Rent Free Period And Lease Contracts: New VAT Developments

Background

The lease of buildings is as a rule VAT exempt but such VAT exemption can be waived through the exercise of a VAT option under certain conditions:

both the lessor and the lessee must qualify as taxable persons for VAT purposes; and the building must be used by the tenant for the exercise of an economic activity allowing the tenant to predominantly deduct input VAT on costs incurred (minimum 50%). The main advantage of opting for the taxation of rents notably lies in the granting of an input VAT deduction right to the landlord on its construction and renovation costs.

In both cases brought before the Luxembourg Tribunal, the landlords had opted for the application of VAT on the lease (considering the use of the building for taxable activities) and the VAT options were accepted by the VAT authorities. However, a rent free period exceeding 6 months was included in the lease agreements which led to a regularisation of the input VAT deducted for this period by the VAT authorities and hence, to the initiation of legal proceedings.

Approach of the VAT authorities: denying the input VAT deduction right for the rent free period

The VAT authorities challenged the input VAT deduction right exercised by the landlords for the rent free period in the absence of any economic activities performed during this period.

Indeed, the VAT authorities rejected the analysis whereby a rental activity should be construed as one single global activity and considered that it should rather be divided into two periods: a rent free period and a period subject to rent payment, which entails the application of two distinct VAT regimes depending on the activity, i.e. a non-economic activity which does not entitle to any input VAT deduction right on the one hand and, on the other hand, a taxable economic activity giving rise to an input VAT deduction right.

According to the VAT authorities, even though the period subject to rent payment does not raise any issue, the absence of output transactions subject to VAT during the rent free period should not entitle the landlords to any input VAT...