The Belgian rules for adjusting VAT on renovations works will have to be re-examined

As we enter the ESG era, which will require major renovations to buildings, this ruling has caused the Belgian regime to falter and could be a cause for concern for the real estate sector. If you want to know more about the case, click here.

Right to deduct and capital goods

European VAT rules (contained in Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax - the VAT Directive) aim to ensure that VAT is 'neutral' for taxable persons. This principle of neutrality is expressed through the recognition of a right to deduct VAT on the part of any taxable person who carries out transactions subject to VAT.

This right of deduction entitles taxable persons to deduct the VAT on the goods and services they use (input transactions) to carry out transactions (output transactions) that are subject to VAT. The positive difference between input VAT and output VAT is paid to the Treasury.

The right of deduction applies not only to ordinary goods and services (e.g., energy supplies, law firm consultancy services, …), but also to goods that are used on a long-term basis for the taxable person's economic activity and whose acquisition cost is depreciated over several financial years. These are referred to as capital goods under articles 187 and 189 of the VAT Directive.

Article 190 of the VAT Directive also allows Member States to consider services " which have characteristics similar to those normally attributed to capital goods " as such capital goods. The Belgian State has made use of this option in order, for example, to consider that construction works constituted capital goods for the taxable person to whom it was invoiced.

What is a VAT adjustment (i.e., clawback)?

VAT incurred on the acquisition of capital goods is immediately and fully deductible. Given that the right to deduct was introduced to specifically reduce the tax burden on the acquisition of capital goods, one will understand why the VAT Directive keeps a close eye on the use of such goods.

To this end, the VAT Directive has introduced the VAT adjustment mechanism which aims, in certain specific situations, to correct the deduction right to avoid inaccuracies in the calculation of VAT deductions on capital goods and unjustified (dis)advantages.

One of the situations is that, broadly speaking, this mechanism requires the taxable person to repay to the State, on a pro rata basis, the VAT initially deducted on a capital good which, within a certain period of time, becomes no longer used to carry out an activity subject to VAT.

Capital goods versus immovable property acquired as capital goods

The period within which the taxable person is required to carry out an adjustment is referred to as the "adjustment period", which varies according to the nature of the capital good:

• In the case of capital goods, the review period is 5 years.
• In the case immovable property acquired as capital goods, the VAT Directive allows Member States to apply an adjustment period of up to 20 years. This longer period is justified by the particularly long economic life of immovable property acquired as capital goods.

Belgium has limited this period to 15 years. VAT Royal Decree No. 3 specifies that this extended period concerns VAT charged on:

• • • The erection of a building ;
    • The acquisition of building (and adjoining land);
    • The acquisition of a right in rem over a building (and the adjoining land).

• In the case of a building used for an optional lease between two companies (a B2B lease based on article 44, §3, 2°, d) of the VAT Code), the period is extended to 25 years for the VAT charged on the aforementioned transactions (in contravention of the VAT Directive).

If the capital good for which VAT has been deducted is no longer used in the taxpayer's business during these periods, a clawback applies and the VAT will have to be repaid to the State pro rata to the years remaining in the adjustment period.

Renovation work: the current Belgian position

Strictly speaking, renovation work is not covered by VAT Royal Decree no. 3, which only applies to construction work.

However, the tax authorities consider that renovation work can be so extensive that it has the effect of making the building new, as if it had been (re)built. In such a case, the work qualifies as “immovable property acquired as capital goods”

To a certain extent, the tax authorities apply the Belgian administrative criteria for the conversion of buildings (see the CJEU's Promo 54 v Belgian State judgment of 9 March 2023) in order to determine which category of capital goods renovation work falls into:

• The 15-year period applies to conversion work, i.e. :
  • are of such importance that the building has undergone a radical change in its essential elements (in its nature, its structure and, where applicable, its purpose); or
  • achieving a cost excluding VAT of at least 60% of the market value of the building (excluding the value of the land) after works.
• In all other cases, the 5-year period applies to renovation work.

