The VAT burden on infrastructure supplies to public authorities

You run a petrol station, a restaurant or you develop a commercial centre and you need a permit from the local authorities to erect the buildings you need to conduct your business. To obtain planning consent, under Romanian law, you are required to transfer any infrastructure facilities to the local authorities after completion of the buildings. What happens next? Either the input VAT incurred from the investments in the construction of the facilities is denied from deduction or you end up having to self-collect output VAT for the free-of-charge supply. Either way, VAT becomes a cost.

This issue is not new and has been tackled in the past as it has frequently triggered discontent from taxpayers, especially those operating in the real estate and retail industries. It is still a matter of concern in many countries and even at the EU level there does not seem to be a consistent approach.

First of all, what is the source of the problem? The main issue arises from the fact that, for the development of real estate projects, taxable persons are required, according to Romanian law governing the approval of urban plans and the erection of buildings, to make the plots of land on which the real estate will be developed viable/practicable by creating sewer systems, roads, electricity connections and other public amenities. Subsequent to the completion of the buildings, the real estate developers have the legal obligation to supply, free of charge, part of the infrastructure developed to the public authorities that will be responsible for their administration. Thus, the question that arises is what happens to the input VAT incurred in these costs?

An internal survey conducted in 2011 by KPMG has revealed that taxpayers in other EU member states face similar problems and the local tax authorities have different approaches: some see the free of charge supply of infrastructure as a deemed taxable supply for which the taxpayer is required to self-collect output VAT, others either deny the VAT deduction right from the beginning (that is at the date of acquisition) or impose VAT adjustments once the infrastructure facilities are granted (free of charge), while a few others allow VAT deductibility without requiring the collection of output VAT, provided some conditions are met.

Our practical experience has shown that, during the period before January 1 2012, the Romanian tax authorities did not apply a consistent approach to the VAT treatment of infrastructure built. However, in most cases, their interpretation was unfavourable to taxpayers. Since the supply of infrastructure to the local authorities was made without consideration, the Romanian tax authorities took the view that the input VAT deducted by companies for building this infrastructure had to be adjusted (that is accounted for as non-deductible) or considered the free of charge provision of infrastructure to qualify as a deemed supply of goods/services for which the taxpayer had the obligation to self-account for output VAT on the value of the infrastructure facilities granted for free.

Starting with the main reason why a developer builds urban infrastructure – to be able to perform its economic activity or to facilitate carrying out its business – the question that arises is to what extent the right to deduct VAT may be limited or refused when these goods are supplied without consideration. Does the transfer free-of-charge still qualify as a deemed supply even if the taxpayer is required by law to perform this transfer and, furthermore, they will continue to take advantage of the benefits deriving from the use of the infrastructure?

The reality is that infrastructure facilities are built for the developer's business purposes and although under legal requirements the developer is required to grant it free of charge to the relevant public authorities, the taxpayer will continue to take advantage of the infrastructure built and will continue to enjoy the benefits from it. Moreover, in most cases, the developer could not even perform its economic activity in the erected building without the appropriate infrastructure.

According to the general rule provided under article168 of the EU VAT Directive (2006/112/EC) taxable persons have the right to deduct any input VAT incurred with respect to acquisitions of goods/services insofar as these goods/services are used for the purposes of transactions that give a VAT deduction right.

In this respect, the VAT deduction system is meant to relieve companies entirely of the burden of the VAT payable or paid in the course of all their economic activities, provided that such activities are themselves, in principle, subject to VAT. The right of VAT deduction, as well as the principle of fiscal neutrality, are frequently reinforced by the decisions of the European Court of Justice issued in VAT related cases.

Therefore, as the position of the Romanian tax authorities with respect to the VAT deduction right exercised by companies for urban infrastructure transferred (without charge) to public authorities did not appear to be in line with the principles underlying the EU VAT systems, a request for the commencement of the infringement procedure was submitted to the European Commission in March 2011.

When confronted with the issue, the Romanian tax authorities claimed that it has already been clarified by an amendment of the VAT law introduced with effect from January 1 2012, stating that taxable persons may exercise their right of deduction on the input VAT incurred on the infrastructure erected and subsequently granted free of charge to the public authorities to the extent that the infrastructure is closely connected to the economic activity of the taxpayers. Moreover, they claimed that a decisive factor in this analysis is whether the taxpayer will recover the costs incurred for the investment, especially if the taxpayer includes these costs in the sale price of its goods/services.

