Drama on building land: merchants deprived of margins?

“At the theatre audiences want to be surprised. But with what they expect.“¹

The soap opera linked to the conditions of application of the margin tax regime on sales of building land has just seen some rather unexpected developments. For many property professionals, the recent decisions by the Conseil d’Etat radically alter the economics of certain transactions, and the marginalisation of cases involving taxation on the margin could border on tragedy.

The tax authorities initially restricted the scope of margin VAT to situations where the property resold was identical to the property acquired in terms of its legal status and physical characteristics. For example, it argued that the resale of building land resulting from the division of a single plot should be taxed on the full price, even if the initial acquisition did not give rise to a right to deduction².

A number of disputes have gradually arisen, with the tax authorities systematically questioning the application of VAT on the margin to purchase/resale transactions where a ‘modification’ has taken place between the purchase and the resale, whether this involves dividing a single plot of land into several lots, subdividing a building sold as is after dividing the land on which it stands, or demolishing a building that encumbered the plot of land purchased, divided and resold in several lots.

Property professionals, thus deprived of taxation on the margin and subject to ‘normal’ VAT on the sale price of building plots, could not resign themselves to seeing their margins significantly impacted and sometimes reduced to nothing: they contested, and asked Members of Parliament to ask the Minister for the Budget to explain.

In the end, there was little debate in this local dispute: the tax authorities relied on their own doctrine, without reference to Article 392 of the Directive, while the taxpayers, to counter these claims, often relied solely on the letter of Article 268 of the CGI.

Article 268 of the CGI in fact provides that ‘With regard to the supply of building land, or a transaction referred to in 2°) of 5 of Article 261 (i.e. the supply of buildings completed more than five years ago) for which the option provided for in 5°) bis of Article 260 has been made, if the acquisition by the transferor did not give rise to a right to deduct value added tax, the taxable amount is made up of the difference between:

1° On the one hand, the price expressed and the charges added to it;
2° On the other hand, as the case may be: a) or the sums that the transferor has paid, on whatever basis, for the acquisition of the land or building’.

In the light of this wording, taxpayers consider that taxation on the margin on the resale of building land simply requires that the acquisition did not give rise to a right to deduction, without any distinction being made as to the qualification that led to the absence of deduction at the time of acquisition.

The most diligent taxpayers also pointed out that the parliamentary works, which are useful if the text of the law is not clear, which is far from obvious in this case, did not mention any restriction as to the identity of the property acquired and resold. As we have pointed out in these very columns⁴, neither the report of the Finance Committee⁵ nor the opinion submitted by Mr Olivier Carré, MP, to the Presidency of the National Assembly on 17 November 2009, establish any intention on the part of the legislature to restrict the scope of VAT on the margin in this way, a restriction which was not ultimately transcribed in the text finally adopted. It is also interesting to note that Mr Olivier Carré, who is in a good position to appreciate the legislator’s intention, was one of the first to alert the Budget Minister, in a written question to the Government, to the fact that certain audit departments were ‘requiring conditions not provided for in this text in order to allow resale prices to be taxed at the margin under Article 268 of the General Tax Code’⁶.

Cornered by questions from Members of Parliament, the Minister initially argued that ‘applying the margin regime in other cases would result in it being impossible to calculate the taxable base since sale price and purchase price would relate to dissimilar goods’.

This arithmetical argument was taken up in litigation by the tax authorities. Some taxpayers still remembered the previous administrative doctrine, under which developers, who had to charge VAT on the margin on sales of plots to private individuals, could estimate the cost price of a plot by deducting a fraction of the total purchase price of the land, using the method of their choice and under the supervision of the Administration⁷. What was once prescribed became materially impossible?

Other taxpayers pointed out that the Danish and Greek governments had supported a similar line of reasoning in the context of a dispute concerning the VAT margin scheme for second-hand goods, a line of reasoning rejected by the CJEU⁸.

This argument has gradually been abandoned by the tax authorities. It is true that the tax authorities have softened their stance by requiring only that the legal classification of the goods acquired and the goods resold be identical⁹. However, this welcome relaxation was not enough for the lower courts.

Following an initial ruling by the Grenoble Administrative Court¹⁰, numerous administrative courts have had to deal with challenges to the application of VAT on the margin to purchase-resale transactions involving building land¹¹.

The solution seemed to be a foregone conclusion, and the Conseil d’Etat itself highlighted one of these rulings¹² in its annual public report published on 12 May 2018.

Although the tax authorities did not systematically appeal these rulings, which were all favourable to the taxpayers, the decisions of the second instance remained set in the same direction¹³.

However, a close examination of these decisions was likely to bring a nuance. In the Promialp case, which will be discussed later, the Lyon Administrative Court of Appeal¹⁴ found in favour of the tax authorities, despite the contrary conclusions of its public rapporteur Jean Paul Vallecchia¹⁵. The latter referred to the filiation of Article 268 of the CGI with Article 392 of the VAT Directive 2006/112/EC of 28 November 2006, according to which ‘Member States may provide that, for supplies of buildings and building land purchased with a view to resale by a taxable person who did not have a right to deduct on the occasion of the acquisition, the taxable amount shall be the difference between the sale price and the purchase price’. It pointed out that ‘the Directive thus establishes the principle that transactions relating to undeveloped land intended to support a building are subject to VAT; the partial exemption by application of the tax on the profit margin alone being therefore only a derogation and subject to strict interpretation’, to deduce from this, without being followed by the Court, that in the case of the acquisition “of a built property exempt from VAT because of a dwelling house completed more than five years ago, finally demolished to become a genuine building plot”, the optional VAT on profit margin regime should be set aside.

