Is an adjustment of input VAT in respect of start-up costs required in an unrealized building project when the optional tax liability ceases? – some comments in the light of Skelleftea Industrihus and the decision of the Swedish Supreme Administrative ...

It has been a well-established case-law of the CJEU that if a person has an intention to commence taxable activities and makes investment expenditures for this purpose, that person may exercise the right to deduct input VAT in respect of such expenditures even before any taxable activity takes place. The taxable person retains the right to deduct even if an investment project is not further implemented due to the circumstances beyond the taxable person’s control. The order of the CJEU in Skellefteå Industrihus has given rise to a question about VAT implications of abandoned building projects covered by the optional tax liability in terms of the adjustment obligation. The subsequent decision of the Swedish Supreme Administrative Court in case No. 6144-18 has raised doubts regarding the correct interpretation by the Court of the CJEU’s order in Skellefteå Industrihus. The purpose of this article is to analyze in what cases a taxable person may be requested to adjust input VAT in respect of start-up costs in an abandoned building project and whether the fact that the costs were incurred when the taxable person was covered by the optional tax liability should have any significance for the obligation to adjust.

1 Introduction

The right to deduct is a fundamental right of the common system of EU VAT. It ensures neutrality for taxable persons carrying out economic activity subject to VAT inasmuch as VAT does not constitute a cost for them.1 From the previous case-law of the CJEU we know that the right to deduct may be exercised even before any taxable activity commences if a taxable person makes preparatory expenditures to be used in planned taxed transactions.2 The taxable person retains the right to deduct even if an investment project is not further implemented due to the circumstances beyond the taxable person’s control.3 On 18 May 2021 the CJEU delivered a reasoned order in the case Skellefteå Industrihus.4 The question for a preliminary ruling concerned the compatibility with the VAT Directive5 of the provisions of the Swedish VAT act6 (mervärdesskattelagen; hereinafter – ‘ML’), namely, Chapter 9, paragraph 11, requiring a property owner, who benefited from the optional tax liability scheme during the construction of a building and who deducted the input VAT in respect of services relating to the building project, to repay the input VAT plus interest due to the fact that the building project was abandoned without any taxable letting of property ever taking place.

According to ML, the right to opt for taxation may be granted by the tax authorities under the construction stage provided that an intention of a taxable person is to use the property for taxable letting. The taxation option may be withdrawn by the tax authorities before any taxable letting takes place if there are no longer conditions for such tax liability.7 In case the optional tax liability ceases, the taxable person has to make a single-step adjustment concerning the remainder of the correction period. Moreover, the taxpayer has to repay input VAT that relates to the period between the issuance of the decision about granting the right to opt for taxation and the withdrawal of such a right.8 In its order, the CJEU concluded that, on one hand, EU law precludes a provision of the Swedish national law, which provides for de facto revocation of the right to deduct the input VAT where that right had been granted to a taxable person in the course of the exercise of the right to taxation option.9 On the other hand, the CJEU held that the adjustment mechanism may be applicable in such a case if a taxable person no longer plans to use the goods and services in question in order to carry out taxed output transactions or uses them to carry out exempt transactions.10 Accordingly, the VAT Directive does not preclude a provision of the national legislation, which provides for an adjustment obligation in such a case.

As has been recognized by Swedish and international tax scholars, the conclusions of the CJEU are far from being straightforward.11 One of the questions arising after the CJEU’s order is how to interpret the statement that an adjustment must be made if the taxable person no longer plans to use the acquired goods and services to carry out taxed output transactions and how this condition reconciles with the previous case-law of the CJEU on the deduction of input VAT in respect of start-up costs. Another question is whether the fact that the taxable person ceased to be covered by the optional tax liability may per se lead to the obligation to adjust input VAT which arose during the time when the taxable person was covered by such liability. On 8 April 2022, the Swedish Supreme Administrative Court (Högsta förvaltningsdomstolen; hereinafter – ‘HFD’) delivered its decision in case 6144-18, which gave rise to the order of the CJEU in Skellefteå Industrihus.12 The HFD established that Chapter 9, paragraph 11 of the Swedish VAT Law in its current wording is compatible with the VAT Directive, and that the obligation to repay input VAT in the whole amount in the case of cessation of optional tax liability lies within the scope of Sweden’s discretion as to the implementation of the general adjustment rules in accordance with Article 186 of the VAT Directive. The decision of the HFD gives rise to doubts as to the correct interpretation by the HFD of the order of the CJEU in Skellefteå Industrihus.

