Introduction

The tax issues of a bankruptcy estate and the creditors differ depending on whether the bankruptcy estate continues the previous business of the debtor company. The effects of a debtor's bankruptcy on the creditor's taxation may be particularly significant where the creditor is a lessor to the debtor.

According to the Value Added Tax Act, businesses can deduct value added tax (VAT) on their real property investments if the property is used for a purpose that is subject to VAT. Real property is considered to be used for a purpose that is subject to VAT if the lessee uses the property for VAT activities. The use of the real property affects the right to deduction, so if the purpose changes later (eg, as a result of changes to the lessee's business), the lessor is obliged to adjust the VAT deductions for its real property investments.

Pursuant to legislation, a bankruptcy estate is, in principle, entitled to choose whether to conduct activity liable to VAT provided that it does not continue the debtor's business. When it comes to business premises leased by the bankruptcy debtor, the use of the premises by the bankruptcy estate for activities that are not subject to VAT could create an obligation for the lessor to adjust its VAT deductions, which might have decisive relevance for the lessor's VAT.

The Administrative Court of Helsinki recently issued a ruling (HHAO, November 21 2017, 17/0862/4) on the requirements for a lessor to register for the transfer of rights to use real property (liable to VAT) in relation to business premises that stand empty after use by the lessee's bankruptcy estate. The court also ruled that the use of the business premises by the lessee's bankruptcy estate for activities that are not subject to VAT did not create an obligation for the lessor to adjust its VAT deductions.

Facts

A company (the lessor) had leased business premises to a retail trade company (lessee). The lessee's activities were subject to VAT. During the lease period, the lessee was declared bankrupt. After the commencement of bankruptcy proceedings, the bankruptcy estate used the premises to conduct the realisation of the debtor's assets. The bankruptcy estate did not register its activities as liable for VAT. After learning that the bankruptcy estate would not commit to the lease agreement and assume the lessee's contractual liabilities, the lessor immediately terminated the lease agreement.

Decision

The court stated that as soon as a debtor is declared bankrupt, the authority over the debtor's assets transfers to the bankruptcy estate, which is administered by the estate administrator on behalf of the creditors. Pursuant to the Lease on Business Premises Act, the lessor has the right to rescind the lease agreement on the grounds of the lessee's bankruptcy if the estate does not commit to the agreement within a time limit set by the lessor of no less than one month. Therefore, the bankruptcy estate has the right to be in possession of the business premises for at least a month, during which time the lessor has no right to terminate the lease agreement.

In the present case, there was a lease agreement in place between the parties at the time the lessee was declared bankrupt. In the agreement the lessee had agreed to use the leased premises for activities subject to VAT. After the commencement of the bankruptcy proceedings, the bankruptcy estate retained possession of the premises but did not use them for VAT activities. The lessor terminated the lease immediately after it discovered that the bankruptcy estate did not commit to the agreement. On the referred grounds, and considering that the lessor's main business was renting the business premises liable to VAT, the court held that under the circumstances it had been a matter of continuation of renting of the business premises subject to VAT and the fact that the bankruptcy estate had been in possession of the premises pursuant to the Lease on Business Premises Act and had used the premises for activities exempt from VAT was not a decisive factor for lessor's VAT. The court deemed that the business premises had still been in use for activities subject to VAT. The use of the premises by the bankruptcy estate did not, under the circumstances, change the intended use of the premises in a way that would create an obligation for the lessor to adjust VAT deductions with respect to its real property investments.

When the business premises had been left empty and the lessor had presented documentation that the premises would be rented out for use by a business subject to VAT in the future, the court considered that tax liability for the premises continued when the premises were left temporarily empty. Therefore, the lessor met the conditions to apply for registration for the transfer of rights to use real property liable to VAT.

Comment

The court held that the lessor met the conditions to apply for registration for the transfer of rights to use real property liable to VAT as business premises, which were left empty following the lessor's bankruptcy and for the period during which the premises were used by the bankruptcy estate for activities exempt from VAT. In addition, the circumstances did not oblige the lessor to adjust VAT deductions with respect to its real property investments.

It can be assumed that one decisive point supporting the decision was the fact that the lessor and the bankruptcy estate had not agreed on a new lease agreement, but the estate temporarily remained the possession of the premises for a relatively short period based on the rights provided in the legislation.

A second point might be that after learning that the bankruptcy estate would not commit to the lease agreement between the lessor and the bankruptcy debtor, the lessor had immediately used it to terminate the lease on the grounds of the lessee's bankruptcy. Perhaps the decision would have been different if the lessor had not used its rights to terminate the agreement effectively.

If the bankruptcy estate had been allowed to continue carrying out activities exempt from VAT within the leased premises, it is likely that the lessor would have been obliged to adjust its VAT deductions with respect to its real property investments. It is also likely that the lessor would have suffered financial damage due to the adjustment. However, the liability for the compensation for such damages could be deemed as receivables from the bankruptcy debtor and such receivables should be lodged in the bankruptcy proceedings.

For further information on this topic please contact Klaus Majamäki at HPP Attorneys Ltd by telephone (+358 9 474 21), fax (+358 9 474 2222) or email (klaus.majamaki@hpp.fi). The HPP Attorneys Ltd website can be accessed at www.hpp.fi.

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