It has become common practice in the Norwegian real estate market for private real estate developers to be required to submit to public authorities, as part of any new real estate project, their plans for the development and financing of that project’s requisite infrastructure.
The extent of these obligations varies, depending on the nature of the project being undertaken. For example, the infrastructure may be located either on the developer’s own land, or on third party land (normally owned by central or local authorities).
When construction is complete, ownership of the infrastructure is transferred, at no cost, to the state or local authorities by virtue of the planning regulations and/or the developer’s agreement with the public authorities.
In the light of this practice, it has become necessary to clarify how infrastructure development costs are to be treated for tax purposes, with respect to both corporate income tax and VAT liability.
Corporate income tax
The Norwegian Tax Act (NTA) provides that all costs relating to earning, maintaining or securing the taxpayer’s taxable income are deductible from that taxable income.
The legislation is generally interpreted to include a requirement that the cost must be incurred before a tax deduction is granted. Further, it is an absolute requirement that the cost is sufficiently related to the taxable income. How such relevance is to be assessed is not specified in the NTA, but is based on a separate and overall evaluation of relevant circumstances.
For a cost to be deductible, it must result in a reduction in the taxpayer’s economic position, meaning that a mere exchange of values does not qualify. If the taxpayer receives a consideration for a payment, there is likely to be no reduction in his or her economic position.
Any cost incurred as part of earning taxable income is tax deductible either:
- directly and in full in the fiscal year the cost incurred, or
- treated as a cost to be capitalized.
If a cost is to be capitalized, it will either: i) be depreciable for tax purposes on a declining balance, or ii) be capitalized as part of the tax base as a non- depreciable business asset, typically applicable to the value of the site.
Non-depreciable assets are generally considered not to be subject to a value decrease. Acquisition costs for such assets are treated as capital investment. Typically this includes the value of the site. These costs are not depreciable and generally only become tax deductible when the asset is sold.
The Norwegian tax authorities have confirmed that in circumstances where a developer agrees to finance infrastructure development costs in order to obtain permission to develop a property, any costs incurred will not be deductible for tax purposes. The rationale for this is that the necessary infrastructure must be in place in order for the developer to obtain permission to develop the real estate, and the cost of this should be considered as part of the investment in the property rather than a cost for tax purposes.
Whether these requirements flow from public regulations or private agreements between public authorities and developers is irrelevant to the tax position. The tax liability will be the same regardless of whether the infrastructure is located on a developer’s own land or on third party land (typically owned by central or local authorities).
The next issue is whether the costs should be capitalized and allocated to the site, or alternatively, capitalized as part of the building or other business assets. A third solution is to split the costs.
The general view of the Norwegian tax authorities has been that any accrued cost directly relevant to the building is to be considered as part of the building’s tax value and depreciated in the same manner as the building. Office buildings are depreciated at a rate of 2 per cent annually. Costs derived from other on- site work with a lasting value, are to be allocated to and capitalized as part of the site’s tax value.
Costs that are part of the building’s tax value are normally costs related to the land that underlies the building. This includes, but is not limited to, demolition and site preparation costs. The same applies to any design costs.
Costs for work to complete access roads and parking, port facilities, etc. are normally added to the tax value of the site. As the site’s tax value is not depreciable, such costs become deductible when the site is sold.
Special rules apply for costs for initial road surfacing, which is depreciable at a rate of 10 per cent annually, as long as the work is carried out on a road used mainly for economic activities. The costs of any subsequent road maintenance are deductible in full in the years those costs are incurred. Further, the costs of work undertaken to route electricity cables for the development are depreciable at an annual rate of 5 per cent.
VAT on infrastructure costs
According to the Norwegian VAT Act (NVA), a registered taxable business entity is entitled to deduct input VAT on procuring goods and services that are intended for use in its registered business if the procurement is sufficiently relevant to the business liable to VAT. This can apply to infrastructure costs.
The sale or leasing of land or buildings is VAT exempt in Norway. Thus input VAT on procurements related to land or buildings meant for sale or lease is, as a general rule, not deductible.
However a lessor can be voluntarily registered for VAT if the lessee is a business registered for VAT. However, the lessor must then charge VAT on rents. Further the lessor is permitted to deduct input VAT on costs which arise in connection with the construction and maintenance of the leased building. This includes costs relating to the infrastructure the developer is providing.
If the infrastructure is transferred to the state or the local authorities on completion, the NVA states that deducted input VAT related to infrastructure must be adjusted accordingly. In other words, the developer must repay the deducted input VAT on infrastructure to the tax authorities.
However, this adjustment can be avoided if the requirement to adjust input VAT is transferred to the new owner of the infrastructure who uses it either in a business liable to VAT or in a business that is entitled to a VAT refund. A local authority will usually have the right to VAT refunds for all its activities, except the sale or leasing of property. Thus, under certain circumstances, it is not possible to transfer the obligation to adjust VAT. Further, some local authorities have been unwilling to accept a transfer of the obligation to adjust VAT. In these cases, the deducted input VAT must be paid to the state if the infrastructure is transferred to the local authority.
The state, on the other hand, is not entitled to a VAT refund. A transfer of infrastructure from a developer to the state means that deducted input VAT must be paid to the tax authorities.
If a local authority itself develops and finances the infrastructure, the local authority is entitled to receive an input VAT refund from the state. Therefore, where a developer is not entitled to deduct input VAT, the project’s costs would be lower if the infrastructure were developed by the local authority.
In order to satisfy both demands (that of the local authority that infrastructure be financed by developers, and that of developers that VAT costs should be as low as possible), a model has been developed where responsibilities are shared. This is known as the investment contribution model.
Under this model, the local authority is the owner of the infrastructure, and is, therefore, entitled to receive a refund of input VAT on the infrastructure from the state.
For a local authority to recover VAT it must be the owner of the infrastructure in question. Consequently the local authority must take complete responsibility (and risk) for the project. All invoices relating to infrastructure development must be issued to the local authority and paid from the local authority’s bank account. The cost of this work must be entered as an expense in the local authority’s accounts.
The local authority and the developer will agree that the latter is to make a contribution to infrastructure costs to the local authority, excluding VAT (as the local authority will get this back from the state). The Norwegian tax authorities have confirmed that the contribution from the developer to the local authority is not a transaction liable to VAT.
Thus, under the investment contribution model, the developer can assist the local authority with regard to planning and administration of the infrastructure development without limiting the local authority’s right to receive an input VAT refund.
In summary, where private developers are required to finance infrastructure, they should focus on the VAT costs involved in the project start-up phase, and if necessary, involve the relevant local authority as early as possible.