Rental to a hotelier: the State Council establishes a single VAT regime for mixed-use premises

I. The facts: VAT deducted and then questioned by the administration

The dispute concerns a lessor company that had a real estate complex built in Val-Thorens, operated by Club Med. After the completion of the work, the company carried out self-deliveries (LASM) in 2016, and deducted all input VAT.

During an audit, the tax authorities contested this full deduction. Based on a distribution key by area, she isolated the rooms used to house staff. For the administration, this rental was separate from the main hotel business and should be exempt from VAT, which justified reintegrating part of the deducted tax.

On the other hand, the lessor maintained that the rental of the two types of premises formed a unique and inseparable transaction, the sole objective of which was to enable Club Med to carry out its activity. In his opinion, it was therefore a single complex service that was entirely subject to VAT.

After two court decisions against it, the lessor company brought the case before the Council of State, maintaining its position.

II. The concept of a single complex operation

The principle in terms of VAT is that each transaction taxable for VAT is distinct and independent and follows its own regime; this is what is recalled in the I of article 257 ter of the CGI.

By way of derogation, in some cases, the elements must be grouped together in a single operation:

• where two or more elements or acts supplied by the taxable person are so closely linked that they form, objectively, a single inseparable economic benefit whose breakdown would be artificial. This is for example the case of a water bottle that includes the plastic that makes it up, the label, its liquid and its cap;

• or when one or more elements should be considered as constituting the “main” operation while, conversely, other elements should be considered as “ancillary”. For example, this is the case of a small figure hidden in a cereal pack..

In such a hypothesis, the transaction, as a whole, is constitutive of a unique complex operation and must receive a single tax treatment, without it being possible to break down the various elements which, if assessed in isolation, would fall under different VAT rules.

To identify a single complex operation, it is necessary to identify successively:

• closely interrelated items;
• to identify if certain items are ancillary;
• to determine the nature of the main elements (delivery of goods or services) for territorial needs;
• to determine the VAT treatment on this basis. As a reminder, if two main elements are included in the same transaction, the highest rate applies. It can also undermine some VAT exemptions.‍

III. The end of a practice of disclosing rent dictated by caution

Until this decision, the dominant practice was to advise landlords of hotel buildings to break down their rents according to the use of the space. This careful approach aimed to secure the VAT regime applicable to each part of the building.

The method was as follows:

• For hotel accommodation areas: The rental was automatically subject to VAT at the reduced rate of 10%, in accordance with the provisions of the General Tax Code (CGI) relating to accommodation services.
• For other surfaces (restaurant, seminar rooms, staff quarters): These premises were treated independently. Qualified as bare rentals, they were in principle exempt from VAT (art. 261 D of the CGI).

In order to be able to deduct all the VAT paid on construction and to avoid the risk of recovery, it was therefore customary for lessors to opt for the VAT liability of these “ancillary” areas. This option, while securing the right to deduct, entailed the application of the standard rate of 20% to the corresponding rent fraction.

In light of the decision of the Council of State, this legal construction, which is complex and fiscally less advantageous, is now obsolete.

IV. The reasoning of the Council of State: the primacy of economic purpose

In its decision, the Council of State followed a two-stage approach.

He begins by reiterating the position of principle, shared by the tax administration and the Administrative Court of Appeal. By analysing each rental in isolation, we end up with a distinct tax treatment:

• The rental of the main building, intended to welcome Club Med customers, is assimilated to a hotel service. It is therefore automatically subject to VAT pursuant to article 261 D, 4°, c of the CGI.
• The rental of the second building, used to house staff, does not fall under this regime. Considered as a bare rental for residential use, it is in principle exempt from VAT.

However, in a second step, the Council of State reversed the analysis based on the lessor's argument. He recalls that, in accordance with the case law of the Court of Justice of the European Union (CJEU), several formally distinct services may, in certain circumstances, be considered as a single complex operation.

A. Applicable rules

The Council of State recalls that, in order to determine the applicable VAT regime, it is necessary to avoid artificially splitting an operation that is economically unitary. Referring in particular to the Frenetikexito judgment (CJEU, 24 March 2021, C-581/19), he sets out the criteria for identifying a single complex transaction:

The existence of a close link: The various elements provided by the service provider must be so closely linked that they form, objectively, a single economic service that is inseparable from the customer's point of view.

Identification of the main element and the ancillary element: Once the unique operation has been characterized, it is necessary to determine which service is main and which is ancillary. A service is considered ancillary when it is not an end in itself for the customer, but a means of benefiting from the main service in the best conditions. Indices such as its value, which is often minimal or marginal in relation to the whole, can support this analysis.

B. The application of the principles to the specific case

Based on this analytical framework, the Council of State applied these principles to the facts:

• A unique economic purpose: The judge considered that the rental of the two buildings pursued one and the same objective for Club Med: to allow the operation of a holiday village. He also noted that the terms of the lease did not allow the tenant to relinquish part of the premises, which reinforced the inseparable nature of the whole.
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• Censorship of the error of the trial judges: The Council of State thus invalidated the reasoning of the Court of Appeal, which had considered that the accommodation of employees had a distinct purpose. The trial judges erred in analysing the purpose of the transaction from the point of view of the multiple activities of the tenant, when it was necessary to consider the overall service provided by the lessor.
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• The classification of a main benefit and an ancillary benefit: As a result, the Council of State ruled that:
  
  • The rental of the main building (the holiday village) was the main service, subject to VAT.
  • The rental of the staff building, which represented only a minimal part of the total rent, was the ancillary benefit. As such, it had to follow the tax regime for the main service, and also be subject to VAT.

The lessor was therefore entitled to deduct all of the input VAT on the entire real estate project.

