Does the landlord’s payment to the tenant for the transferred technical improvement at the end of the lease,
which the tenant arranged and depreciated, constitute payment for a general service subject to VAT or for specific construction work falling under the reverse charge system? The Supreme Administrative Court (“SAC”) considered, and hopefully definitively decided, a long-discussed and previously undecided issue in its judgment 2 Afs 323/2021 – 56.

In the specific case, the tenant performed revitalisation, or technical improvement consisting of construction and installation work, of a train station building, which he continued to use for his economic activity, the sublease. With the lessor’s consent, he wrote off the technical appreciation. At the termination of the lease agreement, the lessee billed the lessor for part of the costs of technical improvement (in the amount of the tax residual price), applying the reverse charge system under Section 92e of the VAT Act. The lessee also requested a binding assessment of the used scheme by the General Financial Directorate. However, according to the decision issued by the GFD, the reverse charge system does not apply in this case. The decision was issued by the GFD only after the performance and invoicing by the lessee, though. The lessee subsequently issued corrective tax documents with VAT added (as a precaution).

The SAC upheld the decision of the tax administrator and subsequently of the Municipal Court, and thus also assessed the supply as a taxable supply of services. It justified its decision mainly on the grounds that:

• the application of the reverse charge regime must be interpreted restrictively because it constitutes an exception to the general principle that VAT is paid by the person who carries out the taxable supply;
• the construction work performed has already been consumed by the lessee, the transfer of the technical improvement at the end of the lease does not correspond to the usual meaning of the provision of construction and installation work;
• upon termination of the lease, the lessor acquires the right of use to the leased object, which constitutes a separate economically measurable service;
• rental, revitalisation (technical improvement) and the return of the improved real estate at its residual value represent three economically and legally distinct transactions and services for VAT purposes;
• the service of transfer of other property value does not fall under sections 41-43 of the CZ-CPA classification.

According to the Supreme Administrative Court (SAC), the transfer of technical improvement for consideration at the termination of a lease can be considered as a transfer of goods for use by another within the meaning of Section 14(1)(b) of the VAT Act, with the proviso that it is irrelevant for the application of VAT under which specific provision of Section 14 of the VAT Act the service falls and that the term “goods” in this provision should be interpreted broadly to include intangible things, including the right to draw economic benefits.

The decision of the Supreme Administrative Court (SAC) therefore finally provides clarity on how to proceed in cases of settlement for consideration regarding technical improvement upon termination of a lease. This is a taxable supply of services for which the lessee should apply VAT at the standard rate. In view of the reasoning of the SAC, the question then arises whether the provisions of Section 92a(7) of the VAT Act, establishing a legal fiction of the correctness of the application of the reverse charge system in case of doubt, and the question of the risk of retroactive assessment of VAT in similar cases, can be sustained in practice.

If you have any questions regarding the article, the SAC judgment or its implications for practice, please do not hesitate to contact us.  

Author: Richard Knobloch