 July 2008 all commercial tenants (and not just office tenants as before) can opt out of their statutory entitlement to renew their leases. The opt-out (or contracting-out) provision applies to all tenants of business premises provided the tenant has obtained independent legal advice and signed a deed of renunciation.This change, coupled with the new VAT regime (which has removed the prohibitive VAT consequences to landlords of granting leases of between ten and twenty years in length) will facilitate the grant of leases of more than five years’ duration. Previously, the only means of preventing renewal rights accruing for retail and industrial tenants was to ensure that a tenancy was for less than five years’ duration. The lack of a contracting-out procedure for retail and industrial users created a high degree of inflexibility and made subletting other than for short terms particularly problematic.
One of the several advantages to landlords of this new development is that concession and franchise arrangements, which are popular in the retail sector, will no longer carry a risk to the landlord of being deemed tenancies provided the lease is structured correctly. This will also benefit department store tenants and large multiples who frequently grant concessions.
The new opt-out provision also means that developers who have short-to medium-term plans to redevelop or refurbish outdated retail schemes will have the certainty of obtaining vacant possession when they need it, and can continue to let premises following the expiration of existing arrangements during the planning application and pre-construction periods, thus securing valuable additional income.
Tenants will also have longer periods to make alternative arrangements.
An interesting aspect of the new contracting-out procedure is that the renunciation is not required to be eff ected prior to the commencement of the tenancy (as was the case with office tenants).
The greater flexibility the new law brings is likely to receive a warm welcome from the property market and will hopefully provide a stimulus for increased activity in the commercial property sector.
BUILDING ENERGY RATING CERTIFICATES: NEW REQUIREMENTS FOR LANDLORDS AND VENDORS
1 January 2009 marks the final implementation of the Building Energy Rating (BER) Certificate scheme. A BER Certifi cate must be prepared by a registered BER assessor and gives an indication of the energy performance of a building, covering energy use for space heating, cooling, water heating, ventilation and lighting.
The rating is based on an A-G energy rating scale, with an A-rated building being the most energy efficient. The BER must be provided to prospective buyers or tenants when a building is constructed, sold or rented.
The BER scheme has been phased in, and already applies to new homes where planning permission was applied for on or after 1 January 2007, and to new buildings (other than homes) where planning permission was applied for on or after 1 July 2008. The scheme applies to all existing buildings for sale or rental after 1 January 2009.
Transitional arrangements will apply to homes where planning permission has been applied for prior to 1 January 2007 if all exterior walls were built by 30 June 2008 and to new buildings (other than homes) where planning permission was applied for prior to 30 June 2008 and the substantial work is completed before 30 June 2010.
A BER Certificate must be accompanied by an advisory report setting out recommendations for cost-effective improvements to the energy performance of the building. However, there will be no legal obligation on sellers or prospective buyers to carry out the recommended improvements.
Landlords face fines of up to €5,000 for non-compliance with the BER regulations. In addition, failure to produce a BER Certifi cate is likely to hinder or delay the completion of a sale or letting or a future disposal of a property.
There are exemptions from the requirement to produce a BER Certificate for certain categories of buildings; for example, protected structures and certain temporary buildings.
For buildings in the course of construction being sold off-plan, provisional BER Certifi cates can be applied for to produce to potential buyers or tenants. These provisional BER Certifi cates will be based on the initial construction drawings and are valid for a maximum of two years. Provisional BER Certificates should also include any recommendations for improvements that can be made to the BER. Once the building is completed a final BER Certificate must then be produced to the purchaser based on the plans of the property as constructed, to take account of any design changes during construction.
STAMP DUTY LOOPHOLE TO BE CLOSED
Stamp duty on documents recording transfers of real estate has been a very significant element of tax revenue for the Irish Exchequer. It is a mandatory tax carrying severe penalties for non-payment.
Stamp duty rates are high; the rate on commercial property transactions is 6% for transactions with a value exceeding €150,000 and that rate was only recently introduced, having been 9% for several years previously. With the longrunning property bull market in Ireland for most of the past decade, it is not diffi cult to understand why successive Irish governments have continually reduced the opportunities to avoid or minimise payment.
The three most common avoidance techniques remaining were:
- resting in contract;
- agreements for lease exceeding 35 years; and
- building licences.
So long as the parties to the transaction (and the lenders/funders involved) were content not to have delivery of a formal transfer or lease of the property, stamp duty could be avoided, or at least deferred for signifi cant periods.
The Finance (No.2) Act 2008, which became law on 24 December 2008, contains a provision stating that resting in contract, agreements for leases exceeding 35 years and building licences will all now be stampable events where 25% of the purchase price is paid over.