IV. Scope and practical implications of the decision

This decision of the Council of State is not a simple case-by-case decision. It redefines the rules applicable to the rental of mixed-use buildings and has major practical consequences.

• The end of the dogma of “surface by area” analysis: The main lesson is that the theory of the single complex operation is fully applicable when it comes to real estate leases. It is no longer necessary to reason in isolation for each premises, but to adopt a global economic approach when the different surfaces serve a unique purpose and are inseparable for the tenant.
  In practice, the administration already admitted this point in some cases implicitly: for example, it did not accept that under the same lease, certain areas were subject to optional VAT while others were not subject to VAT (see parliamentary questions in connection with the consequences of the EMO judgment).
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• Securing hotel arrangements: The decision puts an end to the practice, a source of complexity and additional fiscal cost, which consisted in dividing hotel rents between rooms (10% VAT) and other spaces (often subject to 20% VAT on option). The entire rental can now be subject to a single VAT regime and a single rate.
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• An incentive to audit existing leases: This judgment invites lessors to review rental contracts with mixed VAT regimes (partial exemption, application of different rates). Requalification into a single complex operation could simplify management, optimize the VAT burden and secure deduction rights.

In short, the Council of State favors economic reality over legal formalism, offering welcome security to real estate operators.

V. Issues left unresolved by the decision

While this decision clarifies the lessor's position, it leaves two major questions unresolved that practitioners will need to address.

1. What is the VAT rate for the single transaction?

The logical consequence of qualifying as a single transaction is the application of a single VAT rate. Since the main service is rental to a hotel operator, the reduced rate of 10% should apply to the entire rent, including the ancillary fraction concerning staff accommodation. Although favorable to the tenant, this point is not explicitly resolved by the judgment and could be the subject of future discussions with the administration.

2. What about the right to deduct for the tenant (Club Med)?

The most sensitive issue is undoubtedly that of the right to deduct VAT for the customer. As a reminder, article 206 of Annex II of the CGI provides for an admission coefficient of 0 in the event of expenses related to the accommodation of employees. How should this measure be applied in the future? Does this require a payout through a self-service?

This point will most likely be the subject of future litigation.

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Appendix: reasoning of the Council of State

For information, we reproduce below the analysis carried out by the Council of State:

“It follows from the provisions of Directive 2006/112/EC of 28 November 2006 on the common system of value added tax (VAT), as interpreted by the Court of Justice of the European Union (CJEU), that, when an economic transaction consists of a group of elements and acts, all the circumstances in which it takes place must be taken into account in order to determine whether one is in the presence of one or of several services or deliveries. In principle, each service or delivery must be regarded as distinct and independent.

However, as specified by the CJEU in its judgment of 24 March 2021, Frenetikexito, aff. C-581/19, a transaction consisting of a single economic supply must not be artificially broken down in order not to alter the functionality of the VAT system.

• a) In this respect, a single service exists when several elements or acts supplied by the taxable person to the customer are so closely linked that they form, objectively, a single inseparable economic service. In order to characterize such a unique complex transaction, it is necessary to identify the characteristic elements of the transaction in question, from the point of view of the average consumer. The set of indicators used for this purpose includes various elements:
  
  • (i) the first, of an intellectual nature and of decisive importance, aimed at establishing whether or not the elements of the transaction in question are inseparable and its economic purpose, unique or not,
  • (ii) the second ones, which are material and not of decisive importance, supporting, where appropriate, the analysis of the first elements, such as separate or joint access to the services in question or the existence of a single or separate billing system.
• (b) It also follows from this case-law that an economic transaction constitutes a single service when one or more elements must be considered as constituting the main service, while others must be regarded as one or more ancillary services sharing the fiscal fate of the main service:
  
  • i) In this respect, a first criterion to be taken into consideration is the absence of an autonomous purpose of the service from the point of view of the average consumer. Thus, a service must be considered as ancillary to a main service when it constitutes for customers not an end in itself, but a means of benefiting under the best conditions from the service provider's main service.
  • (ii) A second criterion, which in reality is an index of the first, involves taking into account the respective value of each of the benefits making up the economic transaction, one being minimal, or even marginal, compared to the other.

2) Provisions of a and c of 4° of Article 261 D of the General Tax Code (CGI) providing that the rental by commercial lease of furnished premises to the operator of a holiday village is comparable to a hotel activity subject to VAT, but that, on the other hand, such rental is exempt from VAT, but that, on the other hand, such rental is exempt from VAT when the premises are intended by the tenant for the accommodation of his employees. Company having concluded a commercial lease for the rental of two buildings, a building A intended to accommodate a holiday village and including rooms for staff accommodation, and a building B entirely dedicated to housing the staff of the holiday village:

• a) All the premises of building A competing, from the point of view of the lessee of the premises, for the same economic purpose, consisting in the exercise of the activity of operating a holiday village. Lease relating to the rental of all the premises without distinction between rooms for vacationers and rooms for staff and without the latter giving rise to a rent separate from that provided for the entire building. Under these conditions, the rental of rooms for staff must be regarded as a service inseparable from the rental of rooms for vacationers. Consequently, the rental of building A constitutes a single complex transaction, subject to VAT in application of the combined provisions of a and c of 4° of article 261 D of the General Tax Code.
• b) From the point of view of the lessee of the premises, renting furnished premises in building B intended for the accommodation of its staff in the immediate vicinity of the holiday village, constituting a means of benefiting under better conditions from the service consisting in the rental of premises intended to accommodate the holiday village itself. Service consisting in the rental of building B, which also represents in this case a minimal share in the total rent provided for by the lease for the provision of the set consisting of the two buildings. Under these conditions, the rental of building B constitutes an ancillary service that is not independent of the rental of building A and must therefore also be subject to VAT.”