Beware the Tax Man When Buying Land

Under the new Land Code, Russian and foreign companies will be able to purchase the land under their buildings. They should note, however, that the tax implications of such an acquisition can be significant.

If a company leases a land plot, its land lease expenses are generally deductible for profit-tax purposes. If, however, this land plot was purchased, it would be included in a company's fixed assets. Because land cannot be depreciated, its cost cannot reduce the buyer's profit-tax liabilities. Therefore, owning land may be less tax-effective than leasing it.

Investors should also take into account the additional VAT cost when buying land. If a company leases a land plot from the federal or municipal authorities, the land lease payments are exempt from VAT, while the buyer of land would pay an extra 20 percent VAT in addition to the agreed purchase price.

VAT on land should be recoverable for most investors. However, for investors who are not eligible to reclaim VAT, such as banks, the VAT would represent an additional cost of buying the land. Even some developers of commercial office centers would be unable to recover VAT on land in full if part of their office space were rented by accredited representative offices of foreign companies.

Although land plots are exempt from property tax, they are subject to land tax payable at fixed rates per hectare. If the owner of the building buys the underlying land plot directly from the Moscow authorities at the price that lawmakers set, he may find the land tax is higher than property tax would be.

There is still no concept of single ownership title on land and buildings; they are still considered two separate properties. Therefore, when an investor buys land with a building on it, the total price can be split between the land and the building in a flexible manner. Allocation of the maximum part of the cost to land would reduce the future property-tax liability of the buyer, while the maximization of the building cost would increase depreciation deductions and hence reduce profit tax.

While the advantages of being able to own land are likely to outweigh any tax matters, potential buyers of land should be aware of related tax exposures and should carefully plan for the acquisitions to minimize these exposures.

Steven Snaith is a partner and Dmitry Rudakov a manager at the real estate taxation practice of PricewaterhouseCoopers Russia.