The aim of the proposed change, announced as part of Finance Minister Brian Cowen's 2008 budget speech, is to simplify the rules for VAT on property, while ensuring more equitable treatment for taxpayers. The new rules are designed to be broadly revenue neutral.

The current rules for VAT on property transactions tax the supply of a property if it has been developed since 1972, and if the supplier has had an entitlement to a deduction for the VAT incurred on acquisition or development of the property. The effect of this is twofold. It applies VAT to new residential property as such properties pass to a consumer; these properties then fall out of the VAT net. In the case of commercial properties however, where the use is for a taxable business, the trader must charge VAT indefinitely on any sale. This contrasts with the position for properties that are subject to a long lease, where the freehold reversion falls out of the VAT net. This can lead to difficulties in ascertaining the taxable status of a property, particularly in relation to older properties that may have been subject to a number of transactions, and where records may not be readily available.

Leases of ten years or longer in duration are treated as a supply of goods, and are taxed upfront. The basis for calculating the VAT charge (the capitalised value of the lease) and the anti-avoidance legislation that underpins it are regarded as complex. Short-term leases (less than ten years) are treated as an exempt supply of a service. However, a taxpayer may waive the exemption on such leases and choose to charge VAT on the rents. The landlord is then entitled to deduct the VAT costs on the acquisition or development of the property.

The review concluded that the current system is complex and imposes a significant compliance burden on ordinary transactions and that, broadly, the same revenue yield and taxation effect could be achieved through a revised simpler system of applying VAT on property transactions. The system also needs to be brought more into line with the EU requirements under the VAT Directive.

Provision will be made in the Irish Finance Bill for the introduction of a new system for applying VAT to property transactions. The new system will take effect from 1 July 2008.

The main changes include ceasing to charge VAT on the capitalised value of leases in excess of ten years, removing old properties from the VAT net by confining the period during which VAT will apply to the supply of new properties to a maximum of five years, and making some changes to the treatment of leases. In addition, a Capital Goods Scheme (CGS) will be introduced for property transactions; this will ensure that the VAT deductible will be proportionate to the business use of a property over a twenty-year period.