Hobby as an economic activity

Facts

This BFH (federal fiscal court) case concerns a castle that had been owned by a particular family for centuries and later became a national cultural monument. During the Soviet occupation, the family was expropriated, but the plaintiff, a member of this family, was able to repurchase the castle in recent times.

The plaintiff wanted to renovate and modernise the castle, which was to be financed mainly by subsidies and donations. The concept envisaged renting it out for seminars, weddings, lectures, concerts and similar events. In addition, guest rooms for rental and a small museum were planned. The plaintiff wanted to use a small part of the castle for private residential purposes. At the time of the proceedings, the construction work had already been going on for 14 years and had been interrupted for a long time due to the discovery of harmful substances. The construction was also halted for several years due to a lack of sufficient subsidies. During this entire period, the plaintiff did not generate any VAT taxable supplies with the castle.

The tax office therefore concluded that the plaintiff was not engaged in economic activities and was therefore not entitled to deduct input VAT on the supplies received for the construction work. The authority justified this with the following arguments (presented in the proceedings before the Federal Fiscal Court):

• The plaintiff did not have sufficient financial resources to renovate the castle within a reasonable period of time, so that he was dependent on donations and subsidies from the outset.
• No entrepreneur with serious business intentions would spend years in a preparatory phase.
• The tax court had determined that, from an income tax perspective, this was a hobby. It was contradictory to assume that the plaintiff was an entrepreneur at the same time.
• Even if an economic activity may have been intended at the outset, it must be taken into account how extremely slow the project had developed, which indicated that this intention no longer existed.
• In any case, input VAT deduction was excluded because the expenses were non-deductible entertainment expenses.
• Ultimately, the plaintiff's aim was to maintain his family home, not to engage in economic activity. The expenses related to the lifestyle of the plaintiff and his family and were therefore non-deductible for this reason also.

BFH decision

The senate concurs with the decision of the lower tax court in the previous instance: the plaintiff is engaged in business activities and is therefore entitled to deduct input VAT. Typical economic behaviour in line with market conditions is also economic in the event of a loss. In the case of the management of buildings by a non-profit-oriented person, it is harmless if the buildings are financed to a considerable extent by state subsidies and the management only generates remunerations from minor fees, provided that these remunerations are sustainable in view of the planned duration of its collection. In this context, the economic activity began with the first preparatory acts directed externally and towards the performance of supplies in return for payment – e.g. in the form of the purchase of input supplies – so that the plaintiff was already a VAT taxable person at that point in time. The tax court had deemed the lack of sufficient own funds and the excessive renovation period to be harmless, which the Federal Fiscal Court was bound to accept. It is true that previous BFH case law has established that, in order to prove his intention to let, a VAT taxable person must prepare a rental property within a reasonable period of time in such a way that letting appears possible. Despite the delay, the tax court assumed, in a manner that cannot be challenged on appeal, that the plaintiff had continued to pursue his concept during this time.

Whether the plaintiff still had the proven intention to rent out the castle in a way that does not exclude input VAT deduction in later years is irrelevant for the years in dispute, but must be examined for subsequent years due to a possible input VAT adjustment.

There was no exclusion from input VAT deduction pursuant to section 15 (1a) of the UStG (German VAT Act) for expenses that are not deductible for income tax purposes, because the lower fiscal court had determined in an unobjectionable manner that the renovation of the castle had no connection with the plaintiff's lifestyle (leisure activities). The fact that the castle had belonged to the family for centuries and was a building of special quality did not lead to such an assessment.

The senate referred the matter back to the lower fiscal court because further findings had to be made there regarding the amount of the input VAT deduction entitlement. Among other things, it had to be determined to what extent parts of the building were permanently vacant, used for private residential purposes or open to the public free of charge. Input VAT had to be apportioned accordingly.

Classification

It is undisputed that the status as a VAT taxable person begins with the first preparatory acts aimed at the provision of supplies. However, when assessing the circumstances as they developed over the following fourteen years, a different conclusion would also have been justifiable. In many parts of the ruling, the federal fiscal court points out that the lower tax court assessed the facts in a certain way and that this assessment cannot be revised as long as it does not violate rules of experience and laws of logic. This follows from section 118 of the German Fiscal Court Rules (FGO), according to which the federal fiscal court is generally bound by the factual findings of the lower tax court in appeal proceedings. It seems at least understandable that the tax office lost patience after so many years of input VAT deduction without any output turnover.

Entrepreneurs should not take this case as an example and should continue to ensure that projects are carried out swiftly when renovating buildings so as not to jeopardise their input VAT deduction.

Author: Nadia Schulte