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SAC: transfer of technical improvement after lease end regarded as service from VAT perspective

The Supreme Administrative Court (SAC) ruled on the question whether the transfer of technical improvements (carried out by a lessee at their own expense) to the lessor for compensation at the termination of the lease constitutes a service from the point of view of VAT. The Supreme Administrative Court also considered whether the reverse charge applies to the supply.

A taxpayer concluded a lease for non-residential premises as a lessee and, under the agreement, was allowed to revitalise the premises at their own expense and subsequently depreciate this technical improvement. The parties to the lease contract agreed that at the termination of the lease, the costs incurred for the technical improvement would be settled and the price would be set in the amount of the residual value for tax purposes.

Upon the termination of the lease, the taxpayer issued tax documents in the amount of the tax residual value of the technical improvement and applied the reverse charge as they assessed the supply as the provision of construction and assembly work to the lessor. However, the General Financial Directorate subsequently assessed that the transaction was not subject to the reverse charge mechanism.

The main key to the dispute was the assessment of whether the transfer of the technical improvement to the lessor should be viewed as a service received by the lessee when carrying out the technical improvement (i.e., construction and installation work).

The SAC reiterated that the reverse charge mechanism must be interpreted restrictively. The construction and installation works were ‘consumed’ once the lessee received them for themselves and used them for their economic activity. At the end of the lease, the lessee did not provide construction and installation work to the lessor, but handed the leased object back to the lessor, including the technical improvements the lessee had made to it. The transfer of the technical improvement for consideration by the lessee to the lessor does not fit the ordinary meaning of the term 'provision of construction and installation work' as classified under production codes CZ-CPA 41-43. At the same time, the supply meets the definition of the provision of services set out in the VAT Act.

The SAC thus agreed with the tax administrator and dismissed the taxpayer's cassation complaint. The SAC thus implicitly rejected the application of the legal fiction contained in the VAT Act, according to which the reverse charge shall be applied to a taxable supply if the supplier and the customer (both VAT payers) reasonably believe that the supply is subject to the reverse charge and both apply this mechanism.

In view of the conclusions of this judgment, we recommend that VAT payers carefully consider the possible use of the legal fiction for supplies where they are unsure of the correct VAT treatment. The question remains whether this case law would also apply to situations where technical improvement is transferred during the lease term or where the technical improvement is transferred by the lessee free of charge.