Costly VAT implications relating to building of properties when shifting from VAT-liable activity to entirely VAT-exempt activity

The new practice is relevant when the intended use of a property shifts from VAT-taxable (or partially VAT-taxable) activities to fully VAT-exempt activities during the building process or before the building has been in use for 5 years. In this case self-supply VAT (in Danish: "udtagningsmoms") applies which will result in a 20% payment of the property's market value at the time when the VAT-exempt use commences no matter the value of earlier claimed VAT deductions.

Therefore, unlike the previous immediate rectification, where the VAT repayment was limited to the originally deducted amount, self-supply VAT is calculated based on the property's market value, alternatively the cost price at the time of shift of intend if the market value cannot be assessed. This can lead to a higher VAT liability than the initially deducted amount. 

The definition of "market value" is not specified in the administrative guideline, and future case law will be crucial in determining whether it refers to the market value of the property used for residential letting or the value of condominiums in a sale context.

The new practice is particularly relevant in a situation where the initial purpose was to construct a building for sale, but the property proves not possible to sell. As a result, the building is instead used for VAT-exempt residential letting. When the intend changes, the owner will no longer be entitled to deduct VAT on the costs going forward. Additionally, self-supply VAT becomes payable at the time the VAT-exempt use commences, which occurs once both parties have signed the lease contract.

This can be quite costly; however, the owner will at least receive compensation for the VAT on costs not previously deducted, provided that the change in intent occurs no later than the completion or initial use of the building.

If the initial intent during the building period was VAT-exempt letting but the property is subsequently sold, the owner may deduct the VAT from the change of intent if it can be documented. However, the VAT on costs incurred in earlier periods generally cannot be deducted until the property is sold.

As a consequence, of the new administrative practice, property developers must carefully consider any changes to the intended use of a property, as such changes can have substantial financial implications. Notably, the rules on self-supply VAT only apply if the intended use shifts from VAT-liable (or partially VAT-liable) activities to fully VAT-exempt activities. To mitigate the risk of self-supply VAT, it will be beneficial to retain some VAT-liable activities in the property. 

If the intended use shifts more than five years after completion, the regular capital goods adjustment rules apply, and no self-supply VAT will be payable. According to the capital good adjustment rules any deductible VAT must be adjusted if the property's use changes after completion.

The relevant rules state: 

• VAT on properties is adjusted over 10 financial years following the change in use.
• For repair and maintenance, the adjustment period is limited to five financial years. 

The mentioned 2024 ruling from the City Court found that the Danish VAT Act could not be interpreted to require an immediate rectification in the year of completion if the property's intended use shifted from a planned VAT-liable sale to VAT-exempt letting. Instead, the adjustment should follow the standard 10-year period applicable to properties.

While this ruling could have been favorable for property developers if relevant today, it concerned the income years 2016-2019, before the stricter rules on self-supply VAT took effect on 1 July 2021.

However, due to the ruling it is possible to request for a reopening of the VAT return back to January 2016 if the previous applied practice of rectifying the deducted VAT amount has been unfavorable for the taxpayer compared to the capital good adjustment.