VAT treatment of leasing real estate to municipal kindergartens (Case No 90751)

VAT treatment of leasing real estate to municipal kindergartens (Case No 90751)  ​ 

 

1.            Background
We refer to the letter dated 12 July 2023 from the EFTA Surveillance Authority (“ESA”) (Case No 90751, Document No 1386955), in which it is informed that ESA has received a complaint stating that the Norwegian authorities are granting unlawful state aid by means of a VAT deduction for lessors of premises to municipal kindergartens.

 

The complaint regards the Norwegian Act on Value Added Tax[1] (“the VAT Act”) section 2-3(1)(b) after which businesses and public enterprises that let buildings or facilities may voluntarily register in the Norwegian VAT Register if such buildings or facilities are used “by a public enterprise whose supreme authority is a municipal council (…)”.

 

The complainant alleges that the Norwegian laws on VAT and VAT compensation are in breach of the rules on state aid laid down by the EEA Agreement. The allegation is based on the following main elements:

 

(i)              the fact that the VAT Act section 2-3(1)(b) entitles lessors of premises to municipal kindergartens to register in the VAT Register but not lessors of premises to private kindergartens;

(ii)            that municipal kindergartens that lease premises, mainly lease the premises from municipal lessors due to a lack of competition in this market.

 

This allegedly leads to a differential treatment between private and municipal lessors of premises to kindergartens that fulfils the conditions laid out in Article 61(1) of the EEA Agreement.

 

Furthermore, the complainant states that the alleged differential treatment between municipal and private lessors leads to discrimination and restrictions in the freedom of establishment and to provide services in violation of articles 4, 31 and 36 of the EEA Agreement.

 

ESA has invited the Norwegian authorities to comment on the complaint. The deadline for providing comments is, following our request for a deadline deferral, 15 September 2023.

 

Below you will find the Norwegian authorities’ comments, provided by the Norwegian Ministry of Finance. Please note that there are no business secrets contained in the information.  

2.            Facts
2.1        The VAT treatment of leasing of premises to kindergartens
The Norwegian VAT Act

The main rule is that the supply or letting of real property is exempt from the Norwegian VAT Act. The effect is that the supplier cannot charge output VAT. On the other hand, the supplier is not entitled to deduct any input VAT. Thus, any input VAT on the hand of the supplier is a non-recoverable cost.

 

Pursuant to the Norwegian VAT Act section 2-3, certain categories of letting of buildings or hiring out of plants may be voluntarily registered in the VAT Register. One of the categories is letting of premises which is used “by a public enterprise whose supreme authority is a municipal council (…)”.[2] This includes the letting of premises to municipal kindergartens. The right to register voluntarily depends solely on the use of the premises, not the status of the lessor. Thus, both private and public lessors may be voluntarily registered if the use of the premises fulfils the conditions laid out in the provision.

 

The effect of VAT registration is that the lessor must charge output VAT on the rent.[3] On the other hand, the lessor is entitled to deduct any input VAT they have incurred.[4]

 

The Norwegian VAT Compensation scheme

Most of the activities in the municipal and county municipal sector are not subject to VAT. That is partly because basic municipal activities such as health services, social services and educational services are VAT exempt supplies.[5] The effect is that the municipalities and county municipalities cannot deduct the input VAT incurred on the purchase of goods and services. The lack of deductibility creates a bias towards self-supply to avoid the VAT cost when purchasing goods and services from external parties.

 

The VAT Compensation scheme was established to remove this bias towards self-supply, and thus counteract the distortions of competition that the VAT system leads to.[6] Therefore, pursuant to the VAT Compensation scheme municipalities and county municipalities receive an economic compensation from the Norwegian state that corresponds to any input VAT incurred on the purchase of goods and services from VAT registered businesses.[7]

 

The VAT Compensation scheme also applies to some private businesses. Private or non-profit undertakings are included in the VAT compensation scheme in as far as they carry out health, educational, or social services which are statutory obligations of the municipal or the county municipal. Further, day-care institutions as mentioned in Section 6 of the Norwegian Day Care Act are included.[8] The purpose of including these private businesses is to avoid distortion of competition between municipal and private businesses which produce services that are statutory obligations in the municipal or the county municipal sector.

