VAT Adjustment Procedure for Real Estate Investments Undergoing Reform

The article has also been published in Almatalent Juridiikan ajankohtaiset (in Finnish).

Background

The reforms to the VAT adjustment procedure for real estate investments are based on a judgment delivered by the Court of Justice of the European Union ("CJEU") in November 2020 in case C-787/18, Sögard Fastigheter.

According to the aforementioned judgment, the provisions of Swedish VAT law concerning real estate investment adjustment situations are, in respect of certain real estate transfers, inconsistent with the EU VAT Directive. As the provisions of Finnish VAT law largely correspond to Swedish regulation, it is clear that Finnish legislation also requires amendments to meet the requirements of EU law.

What Will Change?

Real estate investments refer to the purchase or performance of construction services related to new construction or refurbishment of real estate. The purchase of a new building is also regarded as a real estate investment if the seller has paid taxes on their own use of the construction services. The VAT deduction adjustment period begins from the moment the real estate unit is taken into use and continues for ten calendar years. The VAT adjustment right and obligation applies to all real estate owners who have been able to deduct the VAT included in acquisitions in connection with the investment.

Under current domestic legislation, the VAT adjustment obligation transfers to the buyer in a real estate sale when the seller is a business operator or municipality, and the buyer acquires the real estate for use in VAT-liable business activities. If the buyer is not VAT-liable, the amount of the remaining adjustment period is reversed for the seller to repay.

The CJEU judgment sets limits on how the adjustment obligation for real estate investments can be regulated in national legislation. According to the CJEU ruling, a national provision under which a real estate unit seller is released from the obligation to adjust VAT deductions made on real estate investments carried out by them in connection with a real estate sale is contrary to the VAT Directive.

Equally significant can be seen the court's position on the buyer's status. According to the judgment, a national provision under which a real estate unit buyer could become obliged to adjust VAT deductions made on real estate investments that the buyer has not made themselves is contrary to the VAT Directive.

The CJEU confirmed in its judgment that the adjustment obligation for a real estate investment applies only to the VAT-liable person who has themselves carried out the real estate investment, and this obligation cannot be transferred in connection with the transfer of the real estate unit. This principle forms the core of future legislative changes and significantly affects how real estate sales must be structured in the future.

Unclear Legal Situation and the Risks It Causes

The current situation is challenging for real estate sector operators. Due to the unclear legal situation, taxpayers can, on the one hand, act in accordance with the VAT Act in force, but on the other hand, also rely directly on the VAT Directive. This creates significant legal uncertainty between the parties to a transaction.

The seller may consider that they have the right under the VAT Act to transfer the adjustment and correction obligation for the real estate investment to the buyer. However, the buyer may consider that, due to the direct legal effect of the VAT Directive, they do not need to make adjustments to deductions originally made by the seller. This conflict can lead to situations where the parties to a transaction have completely opposing views on who bears the adjustment obligation.

It is known that during the Swedish legislative preparation process, several issues affecting taxpayers' legal protection have been identified, which are also relevant from Finland's perspective. For example, postponing real estate transfers to avoid adverse VAT effects until the real estate investment adjustment period has ended may distort the functioning of real estate markets and delay commercially justified transactions.

Practical Effects on Real Estate Transactions

The effects of the reform on real estate sales may be significant. The accumulation of hidden VAT for buyers in real estate transfer situations is one of the main concerns. If the seller can no longer transfer the adjustment obligation to the buyer but must themselves adjust previously made deductions, this may increase the real estate’s sale price or make the sale more difficult to complete.

The weakening of the neutrality principle prevailing in VAT due to the buyer's loss of deduction right is another significant problem. If the buyer cannot deduct the VAT included in the purchase price, even though they would use the real estate for activities entitling them to deduction, hidden VAT arises, which distorts competition and weakens the neutrality of the VAT system.

What Should Real Estate Sector Operators Do?

Although the Government's proposal has not yet been published, it is clear that changes are coming. It remains to be seen whether the Government's proposal will seek a model from, for example, Germany, where voluntary VAT liability for real estate transfers is in use. Such a system would enable a real estate seller to opt for VAT liability on the sale of the real estate, whereby the buyer could deduct the VAT included in the purchase price.

A possible reverse charge mechanism for the buyer could enable a VAT-liable buyer to at least partially deduct the VAT included in the purchase if the real estate unit is acquired at least partially for activities entitling them to deduction. The reverse charge is a familiar mechanism from other areas of VAT, and its application to real estate sales could offer a practical solution for safeguarding the neutrality principle.

In any case, real estate sector operators should already prepare for the coming changes. In ongoing real estate transactions, particular attention should be paid to contractual terms concerning the adjustment obligation and an assessment should be made of how the CJEU ruling may affect the parties' obligations.

For real estate investments with a long adjustment period, consideration should be given to whether possible transfers should be postponed pending clarification of the legislation. On the other hand, excessive waiting may lead to commercially unfavourable situations. Each situation requires individual assessment and expert assistance.

When the Government's proposal is finally published, it will hopefully bring clarity to the current uncertain situation. Until then, real estate sector operators should closely monitor both domestic legislative developments and corresponding Swedish reforms, which provide indications of the direction in which Finnish legislation is also developing.

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