Imposing VAT on land sales

The Cyprus government is under intense pressure from the EU to introduce 19% VAT on the sale of building and housing plots. Although the matter is currently under discussion in the House of Representatives, there seems to be no way Cyprus can evade the issues, with EU fines in the millions of euros mooted if this is not implemented very soon.

MPs and vested interest groups have argued that the new measure would upset a real estate market that has just started to recover after the financial and banking crisis, and that it will affect not only the property market but also banks, and other credit institutions, that hold land as collateral.

Currently, consumers do not pay any VAT when they buy a plot of land, but, if they then erect a house on that plot they pay 5% VAT. If they buy a house from a developer, by contrast, they pay only the 5% VAT. If the EU directive were to be enacted into national law, consumers would pay 19% VAT on the land purchase, plus an additional 5% VAT if they then built a house.

Arguably, Cyprus has been living on borrowed time as far as imposition of VAT on commercial property sales is concerned. The EU VAT Directive was enacted in 2006 but, when Cyprus acceded to the EU in 2004, it was granted a temporary exemption from the directive, allowing the island to continue to exempt the supply of building land until December 31st, 2007. As a consequence, the country has been acting in contravention of the directive for nearly a decade now, and a hefty fine awaits, comprising a lump sum for the 9 year period of non-compliance, as well as an amount estimated between €100,000 and €300,000 per day of non-compliance after that.

The government has already attempted to mitigate some of the effects of the additional VAT levy by abolishing last year the Immovable Property Tax, and by reducing land transfer fees by 50%. However, those affected by the new legislation argue that the impact on the property market could still be severe, reducing demand from buyers, and impacting on the ability of banks and other credit institutions, who hold property under “asset for debt” swap deals with debtors, to sell their property holdings. There is also a potential issue where banks hold land as a collateral for a loan, because, were VAT to be levied, the market value of the collateral might, effectively be devalued, because that value would effectively now be inclusive, not exclusive of VAT. As a consequence, the banks might demand further collateral for their loans, potentially causing additional hardship for borrowers.

Whilst the proposed tax will not affect those buyers who are VAT payers – they can offset this against their VAT payments – most commercial property buyers are not, especially in cases where they are buying the property for their own use.

Legislators have asked ICPAC (The Certified Public Accountants of Cyprus) to suggest proposals for offsetting the VAT imposition. Meanwhile, because the EU legislation imposes VAT on the supply of building land, there is some flexibility afforded national governments as to how they interpret this. For example, a government bill, submitted last year, exempts farm land, forests and “protected areas£ from the imposition of VAT, and MPs are now trying to restrict the definition of “building land”, so that as many land transactions as possible can be excluded from the new legislation.

At the same time, ruling party Disy and socialist Edek are going to table a proposal which will allow for the non-payment of capital gains tax until the end of 2018 to offset the impact of the VAT change. Another measure being contemplated is an amendment to the legislation whereby young couples who buy land in order to build their first home would be exempt from the 19% charge and would only pay 5% instead; either by paying the lower rate in the first place, or by paying the full rate and then getting the 14% difference refunded from the state.

The 19% VAT would also apply to tax leasing/letting of immovable property for commercial purposes, although it would only apply to those already registered for VAT. Individuals or families renting an apartment will be exempt from the VAT charge.

There are, of course, many critics of commercial developers and their allies in the House of Representatives who will feel little sympathy for them, and argue that this VAT charge should have been in place for many years. There also might be little support for the banks and the impact of the new legislation on their ability to tackle the NPL (Non-Performing Loan) issue which continues to dog the Cyprus economy and its struggles to recover from the bail-in crisis of 4 years ago. People’s anger might also be stirred when it is realised that it will be the Cyprus tax payer who will effectively be forced to pay the EU fines when they are eventually meeted out.

Nevertheless, the new VAT legislation, which is expected to be enacted into law before the Houses of Parliament convenes for their summer recess will have an impact on the Cyprus economy, the impact of which it is hard to assess in advance.

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