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In this article, we present the basic issues concerning value added tax (VAT) on the sale of developed real estate. We discuss various aspects of the process and tax exemptions. Common mistakes can have serious financial consequences, so it is important to determine the correct tax treatment. Taxpayers may assume that, for example, because they bought a property with VAT, its sale must also be subject to VAT. Unfortunately, the rule is not that simple.
Taxation of developed real estate
Tax on the sale of developed real estate depends on whether it contains a building or structure subject to VAT and on the applicable tax rate. The rules arise from Article 29a(8) of the VAT Act and the lack of detailed regulation on this matter. When buildings or structures (or parts thereof) permanently attached to land are sold, the land's value is not separated from the taxable base. The land is subject to VAT under the same rules as the sale of the building or structure. In other words, if a building is VAT-exempt, the exemption also covers the land it occupies. If a building is taxable, sale of the land is taxed at the rate appropriate for that building or structure.
A more difficult issue is the tax treatment of a property sale involving more than one building or structure. Tax must then be calculated separately for each. If buildings are subject to different tax rates (or exemptions), the land value should be allocated to the tax bases using a ratio calculated by value or area. Under the value method, land value is allocated in proportion to the values of the individual buildings; under the area method, it is allocated according to the area occupied by each building. Note that the regulations do not specify how the land value must be divided.
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Sale of real estate and VAT exemption
When discussing tax on the sale of developed real estate, it is important to consider VAT exemptions for such transactions. Under Article 43(1)(10) of the VAT Act, supplies of buildings, structures or their parts are exempt from VAT except when:
- the supply occurs at or before first occupation,
- less than two years have passed between first occupation and the supply of the building, structure or part.
Under Article 2(14) of the VAT Act, first occupation means handing a building, structure or part over for use to the first buyer or user, or beginning to use it for one's own purposes, after:
- its construction, or
- improvement, if the improvement expenses under income-tax regulations amount to at least 30% of its initial value.
What is the difference between an improvement and a renovation?
For the rules on first occupation, it is important to understand the distinction between improvement and renovation. Under Article 22g(17) of the Personal Income Tax Act and Article 16g(13) of the Corporate Income Tax Act, fixed assets are improved by rebuilding, extending, reconstructing, adapting or modernising them. A Supreme Administrative Court judgment of 21 November 2001, I SA/Gd 829/99, gives the following definitions:
- rebuilding is a significant change to the internal structure of an existing property without increasing its area or volume;
- extension increases area or volume;
- reconstruction is rebuilding an object to restore it;
- adaptation makes an object suitable for a new function it did not previously serve;
- modernisation updates an object by adding new components.
However, under the income tax acts, improvement is recognised only when the total expenditure exceeds PLN 10,000 and increases the utility value compared with the value on the day the fixed asset began to be used. The increase can be measured in terms of useful life, productive capacity, the quality of products obtained with the improved fixed assets and operating costs.
The definition of renovation is in the Construction Law. Under Article 3(8), it means construction work on an existing structure to restore its original state, other than routine maintenance. Materials different from those originally used may be employed. However, only improvement expenditure matters in determining whether first occupation has occurred. In this respect, Article 2(14) of the VAT Act does not refer to renovation.
Waiving the tax exemption
Article 43(10) of the VAT Act permits waiving the exemption under Article 43(1)(10) if two conditions are met:
- Both the supplier and buyer must be registered as active VAT taxpayers.
- Before the supply, they must jointly declare that they choose to tax the supply of the building, structure or part, either to the head of the tax office competent for the buyer or in the notarial deed made for the supply.
Waiving the exemption should be considered in light of the obligation under Article 91 of the VAT Act to adjust deducted tax (that is, partly repay it to the office) if the taxpayer sells a property within ten years of acquisition and had a right to deduct VAT on acquisition. In some cases, charging VAT may be beneficial so that the seller need not repay some deducted VAT if the buyer can deduct that tax.
Furthermore, Article 43(1)(10a) of the VAT Act provides another exemption. It is available if:
- the supplied properties are not exempt under Article 43(1)(10),
- the seller had no right to reduce VAT due by input VAT,
- the seller incurred no improvement expenditure giving a right to reduce VAT due by input VAT; if such expenditure was incurred, it must be less than 30% of the properties' initial value.
Financial consequences of incorrect taxation of a property supply
Correctly taxing a property supply is important because an incorrect assessment can have serious financial consequences. In addition to interest on overdue tax, incorrect settlement may expose the taxpayer or the person responsible to fiscal penal liability. For taxpayers other than individuals, an additional tax liability of 30% or 20% of unreported VAT may also arise.
Both seller and buyer may suffer adverse financial effects. If the seller wrongly determines the VAT treatment, the buyer may overstate a VAT refund or understate the tax due. Such errors occur often in practice, so before a transaction of this kind it is advisable to verify the legal and factual circumstances thoroughly and determine the correct treatment.
If you found this article interesting, explore our tax advisory services and read how we can help you:
Summary
At TaxCoach, we know that VAT on sales of developed real estate can be complicated. We want to emphasise that we are here to help clients understand these matters. If you have questions or would like more information, reach us here → contact.
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