The purpose of this article is therefore to analyze in what cases a taxable person may be requested to adjust deductions on start-up costs in an abandoned building project and whether the fact that the taxable person was covered by the optional tax liability at the time of deduction has any significance for determining the existence of the obligation to adjust. For this purpose, a relevant case-law of the CJEU concerning the adjustment of input VAT in respect of start-up costs related to building projects has to be analyzed, as well as the doctrine concerning the interpretation of an obligation to adjust. Furthermore, it has to be determined how much discretion Member State possess concerning the implementation of optional taxation in respect of immovable property, as well as concerning laying down the detailed rules for the application of the general adjustment obligation set forth in Articles 184 and 185 of the VAT Directive. Another purpose is to provide some reflections on the CJEU’s order in Skellefteå Industrihus and on the decision of the HFD in case No 6144-18. The main focus of this article is on the analysis of the provisions of the VAT Directive and their interpretation by the CJEU, although the references are also made to the provisions of the Swedish national legislation. A principle of fiscal neutrality, which must be observed by Member States in exercising their discretion under the VAT Directive, is subtly touched upon inasmuch as it has been already discussed somewhere else in the literature in the similar context.13

The article starts with an overview in section 2.1 of the purpose and the content of the adjustment obligation according to the VAT Directive as interpreted by the CJEU followed by the description of discretion of Member States regarding the laying down of detailed rules for the general adjustment provisions in section 2.2. Section 2.3. briefly outlines the relevant case-law of the CJEU concerning the interpretation of the adjustment obligation in unimplemented investment projects. The cases presented in section 2.3 are selected based on their significance for understanding of the CJEU’s conclusions in Skellefteå Industrihus. In chapter 3, an analysis of Member States’ discretion as to the implementation of option for taxation based on Article 137(1)(d) of the VAT Directive is made. It is also discussed what impact this discretion has on the application of the adjustment rules. In Chapter 4, some reflections on the CJEU’s order in Skelleftå Industrihus is provided. Since the case has already been commented in the literature,14 the author limits herself to a brief description of the case. Some critical remarks on the decision of the HFD in case No. 6144-18 are provided in chapter 5. Finally, the main findings and conclusions are presented in Chapter 6.

2 EU VAT rules on adjustment

3 The scope of discretion of Member States in respect of the implementation of option for taxation for the leasing and letting of immovable property

There exists a perception that the rules governing the right to deduct of input VAT in respect of general costs and start-up costs are not relevant when it comes to activities covered by the optional taxation.67 In view of this, it has to be determined whether discretion of Member States regarding the implementation of optional taxation may affect the adjustment obligation of a taxable person. In accordance with Article 135(1)(l) of the VAT Directive, the leasing and letting of immovable property shall be exempt subject to a number of exceptions listed in paragraph 2 of the same article. Member States, are, however, entitled to grant a waiver of exemption in respect of some categories of exempt transactions including the leasing or letting of immovable property. Article 137(2) of the VAT Directive provides that the detailed rules concerning the exercise of the option for taxation shall be established by Member States. Furthermore, the latter may restrict the scope of the taxation option. The question therefore arises regarding the scope of discretion given to Member States in implementation of the option for taxation and, in particular, whether the withdrawal of the option for taxation followed by a single-step adjustment would fit within the scope of that discretion.