While the 2008 Act has become law, the provision will only become operative after the passing of a ministerial order. At the time of writing, the order has not been passed, but most industry observers believe it will be passed in early 2009.
The new legislation specifically excludes public-private partnership projects and certain tax incentive property transactions, which will continue to avail of the exemption after the ministerial order is made.
Once the ministerial order is passed, it will be very difficult to avoid payment of stamp duty on real estate transactions. Where a company owns real estate and the company is sold rather than the underlying real estate asset, that attracts stamp duty of only 1%. That remains available as a stamp duty minimisation technique, although it is only useful where the company has no other assets.
NEW VAT ON PROPERTY SYSTEM
Under the new system applied under the Finance Act 2008 and effective from 1 July 2008:
- A property is developed if it has undergone construction, demolition, extension, alteration or reconstruction of any building on it or engineering or other operations to effect a material change of use. A category of development known as ‘refurbishment’, being development to a previously existing building, is also recognised.
- Prior to 1 July 2008 the sale by a taxable person of a property developed after 31 October 1972 was potentially taxable. From 1 July 2008 (as will be seen below) new rules apply to ascertain whether or not the sale of a property is taxable.
- An ownership lease (a freehold equivalent interest) in a commercial property is treated as a capital good and the grant of an occupational lease of a commercial property is treated as the supply of a service.
- The first sale by a developer of a new residential property will continue to be taxed at 13.5%.
- The sale of developed property – whether the sale of a freehold or a freehold-equivalent interest – will be taxable only when the property is considered ‘new’. A property is considered new on the first sale within five years after it has been developed. The sale of a property comprising an existing building that is substantially refurbished or has been the subject of works to eff ect a materially altered use will be capable of being considered as the sale of a new property.
- The sale of a previously sold property (nearly new) within five years of completion of a development will also be taxable, except when the property has been occupied for two years or more at the time of the sale.
- The sale of a residential property is not covered by the nearly-new rule.
- The sale of a developed property which is not new or nearly new will be exempt from VAT, but while the property is still in the adjustment period, a clawback of VAT reclaimed on the acquisition or development of the property may apply unless a joint option to tax the sale of the property is exercised. When the joint option to tax the sale of the property is exercised, VAT will be charged at the rate of 13.5% of the consideration paid on the sale and VAT must be accounted for by the purchaser by way of self-supply. This may require an unregistered purchaser to register for VAT in order to comply with VAT obligations.
- The assignment or surrender of an occupational lease granted prior to 1 July 2008 by a taxable person who was entitled to reclaim VAT on the acquisition or development will be treated as a sale of immoveable property and taxed at 13.5% based on an amount calculated under a new VAT formula.
- In contrast to the above, the assignment or surrender of an occupational lease created after 30 June 2008 is treated as the supply of a service, with VAT at 21.5% applying to any premium, but in the case of a surrender only, the premium will not be subject to VAT if the option to tax the rent under the occupational lease at 21.5% does not apply.
- Section 4A of the Value-Added Tax Act 1972 and the old system of taxing a lease for a period of ten years or more by reference to the capitalised value no longer applies.
- With effect from 1 July 2008 the letting of a commercial property is exempt, subject to a landlord’s option to tax the rent at 21.5% as the supply of a service. Failure or inability to exercise the landlord’s option to tax the lease will result in VAT reclaimed by the landlord on the acquisition or development being clawed back under the capital goods system. The landlord’s option to tax a lease does not apply where the landlord and the tenant are connected and the tenant has less than 90% VAT recoverability. Also, if a property is let, the landlord’s option to tax is exercised and the property becomes occupied by a person connected with the landlord or the landlord himself, the landlord’s option to tax is automatically terminated.
- The capital goods system is a mechanism for the adjustment of VAT deductions over the VAT life of a capital good. Where a taxable person acquires a property classified as a capital good, the deductibility for VAT purposes that the taxable person has claimed on the development or acquisition of that property (the initial deduction) is used as a benchmark against which VAT adjustments in each interval in the adjustment period (the life that for VAT purposes is attributed to a capital good) will be made, based on any changes in taxable usage of the particular property.
- All properties in the VAT net will be subject to the capital goods scheme, with certain obligations being relaxed for property in the VAT net on 1 July 2008, known as ‘transitional’ property.
- The definition of ‘taxable person’ has been expanded to include a person engaged in an economic activity but who is not necessarily entitled to reclaim VAT on input costs.
Readers should note that the above is a summary only. It is not intended as a full statement of the law.
For further information please contact: Andrew Muckian, partner in the property department at William Fry, or Michael O’Connor, partner with William Fry Tax Advisors. E-mail: andrew.muckian@williamfry.ie; michael.oconnor@williamfry.ie.