When leasing commercial space in Germany, it is common that tenants pay VAT at the standard tax rate of 19% on the net lease rent. This is contrary to the VAT exemption for leasing and letting of real estate in the German VAT Act.

Therefore, to achieve VATable leasing and letting services, the landlord needs to actively waive this VAT exemption (VAT Option). The VAT Option by the landlord requires the following:

• The landlord leases the building to a tenant, who is an entrepreneur in the sense of German VAT law. 
• The tenant uses the building for its business activities.
• Furthermore, the tenant provides exclusively output-supplies, which are subject to VAT and do not exclude the right to deduct input-VAT (i.e., are not VAT-exempted).
• The landlord must be in a position to demonstrate the fulfillment of such requirements for the VAT Option vis-à-vis the tax authorities at any time.  

As a consequence of a successful VAT Option, the leasing and letting services provided by the landlord are subject to VAT and are no longer VAT-exempt. 

The economic background for the landlord’s VAT Option is to secure its claim to deduct input VAT on any construction or refurbishment services: 

• Landlords, in particular in the commercial renting business, often face significant costs for supplies of goods and services in connection with the construction or refurbishment of the building. 
• Typically, these supplies are subject to VAT at the standard rate of 19%. 
• The landlord is only entitled to deduct input VAT if and to the extent it provides output-supplies that are subject to VAT and are not VAT-exempt.
• The German tax authorities generally apply an observation and correction period of up to 10 calendar years for any input-VAT deductions on construction or refurbishment services. This entitles the German tax authorities to reclaim any (or parts) of the granted input-VAT deduction if the requirements for the input-VAT deduction are not or no longer fulfilled.  

However, for some tenants, the VAT Option is not possible. This is the case if the tenant does not exclusively provide output-supplies that are subject to VAT and not VAT-exempted (so-called “Umsatzsteuerschädling”). In particular, dentists, financial institutions and insurance companies typically provide VAT-exempt services. The business activity of such tenants may have an impact on the VAT position of the landlord, as their VAT status may jeopardize the landlord’s right to deduct input VAT. 

As a denial of the input VAT deduction normally leads to an increase in the final VAT burden at the level of the landlord, it is common to get a refund of such a VAT loss from the tenant by way of an increase in the lease rent. Therefore, the VAT status of the tenant needs to be reviewed at the outset of the lease or when acquiring a leased property. The lease agreement should also include reasonable protection if the VAT status of the tenant changes and hinders the VAT Option of the landlord. Furthermore, the VAT status of the tenant should constantly be reviewed, as it may change (e.g., if the tenant amends or changes its business model). 

When leasing premises or investing in Real Estate, Dentons can assist you in the following: 

• Assessment of the landlord’s VAT position and development of suitable VAT strategies;
• Review of the tenant’s VAT status; 
• Calculation of the VAT loss amount (where the VAT status of the tenant hinders a VAT option by the landlord); 
• Determination of any applicable observation and correction period for incurred input VAT at the level of the landlord; and
• Investment an leasing negotiations regarding VAT