20% VAT on Real Estate: Trouble Brewing

• Who will pay the extra 6 percentage points for sales agreements signed before 2008?

• In principle, the buyer, but it's uncertain if this will be accepted.

• Anticipated disputes between buyers and developers

The increase (upward) of the VAT rate on real estate transactions from 14% to 20% starting January 1, 2008, could cause many disputes between thousands of buyers of homes or commercial properties and real estate developers. Some specialists even speak of "a fire smoldering under the ashes."

What is this about? In most real estate transactions, clients anticipating the upward spiral of the price per square meter, take positions before the construction even begins. It has become common practice, which specialists commonly call "buying off-plan," to pay a deposit on the sale price of the property, with the remainder paid upon delivery.

The 6-percentage-point increase in value-added tax could therefore ignite many fires. Who, the client or the developer, will pay the tax difference for contracts – sales agreements – concluded before the new VAT rate comes into effect? It's expected that many buyers will refuse to pay the extra amount, invoking the terms of the contract, predicts a real estate expert. The risk of conflict is real because the sums involved can be considerable, and the money will have to be found elsewhere, as bank financing is assumed to be secured, he adds.

However, it is important to remember the basic principle of value-added tax: it is the end customer who bears this tax. In other words, the buyer of the property. Will this be enough to convince all those who bought off-plan that they will have to pay extra due to the tax rate change?

The tax authorities, anticipating this issue, have provided clarification. In an internal memo signed by the director general of taxes, it is clearly stated that "the tax due by taxpayers will be paid as the amounts due are received" (see also box). This is simply a reminder of the common law regime concerning VAT, which states that the event that triggers the taxes owed to the Treasury is the receipt of the sale. This regime is adopted in 99% of cases in real estate development, notes Fouad Akesbi, specialist in tax matters and member of the office of the national union of chartered accountants. A clash between the analysis of the tax authorities (based on the interpretation of the law) and commercial practices in real estate development is to be expected. It is certain that tax inspectors will stick to this interpretation and only this one. However, the vast majority of real estate operators sell properties in advance and collect part of the sale price (in the form of a down payment) upon conclusion of the sales agreements before the final sales contract is even drawn up. This is only signed when the occupancy permit is issued, a deadline that occurs well after the properties are put on sale. Those developers who declared and paid VAT on advances received before 2008 (as required by law) can therefore use this event as the triggering event for VAT. A developer who received advances in 2006 or 2007, for example, on a project that will not be completed until 2008, is in principle entitled to apply the 14% rate, if the payments have been declared to the tax authorities. The only precaution, according to experts, is to "include in the 2008 VAT declarations the list of clients who are creditors as of December 31, 2007." The change to the 20% rate could be without consequence, analyzes Fouad Akesbi.

In reality, the problem is that market practices do not evolve at the same pace as tax regulations. According to the latter, the date of the final contract concluded between the seller and the buyer serves as the triggering event for value-added tax. The battle of experts will be fierce.

For the moment, among developers, professional associations are silent on a problem that could, however, result in a cascade of disputes with clients. Many of them probably rely on a strict reading of the principles of value-added tax. As sellers, they are only collectors of the tax. It is the end customer who bears it. We will see if they were right to bet on this interpretation when the first disputes arise.

The tax authorities' interpretation

Real estate operations and work are now subject to a 20% rate from January 1, 2008, compared to 14% previously. For the General Directorate of Taxes (DGI), "amounts received from January 1, 2008, by real estate construction companies, in payment for work or services fully completed and invoiced at a rate of 14% before January 1, 2008, are subject to the tax regime applicable on the date of execution of these operations." Proof must be provided through a list of debtor clients as of December 31, 2007. Experts speak of creditor clients. For the rest, it is the receipt, and only the receipt, that will prevail as the triggering event.

Published January 21, 2008

L’économiste, January 17, 2008