 

The VAT compensation scheme is no aid measure for the undertakings falling within the scope of Section 2 of the VAT Compensation Act. When the general VAT compensation scheme was introduced in 2004, the grants from the government to the municipal sector were reduced accordingly by the expected amount of input tax compensated. The VAT Compensation scheme may thus be described as a self-financing system.[9]

 

The combined effects of the voluntary VAT registration scheme and the VAT Compensation scheme

The combination of the lessor’s right to voluntarily register the letting of premises to municipal kindergartens and the municipal’s right to VAT compensation – after which the VAT cost on the rent gets compensated – means that there is no ultimate VAT cost to be borne by either the lessor or the lessee.

 

In contrast, lessors of premises to private kindergartens do not have the same right to voluntarily register in the Norwegian VAT register. Thus, the lessor cannot charge output VAT and is not entitled to deduct input VAT. The input VAT on the hand of the lessor therefore represents a regular business expense.

 

As mentioned above, private kindergartens are entitled to VAT compensation. However, as the lessor cannot register in the VAT register and charge output VAT, there is no input VAT to be compensated on the hand of the private kindergarten. Any input VAT on the hand of the lessor thus becomes an ultimate cost.  

2.2        The market for letting of premises to kindergartens
The complainant argues that the level of competition is low in the market for letting of premises to municipal kindergartens. In the complaint, point 2.2, the complainant has presented statistics from an analysis from Agenda Kaupang AS. According to the statistics approximately 22 per cent of the municipal kindergartens lease their premises, of which approximately 15 per cent lease from private lessors.

 

The Norwegian authorities do not have similar statistics as regards the municipal kindergartens. Thus, we have not been able to verify the referred numbers. However, we do have statistics as regards the letting of premises to private kindergartens. According to the Norwegian Ministry of Education and Research, in 2021 1,873 private kindergartens incurred rental costs, which amounted to 64.3 per cent of all private kindergartens.

 

In the complaint, point 2.2, the complainant also states:

 

Lease contracts with municipal kindergartens are excluded from the scope of the Norwegian regulations on public procurement, and there is therefore no obligation to subject the contracts to competition.

 

Pursuant to section 2-4(a) of the Norwegian regulations on public procurement[10], the rules on public procurement do not apply to acquisition or leasing of “ground, existing buildings or other real property, or rights to such property”.

 

The exemption set out in section 2-4 does not apply to building and construction contracts. A lease contract after which a lessor shall also perform substantial construction work (e.g. new buildings, extensions to existing buildings or substantial renovation) may be classified as a building and construction contract.[11] In that case, the contracting authority must comply with the rules on public procurement. Consequently, the complainant’s general statement that lease contracts with municipal kindergartens are excluded from the scope of the public procurement regulations, is inaccurate.

 

The classification of a lease contract that also contains building and construction work depends on an overall assessment of the contract, to determine the contract’s main element. Pursuant to case law of The Court of Justice of the European Union a contract should be classified as a building and construction contract if the contracting authority has had a decisive influence on the building design. That will be the case if the requirements of the contracting authority reach beyond the regular demands of a lessee, e.g. if the contracting authority has exercised influence on the building’s architectural design.

