Background
The deduction of VAT on the purchase of capital goods is subject to adjustment rules, set out in various provisions such as Article 48(2) and Article 49 of the Belgian VAT Code (WBTW), as well as in Royal Decree No. 3.
The standard adjustment period is five years. For immovable investment goods, such as buildings, the adjustment period is fifteen years, and in the case of leasing under the VAT option, even twenty-five years. The European VAT Directive stipulates that the adjustment period is generally five years but can be extended to a maximum of twenty years for immovable investment goods. Member States have the discretion to define what constitutes investment goods, but they must respect the principle of fiscal neutrality, which is central to the VAT Directive.
In Belgium, most renovation work falls under the five-year adjustment period unless the work is so extensive that it qualifies as new construction for VAT purposes. When a building is considered new, the extended 15-year adjustment period applies. The question of what exactly qualifies as new construction has led to much debate in practice.
Facts
The case involves a law firm that owns a building used for both private and economic purposes. Between 2007 and 2015, extensive renovation work was carried out on the property. This included the creation of an archive room in the basement, a new glass annex with offices and a lift shaft, dismantling of the building, installing new insulation and cladding, replacing pipes and connections for gas, water, and electricity, rebuilding walls, laying floors, installing ceilings, adjusting the roof, adding new dormer windows, and creating two roof terraces.
As of January 1, 2014, the VAT exemption for lawyers in Belgium was abolished, subjecting the law firm’s services to VAT. At that point, the firm claimed a revision of previously non-deductible VAT based on the 15-year adjustment period.
Following a tax audit, the tax authorities concluded that various VAT violations had occurred between January 2014 and September 2015, resulting in a VAT correction of €163,756.24. Part of the reassessment involved rejecting the adjustment of previously accumulated VAT related to historical renovation work. The tax authorities argued that the renovations had not resulted in a new building that could be sold with VAT applied. Consequently, they maintained that a five-year adjustment period should apply, not the 15 years claimed by the law firm.
The taxpayer, however, argued that the renovations should be subject to the 15-year adjustment period, allowing them to reclaim part of the VAT paid before the VAT obligation was introduced. The dispute was eventually taken to court.
In its defense, the taxpayer argued that the strict interpretation of the concept of "immovable investment goods" under Belgian law conflicts with the VAT Directive. The taxpayer contended that in the EU context, this concept typically refers to goods with a longer usage period, depreciation, and economic lifespan. They argued that the economic lifespan of the property, due to the renovations, is crucial for classifying it as an immovable investment good under the VAT Directive. Additionally, the taxpayer referred to the principle of fiscal neutrality, which requires that all immovable investment goods with a comparable economic lifespan be treated equally for VAT purposes, including the same adjustment period.
Given the uncertainty about whether Belgian law complied with EU law, the taxpayer proposed submitting preliminary questions to the Court of Justice.
Preliminary Questions
The Court of Appeal accepted the taxpayer's request and referred the following preliminary questions to the Court of Justice:
1. Are Articles 187 and 189 of the VAT Directive compatible with national regulations that allow an extended 15-year adjustment period only if a building is considered "new" after renovation work, even when the economic lifespan of a thoroughly renovated building is identical to that of a new building?
2. Does Article 187 of the VAT Directive have direct effect, allowing a taxpayer to rely on the 15-year adjustment period for renovation work that extends the economic lifespan of a building?
In other words: the Court was asked to determine whether Belgian law, which limits the extended 15-year adjustment period to renovations classified as 'new buildings' under national criteria, conflicts with the VAT Directive, and whether a taxpayer can directly rely on the European directive in case of such a conflict.
Court of Justice's Assessment
Do renovations qualify for the extended adjustment period?
The Court began by stressing the importance of the VAT deduction right for taxpayers and the crucial role of fiscal neutrality within the VAT system. According to established case law, taxpayers have the right to deduct VAT paid on goods and services at earlier stages from the VAT they owe. This mechanism ensures no double taxation (tax on tax) in the different stages of the production and distribution chain, which is central to the principle of fiscal neutrality.
The VAT deduction adjustment mechanism plays an essential role in ensuring the accuracy of deductions. It ensures that VAT deductions only apply to goods and services used for VAT-taxable activities. This is particularly important for investment goods, such as immovable property, which may change in purpose over their long lifespan.
The Court clarified that the standard adjustment period is five years, but Member States have the option to extend this period to a maximum of twenty years for immovable investment goods. In Belgium, this period is set at fifteen years.
However, in this case, the Belgian tax authorities classified the renovation work as services, which typically fall under the five-year adjustment period. According to Article 190 of the VAT Directive, however, Member States may choose to treat services, such as renovations, that have the characteristics of investment goods, as equivalent to immovable investment goods. Belgium had exercised this option, allowing the extended 15-year adjustment period to apply to certain construction work.
However, in this case, the Belgian tax authorities classified the renovation work as services, which typically fall under the five-year adjustment period. According to Article 190 of the VAT Directive, however, Member States may choose to treat services, such as renovations, that have the characteristics of investment goods, as equivalent to immovable investment goods. Belgium had exercised this option, allowing the extended 15-year adjustment period to apply to certain construction work.
The Court acknowledged that large-scale renovation work, as in this case, has economic characteristics comparable to immovable investment goods, particularly regarding their long lifespan. It would violate the principle of fiscal neutrality to treat such services differently from immovable investment goods. The economic impact of these renovations is often comparable to new construction, making it unjust to differentiate in their treatment.
The Court concluded that the principle of fiscal neutrality requires that similar services or goods be treated equally for VAT purposes. A difference in the adjustment period between renovations and new construction, while both are economically equivalent, would violate this principle.
Direct effect of article 190 VAT Directive?
Regarding the second question, the Court ruled that national courts must first attempt to interpret national legislation in line with the European VAT Directive. This principle, known as “harmonious interpretation”, requires national courts to interpret national law in the light of the directive. Only when it proves impossible to reconcile national legislation with the directive does the question of the directive’s direct effect arise.
The Court ruled that Article 190 of the VAT Directive is sufficiently precise and unconditional to have direct effect. The fact that Member States can choose whether to treat services as investment goods does not exclude direct effect. Member States must still operate within the discretion granted to them by the directive, which can be reviewed by national courts.
Although Member States have some flexibility in applying Article 190, the Court made it clear that they must remain within the limits of the directive and the principle of fiscal neutrality. When a Member State exceeds this discretion, a taxpayer can directly invoke the directive.
In conclusion, the Court ruled that taxpayers can directly rely on Article 190 of the VAT Directive when national legislation is not in line with the directive’s provisions, as is the case with Belgian regulations.
Commentary
The Court’s ruling has significant implications for Belgian VAT regulations and puts the Belgian legislature in a difficult position. The Court found that renovation work with an economic impact similar to new construction should qualify for the extended 15-year adjustment period. The Belgian practice, where the extended adjustment period only applies to new construction, is therefore in violation of the European directive.
Interestingly, the Court also hinted at another potential issue in Belgian VAT regulations without directly addressing it. The directive sets a maximum adjustment period of twenty years for immovable investment goods, while Belgium applies a twenty-five-year period in cases of leasing a building under the VAT option. It seems only a matter of time before this regulation is also challenged.