In its previous case-law, the CJEU has recognized that Member States have a broad scope of discretion when it comes to the implementation of the right to opt for taxation as it is for them to decide whether to introduce the right to optional taxation, to withdraw that right, as well as restrict the scope of that right.68 In particular, the CJEU found it consistent with the VAT Directive [the Sixth Directive in the case at hand] and the principles of protection of legitimate expectations and legal certainty to withdraw the right of optional taxation in respect of lettings of immovable property by legislative amendment resulting in the obligation to adjust deductions in respect of immovable property acquired as capital goods.69 Otherwise, the omission to require the adjustment in such a situation may amount to state aid.70 However, notwithstanding this wide discretionary power, it may not be used to infringe the provisions of the VAT Directive governing the right to deduct and, particularly, to revoke the right to deduction already acquired.71 The same concerns laying down of procedural requirements for the exercise of the right of option, which, according to the CJEU, must not result in restricting the right to deduct in connection with taxable transactions where the right of option has been properly exercised in accordance with those rules.72 The national procedural rules may not result, for example, in restricting the period in which deductions may be made to a period which is shorter than that provided for in the VAT Directive.73 The CJEU has also clarified that the scope of the right of option which Member States may restrict according to Article 137(2) of the VAT Directive does not include limitations of the right to deduction after the right of option has been exercised.74 Accordingly, Member States in laying down detailed rules concerning the exercise of the taxation option must not infringe the right of deduction. Furthermore, they must comply with the objectives and general principles of the VAT Directive.75

No doubts exist as to the possibility of Member States to establish the conditions when the right to opt for taxation in respect of lettings of immovable property arises and when this right ceases. This should fall within the scope of discretion of Member States regarding laying down of the detailed rules governed the option. However, it is doubtful that it lies within a Member State’s discretion to require the adjustment of input VAT due to the withdrawal of the right to opt for taxation by the tax authorities. As indicated earlier, in exercising their discretion in respect of optional taxation, Member States may not use this power to restrict the right to deduct. As acknowledged by the CJEU, the system of adjustments forms an integral part of the VAT deduction scheme established by the VAT Directive.76 Therefore, the obligation to adjust laid down in the national law of a Member State in case of the withdrawal of the option to taxation must comply with the respective provisions of the VAT Directive concerning the adjustment of VAT. In other words, the adjustment may be requested only in cases provided for in the VAT Directive. As AG Kokott stated in her Opinion in Arvi, the obligation to adjust follows from the VAT Directive and its implementation in the national law and is not dependent on Member States implementation or non-implementation of the right to opt for taxation.77 The conditions for an obligation to adjust input VAT do not lie within the scope of Member States discretion according to Article 137(2) of the VAT Directive and, accordingly, must comply with the provisions of the VAT Directive governing adjustment obligations as interpreted by the CJEU. Therefore, the case-law of the CJEU concerning adjustment of input VAT in investment projects should be relevant even to situations covered by optional taxation. The author believes that the fact that a taxable person incurred input VAT when covered by the optional tax liability should not have an impact on determining the obligation to adjust, which instead should be governed by general adjustment provisions laid down in the VAT Directive.

4 Some reflections on Skellefteå Industrihus

In Skellefteå Industrihus, the CJEU ruled that the right to deduct once arisen may not be revoked if the planned economic activity did not take place or if, by reason of circumstances beyond his or her control, the taxable person did not make use of the goods and services which gave rise to the right to deduction.78 The CJEU has also pointed out that this may not be changed by a discretionary power given to Member States in respect of establishing rules on the exercise of the right to optional taxation, which may not be used to infringe the deduction rules of the VAT Directive.79 Based on this, the CJEU concluded that EU law precludes a provision of the Swedish national law such as laid down in Chapter 9, paragraph 11 of ML, which provides for de facto revocation of the right to deduct the input VAT where that right had been granted to a taxable person in the course of the exercise of the right to taxation option.80 It is difficult to disagree with the conclusions of the CJEU in this respect. Indeed, in its previous case-law, the CJEU maintained that the right to deduct may not in principle be revoked retroactively with the only exception related to situations of fraud or abuse, which was not relevant in the case at hand.