 

Further, we emphasize that even when lease contracts are outside the scope of the rules on public procurement, that does not necessarily mean that there is an absence of competition. In that regard, it should be noted that the Norwegian Agency for Public and Financial Management (DFØ) in their guidance on public procurement states:

 

Lease contracts are exempted from both the law and regulations on public procurement. We do recommend, however, that you comply with the fundamental principles of section 4 of the Act on Public Procurement (…)[12] (Our translation)

 

Section 4 of the Act on Public Procurement reads as follows:

 

The employer shall act in accordance with the fundamental principles of competition, non-discrimination, predictability, controllability, and proportionality. (Our translation)  

3.            The Norwegian autorities’ views on the alleged state aid
3.1        Introduction
Article 61 (1) of the EEA Agreement reads as follows:

 

Save as otherwise provided in this Agreement, any aid granted by EC Member States, EFTA States or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Contracting Parties, be incompatible with the functioning of this Agreement.

 

The following conditions must be met for a measure to constitute state aid within the meaning of Article 61 (1) of the EEA Agreement:

 

·        the measure must be granted by the state or through state resources;

·        it must confer an advantage on an undertaking;

·        the advantage must be selective in that it is limited to certain undertakings;

·        the measure must distort or threaten to distort competition by conferring an advantage on the beneficiary;

·        the measure must affect trade between EEA states.

 

In the view of the Norwegian authorities, state aid is not present as the measure does not favour certain undertakings. Our views are elaborated below.  

3.2        The measure is not selective
The Norwegian VAT Act section 2-3(1)(b) does not differentiate between lessors. The right to voluntarily register in the VAT Register is open to both private and public lessors in as far as they let premises to municipal kindergartens. Thus, the measure is not de jure selective.

 

The complainant argues that the aid is de facto selective. That is based on an argument that the reality is that private lessors do not have the same opportunity to let their premises to municipal kindergartens. This allegedly puts private lessors in a disadvantageous position compared to municipal lessors.

 

The Norwegian Authorities’ view is that the aid is not de facto selective.

 

In our view this already follows from ESA’s decision in 160/13/COL. In that case, Abelia, the business association of Norwegian knowledge- and technology based enterprises within The Confederation of Norwegian Enterprise (NHO), lodged a complaint against Norway concerning alleged state aid to the lessors of premises to public service providers, and in particular public schools.

 

Abelia argued that state aid was present because:

 

(i)   the Norwegian VAT Act section 2-3 (1)(b), which gives the right to voluntarily register in the VAT register and thus charge output VAT and deduct input VAT, only applies to lessors of premises to public schools;

(ii)  public schools receive VAT compensation for the VAT paid on the rent.

 

ESA’s point of view was that there was no evidence of an indirect advantage in favour of lessors of premises to public schools. First, ESA emphasized that there is no a priori distinction or discrimination between lessors to public schools and lessors to private schools that would prevent any operator from offering its rental services to either type of school. Further, ESA emphasized that the lessors of premises to private schools are likely to pass on any VAT paid on their input factors to their (private) lessees in the form of higher rent.

 

The complainant in the present case argues that although the general premises of the ESA decision 160/13/COL are similar to those of the present case, there are some decisive differences which separate the two situations.

 

Firstly, the complainant argues that there is no way for lessors to private kindergartens to pass on the VAT paid on their input factors.

 

The Norwegian authorities would like to point out that the arguments set out in the complaint do not explain why or how there is a difference between lessors to private schools and private kindergartens, respectively, as regards the possibility to pass on the input VAT to the lessee in the form of higher rent. The complainant merely focuses on the difference between lessors to municipal kindergartens and public kindergartens, respectively. Thus, in the view of the Norwegian authorities, the complainant has not explained why the present case is decisively different from the school case (160/13/COL) on this point.

 

In any case, the Norwegian authorities cannot see that the situations are decisively different. In both cases the lessors of premises to the private parties (schools and kindergartens) do not have the right to deduct any VAT paid on their input factors. Consequently, the VAT becomes a regular business expense which may, depending on the market conditions, be passed on to the lessee in the form of higher rent. As mentioned above, the complainant has not presented any arguments to support that private schools are more likely to handle the passing on of the lessor’s input VAT than private kindergartens.

