The European Commission has sent an ultimatum to Cyprus regarding the island's abuse of the European Directive on reduced VAT when buying or building a primary residence.
This ultimatum requires Cyprus to amend the VAT legislation within two months. If parliament fails to amend the legal framework by 15th February, Cyprus faces a significant risk of being referred to the EU Court of Justice increasing the probability of it being fined. It comes nineteen months after the European Commission decided to send a letter of formal notice to Cyprus for its failure to properly apply EU VAT rules for dwellings purchased or constructed in Cyprus.
VAT Directive and its abuse
Although the European VAT Directive does allow EU Member States to apply a reduced rate of VAT on housing as part of a social policy, the wide scope of the Cypriot legislation and the lack of limitations therein indicate that the measure goes far beyond the objective of a social policy.
In Cyprus, the 5% reduced VAT rate is levied on the first 200 sqm. of dwellings when bought or built as a primary residence. Furthermore, the reduced rate is applied regardless of the income, assets and economic situation of the beneficiary, the members of the family that will reside in the dwellings, and the maximum total area of the dwellings concerned.
But even the current law is misused and abused. Between October and December 2022, the Department carried out 2,171 on-site audits of taxpayers who benefited from the reduced rate of VAT. 1,039 taxpayers were found inside the houses; 391 of them admitted they had broken the law as the dwelling concerned was not their primary residence. Some of them went to the Tax Department where they paid the additional 14% tax.
The mind boggles at how many more people have abused the VAT system since the reduced rate of 5% was introduced more than a decade ago and out of how much revenue the Tax Department has been defrauded.
New bill pending in Parliament
The bill pending in Parliament levies the 5% VAT on the first 170 sqm. of houses, with a total area of no more than 220 sqm. and a total value of no more than €350,000. Also, a reduced VAT of 5% will be imposed on the first 90 sqm. of apartments, with a total area of no more than 110 sqm. and a total value of no more than €200,000.
However, there is considerable opposition to this new bill from opposition parties and the construction industry and it will not pass easily through parliament.
As the presidential election will be held 5th February, the government will probably want to buy some time from the European Commission. The question then arises what will opposition parties do, given the probable backlash from the construction industry?
Regular readers may recall that the late Demetris Christofias borrowed money from Russia rather than asking the EU for a financial bailout which came about as the consequence of the worst economic management of public sector finances and a near total lack of regulation and control of the banking system.
Christofias left it to his successor, Nicos Anastasiades, to go cap-in-hand to the EU for a bailout. The terms of the bailout included bank deposit haircuts and the closure of the Laiki bank – all of which was blamed on President Anastasiades rather than his predecessor.
If the political parties continue to play their games, it's virtually certain that Cyprus will be fined millions, which taxpayers will inevitably have to pay