However, in June 2012, an official letter was issued by the Romanian tax authorities relating to the supply of infrastructure to the public authorities, confirming a change of approach. According to the document, these investments can qualify as activities carried out to ensure the furtherance of the taxpayer's business only insofar as the economic activity of the taxpayer could not be performed (or could not be performed under optimal circumstances) without the infrastructure facilities.

In addition, the Romanian tax authorities have emphasised that, as long as there is a direct link between the expenses incurred for building the infrastructure and the taxable income that is envisaged to be obtained from the economic activity, the taxpayer has the right to deduct the input VAT. The deduction right is retained even if the intention of the tax payer is (from the beginning) to supply the infrastructure without consideration to the local authorities, as required by Romanian law. However, the direct link must be supported by documentary, objective evidence.

Nevertheless, the letter from the Ministry of Finance is not a legislative document, and so there still appears to be a need for more formal and comprehensive guidance on the VAT treatment of supplies (without consideration) of infrastructure facilities to the public authorities.

Although the Romanian tax authorities claim that the new provisions included in the VAT law starting from January 1 2012 have clarified this issue, the problem is far from being solved. The general provision included in the VAT law, as well as some official answers to specific queries from taxpayers, do not give clear direction on how to treat the free of charge supply of infrastructure facilities to the public authorities, from a VAT point of view, and, as this continues to be a grey area, many taxpayers prefer to adopt the safe approach and simply adjust their input VAT initially deducted.

The costs of the infrastructure erected and granted free of charge can be quite considerable and may lead to material adjustments of the relevant VAT. Therefore, these expenses are consequently accounted for in the general cost of the investment and, eventually, recovered from the revenues obtained from the activities carried out by the real-estate operators.

However, because the tax authorities' approach has been inconsistent, the business community has long urged them to introduce into Romanian VAT law a provision offering clear direction on the VAT treatment of free of charge supplies of infrastructure to the local authorities. Informal discussions with representatives of the tax authorities have led to the conclusion that, although they are willing to include in VAT legislation specific provisions that will not require taxpayers to adjust their input VAT deducted for constructing the infrastructure facilities, they will also be strict in applying very specific criteria or a closely defined list of public amenities for which the VAT deduction right will be permitted. Nevertheless, even if this is clarified soon there is still an open discussion as to what will happen to VAT adjustments already made in the past and whether these might now be reversed in taxpayers' favour.

Even though the informal position of the Romanian tax authorities, as well as the rather vaguely worded amendment to Romanian VAT law, appear to tip the scales in favour of an interpretation that will allow real estate developers, or other taxpayers incurring these costs, the right to deduct VAT for infrastructure, facilities there is still ambiguity surrounding this topic that creates uncertainty for taxpayers conducting their business in the real estate and other connected industries.

Biography
		Ramona Jurubi?a KPMG Romania SRL Victoria Business Park DN1 Bucuresti-Ploiesti, nr. 69-71 P.O. Box 18-191 Sector 1, Bucuresti 013685 Tel: +40 (741) 800 795 Fax: +40 (741) 800 700 Mobile: +40 (747) 070 640 Email: rjurubita@kpmg.com Ramona is Partner with KPMG in Romania and she mainly focuses on Indirect tax issues, being the Head of Indirect Tax practice in Romania. She is also member of Romanian Association of Chartered Accountants, member of ACCA (Association of Certified Chartered Accountants) and member of the Romanian Chamber of Fiscal Consultants. With more than 11 years of experience in KPMG, Ramona Jurubita is responsible for managing and developing the Romanian indirect tax practice. She also has relevant experience on practical issues regarding tax planning, fiscal compliance, tax audits, etc as well as three years as a Tax Director for a multinational company acting in the FMCG sector. She is also involved in various litigation projects with significant indirect tax implications. Ramona coordinated and attended debates and consultations with the fiscal authorities responsible for fiscal control mainly in the area of indirect taxes, concerning the improvement of the legislation and the accomplish procedures for it. Also she is a regular speaker at various conferences and training sessions inside and outside KPMG on tax issues.