Tamás Fehér

In 2009 the Supreme Court made it clear that the VAT on public-purpose investments related to property developments is deductible if it would not be possible to implement the development without such investment. Recently, however, some alarm was unexpectedly caused by the preliminary opinion of the advocate general of the European Court of Justice (ECJ) in a similar, Bulgarian case, which recommended prohibiting the tax deduction right. Although the ECJ’s judgement published in the middle of last week did not follow the advocate general’s opinion, it did make exercising the deduction right subject to some strict conditions.

VAT on public-purpose investments

For many years property developers incur additional costs because – especially for large projects – the planning authority require them to carry out various investments that, ultimately, serve a public purpose (for example, the developer of a shopping mall might be required to upgrade a nearby road junction). The requirements are typically related to the development itself, but affect public utilities that are under state or local-authority ownership. So effectively, the property developer is obliged to provide services and carry out investments that it must then hand over to the community free of charge.

For many years, problems arose from the fact that Hungarian case law prohibited developers from deducting the input VAT charged in connection with investments of this nature. Because of this, developers not only had to stump up the net cost of the public-purpose investment, but were also “short-changed” when it came to the related VAT. A 2009 Supreme Court resolution, however, gave cause for celebration, as the judges ruled that where the public-purpose investment was ordered by the planning authority as a condition for carrying out a property development, it is immediately and directly linked to all the developer’s economic activity, and accordingly, the right to deduct the related VAT cannot be refused. Hungarian developers, therefore, have planned their investments accordingly since 2009.

Advocate general alarms investors

The waters were muddied, however, by an opinion issued by the ECJ’s advocate general in what is known as the “Iberdrola case” in April of this year. The case was triggered by a large-scale holiday resort construction project launched in Bulgaria by Iberdrola. As a part of the project, it made an agreement with the local authority regarding the refurbishment of the local sewage pumping station, without which the new holiday facilities would not have been able to connect to the sewer system. So, effectively, without the renovation the resort project also could not have gone ahead. But because the pumping station was owned by the local authority, and also because Iberdrola received no consideration whatsoever for its refurbishment, the relevant tax authority refused to allow Iberdrola to deduct the VAT related to these works. The legal dispute was taken to the ECJ, where the advocate general – in contrast to the Hungarian Supreme Court’s above-mentioned practice – took the position that the denial of the right to deduct the tax was legitimate.

ECJ reassures

If the ECJ had agreed with the advocate general’s opinion, this could have created serious problems for numerous real estate projects, possibly even for those ones that were implemented years ago, but still within the limitation period under tax law.

Fortunately, the ECJ departed from the advocate general’s opinion, and ruled that provided certain specific conditions are met, there is nothing to prevent property developers from deducting the VAT related to public-purpose investments. An important caveat, however, is that the right to deduct the VAT is not automatic, but must always be assessed on a case-by-case basis.

According to the ECJ’s judgement, one prerequisite for the deduction is that the investment be directly and immediately linked to the property developer’s taxable transactions and its economic activity. In the case in question, for example, this was achieved because without refurbishment of the pumping station it would not have been possible to connect the resort to the sewer network. As another requirement, the developer must ensure that the cost of the services used, as a general cost, is built into the price of the other services that it provides. This is important, because it ensures that the consumers who use the developer’s services, ultimately pay the VAT on these costs, too.

In addition to all these requirements, the ECJ also set up a necessity test. According to this, the VAT is only deductible in respect of costs associated with the specific parts of the public-purpose investment that were essential in order for the developer to perform its taxable transactions.

Any more questions?

Based on the above no radical change in the existing Hungarian judicial practice can be expected. Nevertheless, the conditions set by the ECJ have tightened the rules, so these conditions need to be thoroughly evaluated in each individual case, so as to ensure that the right of deduction of the VAT is beyond any doubt.

It’s important to bear in mind, on the other hand, that in this case the ECJ did not feel compelled to evaluate the output side of the public-purpose investment. It did not  express an opinion on whether the services provided free of charge to the local authority should be treated as VATable or falling outside the scope of VAT. But it’s encouraging that it did not make the right of VAT deduction contingent on whether delivery of the public-purpose investment is VATable in itself. And this could be useful when further developing Hungarian judicial practice.