The Plenary of the House of Representatives in Cyprus is set to decide on a proposal to impose a reduced VAT rate of 5% for the first 130 sqm of primary residences. This decision comes under the looming pressure of potential fines from the European Court of Justice.

According to a report from the Parliamentary Committee on Finance, the committee unanimously agreed to increase the maximum limit from 110 sqm to 130 sqm. This new limit is based on market data and aims to meet the requirements of the European Directive to the fullest extent possible. It also remains a socially targeted measure, working in conjunction with the upper transaction value, acting as a secondary safeguard.

Notably, the Ministry of Finance presented a new draft law to the committee on May 31, 2023. The draft law proposed a revision of the upper area limits and the introduction of upper value limits for residential properties. The objective was to ensure that the reduced VAT rate of 5% would apply to the first 110 sqm of constructible residential area, without differentiating between apartments and houses. The reduced rate would be applicable up to a value of €350,000, provided that the total transaction value does not exceed €475,000, and the total constructible area does not exceed 190 sqm.

The draft law also includes a provision to apply the reduced VAT rate of 5% for the first 190 sqm of constructible residential area in cases involving individuals with disabilities.

To allow for a smooth transition, the proposed regulations would not apply to cases where urban planning permission has already been obtained or when an application for urban planning permission has been submitted within four months from the date of the proposed law's enforcement.

The Ministry of Finance believes that the current text is a result of thorough discussions within the committee, particularly with regards to eliminating discrimination between apartments and houses concerning square meters. It aligns with the recommendations put forth by the European Commission.

Moreover, the Committee on Finance sought the opinion of the Minister of Finance regarding the amendment made to the draft law, and a response was received on June 6, 2023.

The Minister of Finance informed the committee that the statutory time limits have expired and highlighted the palpable risk of Cyprus being taken to the European Court and incurring fines. In such a scenario, the European Union could potentially claim the full amount of its own resources, augmented by interest accrued due to the loss of revenue resulting from the reduced VAT rates.

Furthermore, it emphasizes that the Ministry of Finance believes that the proposal currently under consideration by the Parliamentary Committee on Economics and Budget is the appropriate solution, especially since it has already received approval from the European Commission, as indicated in their letter dated December 12, 2022.

In addition, the government recognizes the need to respect the authority of the European Union and refrains from assuming the approval of competent EU bodies. Consequently, the government will uphold the proposal put forth by the Commission as a matter of principle.

Building upon the aforementioned data, the government will actively support this proposal through the relevant institutional channels within the European Union.

It is worth noting that the European Commission issued a cautionary letter to the Republic on July 15, 2021. In this communication, the Commission emphasized that the existing legal framework governing the application of the reduced VAT rate (5%) for the purchase and construction of residential properties in Cyprus does not align with the corresponding provisions outlined in the relevant European Directive. The Commission underscored that the framework fails to meet the prescribed social policy requirements specified in the Directive.

Furthermore, the Commission highlighted that there are no specific conditions outlined in the national regulations that justify the application of the reduced VAT rate (5%) for the acquisition or construction of residences, thereby diluting the social character of the measure.

Moreover, the Commission clarified that the measure benefits all citizens of the Republic, as well as citizens from other European Union member states and nationals from third countries, regardless of their income, assets, or economic status. This applies to the purchase of residences in Cyprus, regardless of the individual's familial connections, and without consideration of the total area of the property.

Additionally, the Commission drew attention to the fact that the threshold of 200 square meters, beyond which the reduced VAT rate (5%) would not apply, surpasses the average residential area in Cyprus. According to Eurostat data, the average residential area stands at 141.4 square meters.

On June 1, 2023, the European Commission issued a substantiated opinion to Cyprus due to its incorrect implementation of EU VAT regulations concerning the purchase or construction of residential properties in the country.

The Commission has granted Cyprus a two-month period to rectify the identified shortcomings outlined in the substantiated opinion. Failure to take appropriate action within this timeframe may result in the Commission referring the case to the Court of Justice of the European Union.

It is important to recall that the initial draft legislation was submitted with the intention of amending the Value Added Tax Law. The proposed amendment sought to apply a reduced VAT rate of 5% to the first 140 square meters of residential properties, provided that the total area does not exceed 200 square meters.