Sale of a Passively Rented Property Is Not Subject to VAT: The Navok and Glazer Ruling

The Tel Aviv District Court held on 5.5.2016 that the sale of a property in Tel Aviv, which the owners had leased for years through passive rental, does not constitute a "transaction" subject to VAT, even though the owners were registered as authorized dealers. Registration as a dealer is not determinative. The test is whether a business existed in substance. Adv. Shlomi Vaknin represented the appellants.

• Tel Aviv-Jaffa District Court, Hon. Judge H. Kirsh.

• Result: The appeal was granted.

• Full judgment

Two partners purchased a property in Tel Aviv in 1977 from a private individual. The purchase was not subject to VAT, and they did not deduct input tax on the acquisition or on maintaining the property. Initially the property was leased to a company they owned, and later to other tenants. In 1994 the two opened a partnership file with the VAT authorities, and from then on rental income was reported through that file. From the time their company vacated the property until the sale in 2010, there were only three tenants.

The VAT director treated the sale as a taxable transaction, on the grounds that the partnership was registered as a dealer and the property constituted "equipment" used in the business. The appellants' objection was rejected, and they appealed.

The court examined the facts against the criteria established in case law for the existence of a business. The picture was one of passive rental: only two properties, long periods without tenant turnover, no ongoing work to generate the income, no external financing, and no systematic improvement. Accordingly, the rental income was passive income, the property was not "used in a business" and did not qualify as "equipment" under Section 1 of the Value Added Tax Law, and its sale did not constitute a "transaction" under Section 2 of the Law.

Regarding the registration, the court held that it does not create an irrebuttable evidentiary presumption. The court noted that a person should not be encouraged to register as a dealer when it suits them and then disavow that status at the time of sale. However, where no input tax was deducted on the acquisition or maintenance, the tax outcome should follow the economic reality rather than the registration. The court further held that there is no necessary connection between the nature of the property — commercial or private — and the classification of the income derived from it.

A commercial property owner who registered as an authorized dealer in order to issue tax invoices to tenants is not necessarily liable for VAT upon selling the property. The test is whether actual business activity took place.

A central point in this case was that the owners did not deduct input tax on the property. Under the definition of "transaction" in Section 1 of the Law, the sale of an asset on whose acquisition input tax was deducted constitutes a transaction. Anyone who deducted input tax on the purchase will find it difficult to later argue that no business existed. Pre-sale guidance: Taxation of Complex Real Estate Transactions. When is a property sale subject to VAT and when is it exempt: VAT in Real Estate Transactions and Urban Renewal.

1. Check whether input tax was deducted on the purchase of the property or on its renovation.

2. Compile data on the nature of the rental: the number of properties, the number of tenants over the years, the length of the leases, and whether any improvements were made.

3. If the property is reported under an authorized dealer file, obtain a legal opinion before signing the sale agreement, to determine whether VAT should be included in the price.

4. Received an assessment on such a sale? See Representation in Assessment and Objection Proceedings.