Often a real estate developer faces a situation which could be described as a "tax surprise." An example is the taxation of the sale of buildings before their first use after renovation. The basis may have its roots in the EU's unified system of value added tax (and therefore limitations on exemptions) and the following amendments to Estonian, Latvian and Lithuanian legislation.
For example, starting Jan. 1, 2006, Estonia's VAT law no longer allows for an exemption in a sale of a renovated building, even partially. Previously there was no such provision stating that if a property with an improved construction, or a part thereof, is sold before the post-improvement commencing of use is taxed. There is also no clause stating how long the building has to be in use before the possibility of sale without adding VAT.
As of Jan. 1, 2006, a tax is applied to a sale of a renovated building if the costs related to the renovation exceed at least 10 percent of the acquisition value of the building, or part thereof, prior to renovation. If you decided not to deduct the VAT related to renovation costs, you are now according to the law obliged to calculate and add output VAT to the sale.
This leads to a situation where entrepreneurs might be paying tax twice 's i.e., in addition to output tax, also on the amount that they decided not to deduct in belief that no VAT must be added to the sales price. We have helped one of our clients avoid such tax obligations by proving to the Tax and Customs Board that the wording of the VAT law of Estonia contradicts with the VAT-neutrality principle under the EU law.
In general, VAT must also be added with the sale of a renovated building in Latvia and Lithuania, although different regulations apply. Lithuanian Law on VAT provides that a building for a period of 24 months following its material improvement (renovation) is subject to VAT.
Latvian VAT rules provide that if the real estate is sold within 10 years from its acquisition or acceptance for exploitation, the input VAT deducted attributable to the reconstruction or renovation must be repaid to the state by multiplying 1/10 of the deducted input VAT with the number of years left to the 10 year-term.
To be sure about VAT consequences involving reconstructed and restored buildings in the Baltics, it is always a good idea to consider all the legal details, as the VAT law in the real estate sphere is one of the most complex regulations. Thus consulting your lawyer before such transactions is recommended.
Mart Angerjarv is an associate at Sorainen Law Offices in Tallinn