Real estate and VAT Demolition costs and input tax deduction

BACKGROUND

From a VAT perspective, the commercial use of a property regularly passes through three "life phases":

1. Creation/acquisition
2. Operation
3. Dismantling or sale

From a VAT perspective, different and sometimes controversial questions arise in every phase of this lifecycle. In the recent past, the courts have ruled on issues relating in particular to the demolition of properties and the associated right to deduct input tax.

GENERAL INPUT TAX DEDUCTION 

The taxable person can in principle deduct the VAT invoiced to and paid by them, the acquisition tax and the import tax as input tax within the scope of their business activity.

There is no entitlement to input tax deduction for supplies and the importation of goods that are used for the provision of services that are exempt from tax and for the taxation of which has not been opted.

This reservation is of particular relevance in connection with real estate, as the transfer and creation of rights in rem to real estate, services provided by condominium owners' associations to the condominium owners and the transfer of real estate and parts of real estate for use or utilisation are generally exempt from tax.

There are exceptions for certain uses (e.g. the letting of living rooms and bedrooms for the accommodation of guests and the letting of rooms in the hotel and catering industry or the letting of spaces not in public use for the parking of vehicles).

It is also possible to voluntarily subject the corresponding supplies to VAT (so-called option). However, the option is subject to the proviso that the item is not used or intended to be used by the recipient exclusively for residential purposes.

DISMANTLING COSTS AND INPUT TAX DEDUCTION

When deducting input tax in connection with demolition costs, a distinction must first be made as to whether the demolition costs were preceded by a change of ownership (i.e. the demolition is carried out by the purchaser of the property) or not (i.e. the demolition is carried out by the previous owner of the property).

DISMANTLING COSTS WITHOUT PRIOR CHANGE OF OWNERSHIP

The dismantling represents the final phase of the previous business use. The assessment of whether input tax is deductible in connection with the dismantling is based on the previous use for supplies that entitle input tax to be deducted or supplies that do not entitle input tax to be deducted. The intended future use and any associated change of use is not relevant.

• Example: Holzbau Müller AG owns a large area of land on the outskirts of Zurich with various tool sheds and buildings with wood-processing machinery. In future, Holzbau Müller AG intends to outsource production to timber construction companies in the Zurich hinterland and reduce its own machinery and vehicle fleet accordingly. Holzbau Müller AG intends to realise a large residential development on the site on the outskirts of Zurich.
• The input tax in connection with the dismantling is fully deductible. The decisive factor for the assessment of the input tax deduction is not the planned future use (which would presumably not entitle to input tax deduction here), but the previous use in the context of the timber construction business.

DISMANTLING COSTS WITH PRIOR CHANGE OF OWNERSHIP

In the opinion of the Federal Supreme Court, further differentiation is required here:

If the purchaser initiates the demolition of the property "immediately" after acquisition, he enters the first VAT-related life phase of the future property ("construction"). Accordingly, the right to deduct input tax depends on the future use of the property (to be constructed).

• Example: In order to realise its project, Holzbau Müller AG acquires a neighbouring property that was used by a garage owner. Holzbau Müller AG immediately demolishes the garage owner's premises and remediates the contaminated site.

• The input tax in connection with the demolition and renovation expenses is not deductible. The decisive factor for the assessment of the input tax deduction is not the previous use (which presumably would have allowed input tax deduction here), but the future use as a residential development.

If the purchaser does not initiate the demolition of the property "immediately" after acquisition, but instead puts it to an interim use, it must be examined whether this interim use is to be regarded as an independent operating phase or as a "non-independent interim use".

In the case of an independent operating phase, the demolition costs are part of the last life cycle phase of the current use of the property and the right to deduct input tax is based on the previous use. In the case of non-independent interim use, on the other hand, the demolition costs are included in the first life cycle phase of the "construction" of the new property to be built.

• Example: In order to realise its project, Holzbau Müller AG acquires another neighbouring plot of land. There is a haulage company on this site. As the haul-age company will not be able to move into its new headquarters for another nine months, it concludes a fixed-term rental agreement (opted for taxation) with Holzbau Müller AG until its new headquarters are completed. After the haulage company has moved out, Holzbau Müller AG has the company buildings demol-ished.
• The input tax in connection with the demolition is (probably) not deductible. The assessment of the input tax deduction is not based on the previous use (opted letting), as this was only for a short transitional period and there-fore cannot be regarded as an independent operating phase. In this respect, the right to deduct input tax depends on the planned future use.

CONCLUSION

Particularly in connection with interim use, it must be carefully examined whether this must be regarded as an independent operating phase or whether it merely represents non-independent interim use. However, the demarcation criteria are not very clear-cut and neither the administration nor the relevant case law offer any help here.

On the other hand, it is clear that forward-looking planning in connection with property transactions offers considerable potential for optimisation.