The second part of the CJEU’s analysis concerned whether the provision of ML, such as chapter 9, paragraph 11, may still be allowed in the light of the adjustment provisions of the VAT Directive. The CJEU reiterated what it earlier stated in ITH Comercial Timişoara that if the taxable person no longer plans to use the goods and services in question in order to carry out taxed output transactions or uses them to carry out exempt transactions, the close and direct relationship, which is necessary between the right to deduct the input VAT and the carrying out of the planned taxed transactions, is broken.81 The CJEU further held that in that case the adjustment mechanism would be applicable. The CJEU also commented on the applicable adjustment provisions of the VAT Directive to the situation at hand, which, according to the Court, do not fall within the scope of Article 187 of the VAT Directive,82 and, as such, must fall within the scope of Articles 184 and 185 of the VAT Directive. In the end, the CJEU concluded that EU law does not preclude the national legislation establishing an obligation to adjust in a situation where a taxable person, who benefited from the optional tax liability during the construction of a building and who deducted input VAT in respect of that building project but whose project did not result in any taxed activity.

It is apparent from the CJEU’s order that the difference exists between the revocation of the right to deduct and an obligation to adjust VAT deduction, which arose earlier.83 While the former is incompatible with the VAT Directive, the latter is not precluded by EU law. What remains unclear is why the CJEU concluded that the adjustment obligation may be relevant in the case at hand. To recall, in ITH Comercial Timişoara the CJEU stated that the adjustment was not needed since the taxable person still intended to use the acquired goods and services for its taxable transactions, although the project had been abandoned in a situation which is similar to the present case.84 The author of this article also notes the difference in the wording between paragraph 46 and paragraph 50 of the order of the CJEU. While in the former the CJEU referred to the intention of the taxable person (if the taxable person no longer plans to use), in the latter the CJEU mentioned the adjustment on the ground that planned building project did not result in any taxed activity. The author believes that a change of the intention by the taxable person and the abandonment of a project, which, consequently, does not result in taxed activities, are not necessarily similar. In fact, any aborted investment project implies that goods and services acquired for the purposes of that project may not be used for that particular project. However, if the taxable person continues its economic activity, it may be claimed that the close and direct relationship between the right to deduct and taxed output transactions of the taxpayer is preserved. A taxable person may, for example, sell subject to VAT any unused materials acquired for the purposes of an unimplemented project. When it comes to services, like architectural services related to the planned building in the current case, it may be asserted that such services are linked to a particular land plot, and, as such, their VAT treatment should depend on how that particular land plot will be used (it may be used, for example, in another project giving rise to taxed transactions). Furthermore, it may be advocated that even if the acquired services may not be used, they still retain a close and direct relationship with the taxed activity of a taxable person as a whole on the condition that a taxable person continues its taxable economic activity.

In its previous case-law, the CJEU acknowledged the existence of an obligation to make an adjustment in cases where investment assets in relation to which expenses had been made were disposed by the taxable person. For example, in Ghent Coal the taxable person had to exchange a land plot in respect of which expenses were made to another one.85 In Breitsohl, the taxable person sold a land plot with the building works completed. In Vittamed technologijos, which was decided after Skellefteå Industrihus, the CJEU recognized the obligation to adjust when the taxable person’s assets remained unsold after it was placed into liquidation, i.e. its economic activity ceased. In the situation at hand, the taxable person abandoned a concrete investment project on a particular land plot but it remained carrying out its economic activity. It does not follow from the materials of the case whether the taxable person was going to sell the land plot or use it in another investment project. Therefore, it is doubtful that a general conclusion may be inferred from Skellefteå Industrihus that any building project not resulting in taxed activity should give rise to an obligation to adjust. This is also confirmed by Vittamed technologijos, where the CJEU recognized that no adjustment is required if after the abandonment of an investment project due to reasons beyond the taxable person’s control the latter still intends to use acquired goods and services for purposes of taxable transactions.86

The situation would be different if the taxable person used the acquired goods and services to carry out exempt transactions or transactions that are outside the scope of the VAT Directive, which would imply that the initial intention of the taxable person to use the inputs in its taxable operations has changed. Remarkably, the CJEU acknowledged that it is for the national court to establish that the taxable person no longer plans to use the goods and services for taxed output transactions or uses them to carry out exempt transactions.87 It may be inferred from this statement that the obligation to adjust depends on a particular behavior of a taxable person substantiated by objective evidence.

