Cadastral values and changes to property tax calculation:Implications for the real estate market
Real Estate Quarterly, 2014
Changes to the valuation system affect buildings and premises intended for office or retail use though not for warehousing or industry. This is only one of the technicalites of the new law that demands attention.
The main change going on in Russia is the new civil code and this has huge implications, inter alia, for construction and development. Generally the legal system is developing, the government is trying to make the regulations more efficient, transparent and honest.
Cadastral values have traditionally been used in Russia for calculating land taxes. Although the modern cadastral land valuation system was introduced in 1968, cadastral values have been used for broadly similar purposes since the 10th Century. Although there has been significant volatility in cadastral values, especially after the revision of land cadastral values in Moscow and the Moscow region in 2006, cadastral value currently is close to market price and there is a vast body of court practice related to contesting non-market valuation results.
In November 2013, the Russian Tax Code was amended to require owners of particular types of real estate to calculate corporate property tax using cadastral values rather than nominal book values, from January 1, 2014. Legislative changes relating to cadastral valuations of property have also been introduced at a regional level.
The new tax rules apply to property (including buildings and premises) intended for office or retail purposes and not, for example, intended for warehouses and production facilities. To come to an answer about why the new process applies only to offices and retail property, it is worth considering that most of such office and retail property is concentrated within large cities, making it technically easier to assess cadastral values in aggregate. It is also possible that once the new processes have been applied for retail and office buildings, they will be extended to other types of property.
The new taxation regime has increased taxes applying to offshore based Special Purpose Vehicles holding rights to Russian real estate, which have no commercial presence in Russia (previously such SPVs were entitled to calculate property tax based on relatively low inventory value), making such SPV’s much less effective as a tax minimizing measure.
Moscow cadastral valuations are set out in an appendix to Moscow Government Resolution N 752-PP “On the approval of the results of cadastral value calculation for capital construction objects in Moscow” dated 26.11.2013. Where the retail or office facility is not listed, then property tax can be calculated using its nominal book value until its cadastral value listed. Any property not listed this year might be listed next year. It should also be noted that currently there is no public program for real estate cadastral valuation in place for next year, meaning that it is not possible to determine whether a cadastral value for a specific property will be established by then. However it can be confidently stated that all office and retail property will undergo cadastral valuation.
With the new rules having only been in place since 1 January 2014, the first quarter of 2014 sees owners using cadastral values to calculate property tax for the first time, and potential problems are already being widely discussed. An issue that is already gaining awareness is the possibility that owners of existing large complexes, developed by the same owners in the past, may face a double taxation problem, with it often being the case that during construction customers accept different construction works from different contractors: general construction works on the building shell, installation of security systems, fire prevention systems, air conditioning etc - these systems are booked separately, for accounting purposes, as capital assets along with the building shell. Under the old rules, all these facilities were subject to taxation on their book value, which reflected the value of the building as a whole.
The new rules have introduced a situation where the cadastral value is determined from the fact that the building is functioning, guarded, heated -i.e. that all systems booked separately for accounting purposes are included in the cadastral evaluation of the building. At the same time, the owner will also pay tax on the book value of the systems separately booked as capital assets. Please note that this situation can only arise in relation to moveable assets booked before 2013 (moveable property registered on balance after this is not liable to property tax).
Under the valuation law, real estate cadastral evaluation may not be conducted more than once every five years, though the value of real estate increases over time and it is likely that the cadastral value will rise. This will fundamentally change property tax strategies, as the book values previously used generally decreased over time, with depreciation techniques resulting in lower tax. But now the opposite applies. However, more positively for many owners, the new process means that the revaluation of real estate assets (provided in order to increase book value of a company’s assets), taxed according to the new rules, will not result in an increased real estate tax burden.
For cadastral valuations, the Moscow Government engages professional, independent appraisers, selected by tender. This procedure ostensibly ensures appraisal impartiality, and valuation results reflecting the market. The same procedures apply to cadastral valuations of land plots. In practice this means that there are regularly instances where, in an owner’s opinion, the new cadastral value does not conform to the market value, and such owner will seek to challenge the results of the cadastral valuation.
There are two main ways to challenge cadastral values: through the courts or a commission. Many owners have already initiated legal challenges to cadastral valuations of their facilities in courts. This is the case with facilities which have been assessed using the general (unselective) valuation methodology, without regard to specific objects. A judicial challenge may be initiated at any time during the general limitation period (three years), though possible objections by state authorities, and the potential for such challenges to take a long period must be taken into account. The process of challenging a cadastral value using the commission is called on to speed up this process, but an owner only has six months to go to the commission after the new cadastral property value is published. So the period in which an appeal to the commission relating to cadastral values specified in the Moscow Government Resolution No. 752-PP runs out on July 1, 2014. There is a draft law that intends to cut the time for disputing a cadastral value through the courts to six months, and will introduce a series of other challenge restrictions. This means that owners will need to be extra diligent in monitoring the status of their property and the relevant cadastral value.
The direct consequences for the market include the following:
An increase in the tax burden on owners of office and retail property, which will undoubtedly affect rental rates or OPEX (operating costs) (or has already done so). Landlords, however, find themselves better off if they apply the open book principle, according to which operating costs are not fixed but depend directly on the Landlord’s actual costs incurred in maintaining a facility. It should also be noted that the legislation relating to Moscow and the Moscow region foresees a gradual increase in the tax rate over 2014-2018, meaning that the tax burden will grow year by year.
The emergence of a discrepancy between owners with property that has already been evaluated and those that still pay book value based property tax. It should be noted that, in the medium term, this should not seriously encourage tenants to move to landlords applying the old taxation scheme, as a new leased property might be evaluated soon after and the moving costs might not be covered.
The revision of the budgets for new office and retail property construction and operation projects.
The appearance, initially, of technical difficulties in determining the tax base (including in connection with the risk of double taxation).
It should be noted that the introduction of the new taxation procedure appears justifiable from the market’s point of view, since tax will be directly linked to the value of the taxed property, but disputable in that it applies to specific types of real estate. The lack of any transitional period also appears flawed, as this creates a situation in which tax can be calculated differently for facilities with the same functional purpose (until the process of evaluating all retail and office premises is completed). On the other hand, the amendments to the Tax Code have been discussed for a long time and the market has been preparing for the changes. Implementation of them has not, seemingly, caused any serious problems, with no major changes being seen in tenant flows, rarely contested indexation of rental rates, and the changes not, on the whole, engendering many disputes.
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