 

Secondly, the complainant argues that the level of competition is different in the respective markets (letting of premises to public schools and municipal kindergartens, respectively). Therefore, ESA’s argument in 160/13/COL that both private and municipal lessors are free to compete for lease contracts to public schools, is allegedly not applicable to lessors of premises to municipal kindergartens.

 

The complainant has referred to an analysis carried out by Agenda Kaupang AS to support the allegation that the level of competition is low in the market for letting of premises to municipal kindergartens. The analysis as such has not been presented to ESA or the Norwegian authorities. We are therefore unable to comment on the referred statistics.

 

However, the Norwegian authorities would like to point out that the referred statistics as such have limited evidential value as regards the level of competition.

To clarify the level of competition an extensive analysis is required. It would not be sufficient to look at aggregate numbers; one would have to examine the individual circumstances of each case. The Norwegian authorities have not been able to obtain such detailed information on how the municipalities choose the lessors of premises to municipal kindergartens.

 

Further, and as stated in point 2.2 above, the fact that lease contracts are exempted from the scope of the regulations on public procurement, is not in itself sufficient to prove a lack of competition. Firstly, lease contracts may be classified as building and construction contracts and thus subject to the public procurement regulations. Secondly, pursuant to the guidance from the Norwegian Agency for Public and Financial Management (DFØ) the municipalities should in any case comply with the fundamental principles of section 4 of the Act on Public Procurement when awarding lease contracts.

 

Finally, we do mention that although the case 160/13/COL primarily regarded lessors of premises to publicly operated schools, the initial complaint was also targeted at lessors of premises to public sector providers in general. The complainant stated that the same preferential treatment – i.e. the preferential treatment of lessors of premises to publicly operated schools as opposed to lessors of premises to private schools – is granted to lessors of premises to inter alia kindergartens run by municipalities. Private Barnehagers Landsforbund[13] also submitted a letter to ESA.

 

In the decision 160/13/COL, ESA stated:

 

The detailed information in the complaint and the subsequent correspondence relate almost exclusively to the particular circumstances of Norwegian schools. In view of the available information, the Authority therefore can only assess the question of alleged state aid to lessors of premises to public schools in Norway. However, the findings in the present decision most likely also apply to other comparable situations. (Our underlining)

 

This further supports the Norwegian authorities’ view that the Norwegian rules on VAT and VAT compensation as regards letting of premises to municipal kindergartens do not have the effect of granting state aid to the lessors of premises to municipal kindergartens.

4.            Conclusions
The Norwegian authorities dispute the complainant’s argument that the measure entails state aid.

 

Further, it follows from the views expressed above that the Norwegian authorities also dispute the complainant’s argument that the alleged differential treatment between municipal and private lessors leads to discrimination and restrictions in the freedom of establishment and to provide services in violation of articles 4, 31 and 36 of the EEA Agreement. 

Yours sincerely,

 

 

Frédéric Wilt
Deputy Director General

 

Lars Rønningen Sandbu
Senior tax adviser

 

[1] Lov om merverdiavgift LOV-2009-06-19-58.
[2] Section 2-3(1)(b).
[3] The VAT Act section 3-1(1) cf. 3-11(2)(k).
[4] The VAT Act section 8-1.
[5] The VAT Act sections 3-2, 3-4 and 3-5.
[6] Lov om kompensasjon av merverdiavgift for kommuner, fylkeskommuner mv. LOV-2003-12-12-108.
[7] The VAT Compensation Act section 2(1)(a), and section 3.
[8] The VAT Compensation Act section 2(1)(b) and (d), and section 3.
[9] Ot.prp. nr. 1(2003-2004) point 20.8.7.
[10] Forskrift om offentlige anskaffelser FOR-2016-08-12-974.
[11] See inter alia Leige av eigedom | Anskaffelser.no.
[12] Leige av eigedom | Anskaffelser.no
[13] A national interest and employer organisation for private kindergartens.