Dutch Supreme Court: real estate conversion rarely results in new buildings for tax purposes

In a preliminary ruling, the Dutch Supreme Court has ruled on the tax classification of substantial modifications and conversions of real estate. Under certain circumstances, such modifications and conversions could lead to the creation of a new building for tax purposes, of which the supply is subject to VAT and exempt from real estate transfer tax (RETT). In line with previous rulings, however, the court found that the creation of a new building does not easily occur. Only substantial alterations to the supporting structure, including replacement of all or part of the existing supporting structure, can justify that conclusion.

New buildings

The supply of a new building located in the Netherlands by a VAT entrepreneur is subject to VAT by virtue of law. This concerns real estate that has not yet been put into use or that has been in use for less than two years. Under certain conditions, the RETT concurrence exemption can be claimed. (This exemption can also be claimed for commercial real estate unless the property has been used or leased out for more than six months). After those two years, the supply of real estate is VAT exempt and in principle subject to RETT.

The European VAT Directive allows EU member states to treat real estate that has been substantially modified as a new building for tax purposes. Such real estate then enters a new VAT-taxed and RETT-exempt phase. The Netherlands has made use of this possibility and set the condition that the modification must, in essence, produce a newly created real estate property. However, the Dutch legislator did not further define the term 'new real estate'. The result was difficult discussions with the Dutch tax authorities and court proceedings regarding large-scale conversions and transformations. The tendency in case-law was that after a conversion a property was only considered a new building for tax purposes if the building's supporting structure had been changed.

Kozuba

In the (originally Polish) Kozuba case (ECLI:EU:C:2017:869), the European Court of Justice (ECJ) suggested that a conversion could more easily result in a new building for tax purposes. The decision appeared to state that changes to the property's structure were not essential, provided that the building in question had undergone "significant changes intended to change its use or to substantially alter the conditions in which it is occupied". Moreover, high rebuilding costs (in this case, 55% of the initial value) appeared to be an indication of substantial alteration.

The question was whether this European judgment would also make it more likely that a conversion would lead to a new building for tax purposes in the Netherlands and whether other criteria (including changes of function or high renovation costs) could lead to that conclusion.

Preliminary ruling of the Dutch Supreme Court

Today, the Supreme Court responded to the Kozuba case for the first time. According to the Supreme Court, the European Court in this case only set the minimum for qualifying conversions. The Dutch legislator, however, has set a stricter limit: a new building is only deemed created if the renovations resulted in the creation of a building that did not exist before. And only substantial alterations to the supporting structure, including replacement of all or part of the existing supporting structure, can justify that conclusion. Whether changes to the supporting structure are substantial enough in a specific case depends on all the facts and circumstances of that case. However, other factors (including change of function, change of external recognisability, investments made and added value created) are not of decisive importance or necessary, either in itself or taken together.

Conclusion and recommendations

Based on the preliminary ruling, we conclude that a conversion or transformation of real estate will not easily lead to the creation of a new building for tax purposes. If an old property is converted and subsequently sold, it may be tax advantageous if the buyer directly appoints the contractor to renovate the property after acquisition. This would allow the costs of conversion or renovations to be exempt from Dutch RETT (currently 8%; most likely 10.4% as per 1 January 2023).

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