Currently, the deduction of value added tax (VAT) incurred in a real estate which is in VATable use (typically VAT charged on construction or major renovation costs) must be monitored separately for ten years. In a typical real estate divestment, this adjustment responsibility passes to the buyer of the real estate where the real estate remains in VATable use after completion of the divestment. If the real estate is sold for a purpose that is not subject to VAT, the seller of the real estate is obliged to refund the input VAT included in the real estate investment. A similar rule is in force in Sweden. A recent ECJ decision has now altered this position.
On 26 November 2020, the European Court of Justice (ECJ) gave a preliminary ruling C-787/18, that the current regulation is contrary to EU law. The preliminary ruling concerned a situation in which the VAT included in the construction costs of the real estate had been deducted by the original owner of the real estate from whom the Swedish company Sögård Fastigheter had purchased the real estate. Both original owner and the new owner used the real estate for a purpose subject to VAT. When Sögård Fastigheter sold the real estate to two private persons who didn’t use the real estate for a taxable purpose, Sögård Fastigheter had to pay a VAT adjustment to the Swedish tax authority.
According to the preliminary ruling of the ECJ, this VAT adjustment could not be recovered from Sögård Fastigheter because the relevant corresponding VAT which the adjustment related to had been deducted by the original owner of the real estate. Based on the preliminary ruling, the obligation to pay the adjustment amount can only be assigned to the seller if the seller himself has made and received the benefit of the VAT deduction in respect of the real estate investment.
The preliminary ruling will probably lead to a change in legislation in Finland, but the judgment also has a direct interpretive effect on current Finnish VAT legislation. Based on the judgment, it should also now be possible in Finland for a seller to avoid the liability to pay the adjustment to the extent that the real estate is being sold for a purpose that is not subject to VAT, and the seller has not made a VAT deduction regarding the real estate investment itself.
The judgment leaves many questions unanswered. For example whether there is a possibility to allocate the VAT refund liability to the original owner who actually made the VAT deduction and the fulfilment of the audit responsibility based on the VAT utilization rate, if the audit responsibility has passed to the new owner of the real estate during the real estate transaction. In our view, it would be prudent for sellers to protect themselves from the VAT refund obligation in situations where the VAT utilization rate of the real estate decreases because of the buyer’s post-completion actions.
In Finland, real estates which are subject to VAT are often owned by a mutual real estate company. In our view, the ECJ ruling will not apply to the sale of shares owned by a mutual real estate company, when the MREC itself has made a real estate investment and made a similar VAT deduction.
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