5 Case No. 6144-18

The HFD’s decision after the order of the CJEU came as a surprise. It could be expected that the HFD would find chapter 9, paragraph 11 of ML incompatible with EU law in part of the obligation to repay the input VAT. Instead, the HFD concluded that the mentioned provision of ML lies within the scope of Sweden’s discretion according to Article 186 of the VAT Directive as to the laying down of detailed rules for the application of Articles 184–185 of the VAT Directive. In other words, the HFD equalized the obligation to repay all input VAT with the obligation to adjust. To substantiate its conclusion, the HFD referred to Stichting Schoonzicht where the CJEU found compatible with EU law a provision of the Netherlands law according to which a single-step adjustment of input VAT incurred during construction was required if at the exact time of the first use of a building it turned out that part of the building was used for exempt rental, while it was initially intended to use the whole building for taxed transactions.

The argument of the HFD does not look convincing. As confirmed by the CJEU in Skellefteå Industrihus, the distinction exists between the revocation of the right to deduct and the obligation to adjust. An obligation to adjust depends on the actual behavior of a taxpayer, i.e. his intended/actual use of the acquired goods and services, and the extent of which, as such, has to be determined in each individual case. An obligation to repay all the amount of input VAT constitutes de facto revocation of the initial right to deduct. Furthermore, the national provision of the Netherlands law, which was subject of the dispute in Stichting Schoonzicht, contrary to what is claimed by the HFD, did not provide for the repayment of the whole amount of the input VAT but for the obligation to adjust at the time at which the taxpayer started to use goods or services, which could also result in a refund of non-deducted VAT to the taxable person. It is apparent that chapter 9, paragraph 11 of ML does not establish such a possibility. Neither is it clear why the HFD referred to Stichting Schoonzicht, which does not resemble the present case, to substantiate its conclusions. In the mentioned case, the taxable person leased some of the apartments in the apartment complex it had built exempt from VAT, whereas the initial intention was to use it for taxable purposes, while in Skellefteå Industrihus, the construction had not even started since the investment project was abandoned. The author assumes that the reason why in Skellefteå Industrihus the CJEU referred to the case Stichting Schoonzicht was to substantiate the exclusion of the application of Article 187 of the VAT Directive dealing with the adjustment in respect of capital goods to the situation at hand. In Stichting Schoonzicht, the CJEU particularly made a distinction between the adjustment in respect of capital goods required under Article 187 of the VAT Directive, which applies from the time the capital goods are acquired/manufactured or used for the first time, and which aims at taking into account variations that may occur in the factors initially taken into consideration to determine the amount to be deducted, during the use of the capital goods, and the adjustment that must be made at the exact time capital goods are used for the first time, which falls within the scope of Articles 184 and 185 of the VAT Directive.88

Following the decision of the HFD in case 6144-18, the Swedish tax authorities have amended their guidelines regarding the application of chapter 9, paragraph 11 of ML laying down the obligation to repay input VAT and make the adjustment in case of the cessation of optional tax liability. According to the tax authorities, the obligation to repay input VAT/adjust is now applicable both if an immovable property commences to be used in exempt activities, and when it is not used at all.89

6 Conclusions

The principle of fiscal neutrality precludes that taxable persons are burdened with VAT (unless it is the intention of the legislature), which is ensured by the system of deductions. The principle of neutrality also requires that a taxable person may deduct input VAT in respect of acquired goods and services only to the extent the latter are used for taxed output supplies of the taxpayer. As has been indicated in section 2.1 above, the overall purpose of the system of adjustments is to ensure the existence of a close and direct link between the acquired goods and services and their use for taxed output transactions. If that link is broken, for example, when inputs are used by a taxable person for purposes of exempt transactions or for non-economic activity, an adjustment should be required. The mentioned link is retained if a taxable person due to circumstances beyond its control abandons an investment project but still has an intention to use acquired goods or services in its economic activity.90 On the other hand, the close and direct link between the right to deduct and carrying out of taxed output transactions is broken in a situation where the taxable person is placed in a liquidation, which, according to the CJEU, indicates that the taxable person no longer has an intention to use acquired goods or services for its taxable transactions. The author notes that such a formulation departs from what the CJEU previously stated in INZO.91 If however, placing into liquidation of a taxable person results in taxed transactions, for example sale of capital assets for extinguishing of debts, the mentioned link would be retained and no obligation to adjust would be relevant. The recent case-law of the CJEU indicates that an intention of the taxable person regarding the use of acquired goods and services in its taxed activity is decisive for determining the obligation to adjust.