It is true that Article 268 of the General Tax Code, which transposes the provisions of Article 392 of the VAT Directive into domestic law, must be interpreted in the light of these provisions¹⁶. Administrative doctrine had never insisted on this point. However, it was in the light of the Directive that the Conseil d’Etat ‘saved’ this doctrine.

In its ‘Promialp’ ruling of 27 March¹⁷, the Conseil d’Etat censured the ruling of the Lyon Administrative Court of Appeal, which had held that ‘it has no bearing (…) on the fact that the physical characteristics and classification of the goods in question were modified between their acquisition and sale. ’ By reading Article 268 of the General Tax Code “in the light” of the provisions of Article 392 of the VAT Directive, it held that ’the derogating rules for calculating value added tax that they provide for apply to transactions involving the sale of building land that has been acquired with a view to resale and therefore do not apply to a sale of building land that, at the time of their acquisition, had the character of built-up land, when the building on which they were built has been demolished by the purchaser-reseller. ’

Let’s go back for a moment to this issue of transposition into domestic law: the directive allows the margin system to be applied only to ‘purchases with a view to resale’, a condition not included in the wording of Article 268 of the CGI. Should we see in this wording a (very) implicit condition of identity? Could the fact that Article 392 of the Directive refers to purchases with a view to resale rule out any transformation of the goods between purchase and resale? This is the position of the Conseil d’Etat, which confirmed its position in a recent decision: VAT on the margin is not applicable when the building on which the property was built has been demolished by the purchaser-reseller¹⁸.

The Conseil d’Etat’s solution is clear: after demolition of a building encumbering the land acquired for resale, the resale of the building plot(s) cannot be taxed on the margin alone. As a result, it is now advisable to accept the administration’s invitation¹⁹ to proceed, prior to any acquisition, with a plot division ‘enabling a distinction to be made between the part of the right-of-way free of buildings that can be used as such, the sale of which will be taxed as building land, and the part already built on that can be used as such, the tax classification of which will depend on the specific characteristics’. Better still, in a situation similar to that in the Promialp case, the professional could ask the seller to demolish the unsuitable building himself, even if it meant indirectly assuming the cost as part of the price calculation. Such a request would have little chance of succeeding given the tax contingencies specific to the private seller²⁰.

Finally, the most combative will be able to argue that a plot of land encumbered by buildings intended for demolition is… a building plot. The CJEU has ruled that a plot of land on which there is still an outdated building that must be demolished so that a new building can be erected on its site, and whose demolition for this purpose, undertaken by the seller, had already begun before this sale, constituted building land²¹. This reasoning could be applied in the case of land on which a building has been erected but is not in use on the day it is acquired²².

Apart from the case of demolition, the criterion of identical tax classification established by the Conseil d’Etat will mean that professionals who acquire built-up land, divide it up and resell the various lots as they are, without any demolition or construction being carried out, will not be taxed on their margins alone. In such a situation, the application of the principle of neutrality is questionable: two taxpayers will be subject to different tax assessment rules for the same purchase-division-resale transaction, depending on whether or not the simple division of the property changes the tax status of the assets acquired… In her conclusions at the foot of the RGMB²³ judgment, Karin CIAVALDINI, the public rapporteur, responds to this question: the scope of the Promialp decision should not be limited to cases in which demolition takes place, but should be extended to all situations in which a plot of land had the nature of a built-up plot when it was acquired and is resold as a building plot. In the end, this solution is quite shocking: the resale of nine plots of land, one of which consists of a building plot and the other eight of bare land, all resulting from the division of a property complex acquired without entitlement to a deduction, is taxed in full.

The philosophy behind taxation on the margin is to allow only the value added by the professional between purchase and resale to be taxed when the acquisition of a property has not given rise to a right of deduction. However, the solution adopted by the Conseil d’Etat, particularly in the RGMB case, results in VAT being charged not on the professional’s activity but on goods acquired by him which were exempt from VAT. In such a case, it seems to us that the professional is acting in a trading capacity (buying to resell), and not in a production capacity, in which the good acquired is merely the means for creating a new good or service.

As we have seen, the Conseil d’Etat’s reasoning is essentially based on an interpretation of Article 392 of the Directive, of which Article 268 of the CGI is only an incomplete transposition. The fact that Article 392 of the Directive refers to purchases with a view to resale could rule out any transformation of the property between purchase and resale, whether this involves demolition (Promialp and Immoxtine cases) or a simple division that changes the classification of the property acquired (RGMB decision).

The CJEU has never ruled on this condition of identity of classification. A reference for a preliminary ruling could therefore shed decisive light on the existence of such an implicit condition of identity and on its interpretation.

However, in the context of a dispute concerning the former real estate VAT regime, the Conseil d’État²⁴ has referred a question to the CJEU for a preliminary ruling that could have consequences for the current ‘saga’.

The CJEU will be asked to rule on whether Article 392 of the Directive should be interpreted as excluding sales of building land from the application of the margin tax regime in two circumstances: between the time of acquisition and the time of resale by the taxable person, (i) the land, acquired undeveloped, has become building land, or (ii) the characteristics of the land have been altered, such as by dividing it into lots or carrying out works. In the words of public rapporteur Marie-Gabrielle Merloz²⁵, ‘the concept of building land retains, under the new provisions, a degree of obscurity, as evidenced by (the) Promialp decision’.

This preliminary question goes beyond the difficulty raised by the current litigation. The last act may hold new surprises.