A VAT Loophole in Rental Transactions

Germany’s highest tax court recently issued a taxpayer-friendly ruling regarding a landlord’s ability to claim input tax credits on incurred expenses.

A taxpayer purchased a property, renovated it, and rented it out partly as a residence and partly as an office. He wanted to claim as much input tax as possible and receive a refund. However, this is only possible for sales (rental income) if the recipient (tenant) uses the property exclusively for sales that do not preclude input tax deduction and if they waive the VAT exemption that would otherwise apply. This was the case for a bistro in the building complex. However, it failed entirely for the dormitory and partially for the office because the tenant used only a portion of the space—specifically, 17 square meters out of the total 295 square meters—to manage his own real estate holdings.

The tax office and the tax court denied any claim for input tax on the office because the entire office was not used exclusively for taxable transactions. The building owner, on the other hand, wanted to claim input tax on the entire office and appealed all the way to the highest court.

Opinion of the Federal Fiscal Court

The judges not only ruled in favor of the plaintiff by allowing him to claim input tax deduction for 228 + 50 = 278 square meters. They also suggested deducting input tax from the proportional ancillary areas such as the hallway, kitchen, and restrooms.

They justified their opinion as follows: If the law entitles a building owner to waive tax exemption, this also applies to partial areas of the leased property. The waiver can therefore also be effective in part for individual sub-areas if they can be clearly identified. This is the case for individual rooms, but not for parts of a room. In this context, common areas such as hallways, etc., can also be allocated proportionally to the taxable leased areas.

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