The obligation to adjust deductions in unimplemented building projects would depend on different factors. The case-law of the CJEU referred to in section 2.3 above, speaks for the obligation to adjust in a situation when assets that are created in the course of a project are sold exempt from VAT or used for exempt output transactions. The obligation to adjust would also be relevant if a land plot on which a construction was planned and in respect of which services were acquired would be disposed exempt from VAT. Moreover, the obligation to adjust would be relevant if the taxable person is put into liquidation and its capital assets remain unsold. The situation would be different if no assets are created, like in Skellefteå Industrihus, and the land plot is not disposed of. The author believes that in such a situation, the taxable person would retain its right to deduct and no adjustments should be required on the condition that the taxable person continues to carry out taxable transactions. According to the CJEU, as an exception and in specific circumstances, the right to deduct exists even if a direct and immediate link between a particular input transaction and an output transaction or transactions giving rise to the right to deduct cannot be established.92 In this respect, the author agrees with Espenkrona about the possibility to consider the costs in an unimplemented building project, such as that in case No 6144-18, as general costs of the taxable person attributable to its economic activity as a whole.93 It would be against the general logic of the VAT Directive and the purpose of the adjustment system to ensure fiscal neutrality to burden with VAT a taxable person who continues its taxable activity. Furthermore, the obligation to adjust in such a situation would constitute a punishment for taxable persons seeking to start a new project and taking business risks in this connection.

As it has been claimed in this article,94 the fact that a taxable person is covered by the optional tax liability when VAT deduction is made should not affect the taxpayer’s obligation to adjust deduction in the case of cessation of the optional tax liability. Member States’ discretion as to the implementation of the taxation option in respect of letting of immovable property may not affect the system of adjustments laid down in the VAT Directive. No matter whether a taxpayer was covered by an optional tax liability when exercising the right to deduct or not, the principle of fiscal neutrality would require no difference in their VAT treatment by the national legislature in terms of the right to deduct. Provided that the latter was exercised in a proper way based on the taxable person’s intention to use the acquired services to carry out taxable supplies, it is an actual behavior of a taxable person that would determine the obligation to adjust deductions and not the cessation of the optional tax liability established by a national provision.

As has been illustrated in section 5 above, the order of the CJEU in Skellefteå Industrihus raised questions about its interpretation. The author believes that a general conclusion that any unimplemented building project should give rise to an obligation to adjust may not be inferred from this case. This conclusion is also reconfirmed by Vittamed technologijos, where the CJEU emphasized the intention of the taxable person to use acquired goods or services in its taxed transactions as a decisive factor for retaining the right to deduct. In Skellefteå Industrihus it was not the intention to use the services for taxable transactions of the taxpayer that was changed but rather impossibility to implement an investment project due to the circumstances beyond the taxpayer’s control, which, according to the CJEU, does not lead to the breakage of the link between the right to deduct and economic activity of the taxpayer. When it comes to the conclusions of the HFD in case No 6144-18, they appear not to be consistent with the interpretation of EU law by the CJEU in Skellefteå Industrihus. The obligation to repay the initially deducted VAT plus interest thereon according to the second sentence of Chapter 9, paragraph 11 of ML may not be equalized with the obligation to adjust but it is an actual revocation of the right to deduct prohibited by EU law. Apparently, the Swedish implementation of the VAT Directive in this regard and the guidelines adopted by the tax authorities following the case No 6144-18 are moving in a wrong direction, which may only be cured by respective legislative amendments in ML.

Mariya Senyk is Doctor of Laws and Senior Lecturer at Lund University.