Clearly, for taxable persons, the 5-year review period is in principle more favourable than the 15-year period in terms of the obligation to review.

We shall see that the Drebers case is likely to reshuffle the cards in this area.

Drebers case: the facts

The facts behind this judgment are somewhat peculiar. In practice, there is usually an adjustment because the capital good on which VAT was deducted is no longer used for the business, so the VAT has to be refunded.

In this case, the adjustment was reversed: due to a change in legislation, the taxpayer obtained the right to deduct VAT on capital goods for which he was initially not entitled to deduct VAT.

Until 2013, lawyers were not subject to VAT, but as of 1^er January 2014, the VAT exemption for practising as a lawyer was abolished. Since then, the lawyer in question has been registered as a taxpayer.

Specifically, the case concerned a lawyer who owned a building (some of which he also used for private purposes) that had undergone a thorough renovation between 2007 and 2015. After the renovation work, the property consisted of a renovated main building and an intermediate building, as well as a newly constructed basement, a glazed annexe and a lift shaft. The various areas were linked by corridors on the ground and ground floors, and there was also lift access to all floors of the main and intermediate buildings (including the privately used parts of the building).

A single "cadastral income" was attributed to the building, which amounted to EUR 2,456 before the start of the work and EUR 3,850 afterwards. The building thus converted was 40% for private use and 60% for professional use.

The total cost of the works was just under EUR 2,000,000.

The abolition of the exemption also expressly provided that VAT incurred on capital goods made before the abolition could still be deducted, insofar as the adjustment period had not yet expired.

The lawyer considered that the renovation work qualified as immovable property acquired as capital goods subject to the 15-year adjustment period, which allowed him to claim back 8/15 of the VAT charged on the renovation work.

Following a tax audit, however, the Belgian tax authorities took the unsurprising view that the renovation work was only subject to the 5-year adjustment period, on the grounds that the work did not result in the conversion of the building.

The dispute was finally brought before the CJEU, which handed down a very interesting decision on the applicable period.

The CJEU conclusion

The Court concluded that:

• In this case, the renovation work carried out by the taxpayer is much more similar to immovable property acquired as capital goods than to capital goods other than immovable property.
• It is irrelevant whether the immovable works constitute a conversion within the meaning of supplies of goods (although this is the Belgian criterion applicable to renovation).
• The VAT Directive precludes national legislation on the adjustment of deductions of VAT under which the extended adjustment period for immovable property acquired as capital goods is not applicable to immovable property works, subject to VAT as supplies of services within the meaning of that Directive, which involve a significant extension and/or substantial renovation of the building concerned by that work and the effects of which have a duration of economic life which corresponds to that of a new building.

Consequences

This ruling is undoubtedly a victory for the Belgian lawyer concerned: his 'positive' VAT adjustment can now go back up to 15 years. The work begun in 2007 could still be subject to an adjustment in 2014 for a prorate of 8/15.

For the real sector as a whole, this isolated victory will have a potentially bitter taste.

Although the current Belgian administrative criteria were established in the context of property sales and are sometimes difficult to apply in practice, the Belgian tax authorities have demonstrated consistency, uniformity and predictability by also applying them to renovation work in the context of VAT reviews.

With this ruling, there is therefore a grey area, since it is not necessary (or even simply irrelevant) for immovables works to amount to a conversion in order to qualify as immovable property acquired as capital goods subject to the 15-year clawback period: it is necessary, but sufficient, that the works (i) involve a significant extension and/or substantial renovation of the building and (ii) the effects of which have a duration of economic life which corresponds to that of a new building.

It remains to be seen how the Belgian tax authorities or legislator will implement this ruling which, while not legally inconsistent, is a potential source of interpretation difficulties.

In any case, it is to be expected that, with this ruling, renovation work in Belgium is likely to fall ‘more frequently’ within the 15-year adjustment period than at present.