1    Background

The VAT treatment of construction and renovation of real estate regularly raises complex questions. The extent to which input VAT deduction is possible is a recurring issue in both practice and case law. In addition to this question, the Federal Fiscal Court, in its judgment of 9 July 2025 (XI R 32/22), had to address further “classic” issues: What impact does the financing of the measure through donations or grants have on input VAT deduction? What are the requirements to act as a taxable person in the case of permanently loss-making activities? When does a detrimental representation expense, within the meaning of sec. 15 para. 1a of the German VAT Act (UStG), arise?

2    Facts of the case

The plaintiff renovated a castle, classified as a cultural monument, over a period of more than ten years. The financing was largely provided by public grants and private donations. The overall concept envisaged, besides the undisputed use for taxable activities of a renovated stable and a granary, included the future renting out the majority of the castle (89%), subject to VAT, for example as guest accommodation, for events/seminars, and as museum space. A small part (11%) was intended for private and administrative use. The renovation was delayed due to unexpected contamination and a financial shortfall. Private use ultimately turned out to be more extensive than originally planned. The tax office denied the input VAT deduction, arguing that there was no demonstrable intent to use the castle for taxable activities; the measures were predominantly privately motivated and should be considered representation expenses. The Fiscal Court, however, followed the plaintiff’s view.

3    Decision of the Federal Fiscal Court

The Federal Fiscal Court essentially confirmed the Fiscal Court’s decision. The plaintiff was acting as a taxable person regarding the renovation of the castle. In particular, it does not matter whether the activity is aimed at making a profit. A typical market-oriented act, as a taxable person, remains the same even in the case of losses. The overall concept from 2008 indicated that the intention presented by the plaintiff – to supplement the non-detrimental use of the renovated granary and stable with the future short-term rental of guest rooms in the renovated castle for accommodation and other taxable uses – existed and was seriously pursued. The lengthy renovation, given the circumstances, does not argue against the assumption of this intention. The plaintiff’s input VAT deduction is also not precluded by sec. 15 para. 1a UStG. The Federal Fiscal Court states: With the aim of renting, the plaintiff does not pursue similar purposes within the meaning of sec. 4 para. 5 sentence 1 no. 4 of the German Income Tax Act (EStG). The expenses are not related to the plaintiff’s or their business associates’ lifestyle. It is irrelevant that the supplies received also serve to preserve family property. Input VAT deduction is therefore possible if, at the time of receiving the supplies, the intention to generate taxable rental income in the future is substantiated by objective evidence and there is a direct connection to these revenues. The financing of the renovation (e.g., through donations or grants) is irrelevant in this respect. What matters is not how an acquisition is financed, but how or for which supply it is used. However, input VAT deduction is excluded if the acquisitions are related to VAT-exempt, non-taxable transactions, or private use. In such cases, an appropriate allocation must be made. In this respect, the Federal Fiscal Court refers to the principles developed by case law for input VAT allocation in mixed-use buildings. The Fiscal Court must still determine the exact amount of deductible input VAT and any necessary adjustments. In view of the deviation from the overall concept, it must be verified when a change of intention, due to increased private use, occurred and whether this already affects the input VAT deduction or only leads to a later input VAT adjustment.

4    Practical Implications

Given the numerous questions relevant to input VAT deduction, the Federal Fiscal Court judgment deserves special attention. During the construction and renovation phase, discussions with the tax authorities are common, especially when the actual use of the property after completion deviates from the intended use that formed the basis for the original input VAT deduction. To secure the input VAT deduction, complete and comprehensible documentation of the intended use, at the time of receiving the acquisitions, is required. When determining the input VAT ratio, the principles developed by case law are decisive, which are now anchored in sec. 15.17 para. 5–8 of the German Administrative VAT Guidelines and by the Act to Modernize and Digitize the Fight Against Illegal Employment in sec. 15 para. 4 sentence 4 UStG.

If there is no intention to make a profit, hobby activities are irrelevant for VAT purposes (see also KMLZ VAT Newsletter 18│2023). A market-oriented act, as a taxable person, is decisive. Renovation expenses for real estate that is predominantly used for business purposes are generally not non-deductible representation expenses within the meaning of sec. 15 para.  1a UStG in conjunction with sec. 4 para. 5 sentence 1 no. 4 or 7 EStG, provided they are part of an overall business concept and private use is only minor. Finally, the Federal Fiscal Court, once again, confirms that the type of financing – such as through grants – does not preclude input VAT deduction if the acquisitions are used for supplies subject to VAT.