VAT on real estate transactions and, in particular, VAT on the acquisition of construction services has always been a difficult issue for property developers, public bodies, and the courts in Portugal.
The matter is especially relevant in the housing sector, where, as a rule, the VAT paid on construction is not deductible, being a cost for the developer, with consequent effects on profit margins and access to housing.
As a way of mitigating this effect and, at the same time, promoting the rehabilitation of urban areas, various tax benefits and incentives were introduced several years ago.
The 6% VAT incentive and the ARU/ORU framework
Among the incentives is the application of a reduced VAT rate of 6% (instead of the normal rate of 23%) to rehabilitation works carried out on properties located in urban rehabilitation areas (áreas de reabilitação urbana, or ARUs).
This incentive is set out in paragraph 2.23 of List I of the Portuguese VAT Code, which has undergone some changes over the years but until recently determined that the reduced rate applied to “urban rehabilitation works, as defined in a specific statute, carried out on real estate [...] located in urban rehabilitation areas [...]”.
The concept of ‘urban rehabilitation’ is not clearly defined and there have been several disagreements between taxpayers and the tax authorities over it.
On the one hand, the tax authorities considered that to fit into the concept of urban rehabilitation, the works not only had to refer to a property located in an ARU but also had to be part of an urban rehabilitation operation (operação de reabilitação urbana, or ORU).
ORUs are, in essence, an articulated set of interventions aimed at rehabilitation to be approved by the municipalities, which define the strategy and the specific operations to be carried out to restore all or part of the ARU delimited by them.
Since 2012, municipalities have been allowed to approve an ARU without immediately approving an ORU for the area, with the aim of allowing private developers to carry out rehabilitation projects even before the municipalities adopt a rehabilitation strategy, in their own time and way.
Although several developers and even renowned scholars have opposed the tax authorities’ view, in some cases supported by certificates issued by the city councils, the tax authorities’ restrictive understanding, which has been backed by several court rulings, has significantly limited the scope of the reduced rate.
On the other hand, the tax authorities have argued – once again, based on the concept of urban rehabilitation – that the 6% rate could not apply to the construction of new buildings, but only to the reconstruction of existing ones.
This understanding has been rejected by the courts.
The Programa Mais Habitação reform
In 2023, another amendment to the law was approved, in this case as part of a larger plan to tackle the housing crisis and promote access to affordable housing, the so-called Programa Mais Habitação.
Since then, the reduced rate has applied to “building rehabilitation works [...] located in urban rehabilitation areas (critical urban recovery and reconversion areas, intervention zones for urban rehabilitation societies and others) defined under the terms of the law [...]”.
Taking into account the new wording of the law, the tax authorities considered that the enforcement of the reduced rate:
Was now limited to the reconstruction of buildings, thus excluding the construction of new buildings; but
No longer required the approval of an ORU.
A transitional regime was established together with this amendment to the law to protect taxpayers from the change that excluded new construction from the scope of the reduced rate.
This regime provided that the new rules would only apply to new projects based on the status of the licensing process when the amendment to the law was adopted.
However, no clarification was introduced with regard to the need for an ORU; in particular, it was not made clear that the requirement was no longer applicable to both future and ongoing projects.
This is why a recent decision by the Supreme Administrative Court on the matter caused such a stir in the market.
A controversial Supreme Administrative Court ruling
In the above judgment, handed down with regard to the previous wording of the law, the court ruled that in order for the reduced rate to apply, an ORU must be in force, endorsing the tax authorities’ past opinion and thus significantly limiting the application of the reduced rate.
The decision caused perplexity in the market, not only because there were already several decisions from lower courts to the contrary but also because it was not in line with the position adopted by the tax authorities following the Programa Mais Habitação and with all the political and social mobilisation around the housing crisis.
In addition, although there is no system of precedent in Portugal, this decision will likely impact pending litigation and ongoing projects whose licensing process pre-dates the new wording of the law and the new understanding of the tax authorities.
The legislator and the tax authorities have therefore taken a welcome step forward with the Programa Mais Habitação and the clarification that, at least for the future, it is no longer necessary to approve an ORU to apply the 6% VAT rate.
However, it is difficult to understand, given all the context, the exclusion of the construction of new buildings from the scope of the 6% rate and the missed opportunity of clarifying long-standing controversies; in particular, the ORU requirement.
Final comments on the changes
The above two circumstances, because of the damage and uncertainty they cause, may well constitute real steps backwards in the regime and in the goal of overcoming the housing crisis.
It is to be hoped that the policymakers are paying attention and manage to reverse the situation soon.
