Editor's Note: In real estate projects, civil air defense parking spaces are a common type of project. Due to the special nature of the property rights of civil air defense, it has triggered many disputes over land value-added tax. For example, whether civil air defense parking spaces should be taxed with land value-added tax, whether they belong to the settlement scope, whether the consideration obtained should be included in the income, whether the construction cost can be deducted as a deduction item, and how to collect the cost, etc. This article will discuss several focal points among many controversial issues and provide suggestions on how to avoid the risk of land value-added tax settlement for civil air defense parking spaces.

Ⅰ.Case Introduction: Disputes Over the Settlement of Value-Added Tax for Civil Air Defense Parking Spaces

(1) Basic Project Information

The "Century Garden" project developed by Real Estate Company A includes residential buildings above ground, commercial areas, and underground parking spaces. The total construction area is 85,000 square meters. Among them, the above-ground residential buildings cover 70,000 square meters, meeting the local standards for ordinary residential buildings. The commercial area covers 5,000 square meters, while the underground parking spaces cover 10,000 square meters, which were converted from civil air defense projects and cannot have property rights. After completion, due to the government's failure to conduct acceptance and handover of the civil air defense project, Company A leased the parking spaces to homeowners within the community.

According to the land transfer contract for the project, the land transfer fee was 850 million yuan (15 stories above ground and 1 story underground), but the contract did not clearly distinguish the corresponding land costs for each property type.

(2) Focus of the Dispute

During the settlement of value-added tax, there are three disputes between the tax authorities and the enterprise regarding the settlement of civil air defense parking spaces:

1. Are civil air defense parking spaces saleable?

2. Can the land costs corresponding to civil air defense parking spaces be included in the deductible project amount?

3. Should civil air defense parking spaces participate in the aggregation of deductible projects?

(3) Views of Tax Authorities and Enterprise

Company A believes that:

1. Since the government has not conducted acceptance and handover of the civil air defense project, the involved civil air defense parking spaces are considered saleable real estate, and the 10,000 square meters of civil air defense parking spaces should be included in the saleable area of "other types of real estate".

2. According to the National Taxation Administration Notice [2006] No. 187, deductible costs and expenses are allowed for saleable real estate. Therefore, the land costs corresponding to civil air defense parking spaces should be included in the deductible project amount. That is, the total land cost of 850 million yuan for this project belongs to the deductible project amount and should not be reduced.

3. Following the principle of matching income and costs, as no transfer income has been received for civil air defense parking spaces, they will not participate in the aggregation and allocation of deductible projects. The land costs will be allocated based on the proportion of the respective building areas of ordinary standard residential buildings and commercial areas. The settlement conclusion is: ordinary standard residential buildings share 793 million yuan in land costs (850 million yuan / 75,000 square meters   70,000 square meters), and other types of real estate share 56.7 million yuan in land costs (850 million yuan / 75,000 square meters   5,000 square meters).

Based on Company A's settlement report, the value-added tax rate for ordinary standard residential buildings is 12.5%, which meets the exemption conditions, and a tax refund of 25.2 million yuan should be issued. Other types of real estate should pay an additional tax of 16 million yuan, resulting in a total tax refund of 9.2 million yuan.

The tax authorities believe that:

1. The property rights of civil air defense parking spaces belong to the state and are considered non-saleable real estate. Therefore, the 10,000 square meters of civil air defense parking spaces should be excluded from the saleable area.

2. According to the National Taxation Administration Notice [2006] No. 187, as the civil air defense parking spaces have not been transferred to the government or used for public utilities, the corresponding land costs should be deducted from the deductible project amount. Since the land transfer fees for this project were paid in a lump sum, and it is impossible to distinguish the land costs corresponding to different property types, the land costs included in the deductible project amount should be calculated using the "building area proportion coefficient method": 850 million yuan - 850 million yuan   (10,000 square meters / 85,000 square meters) = 750 million yuan.

3. Based on the "sellable construction area method" adopted by the city for cost allocation, civil air defense parking spaces are considered non-sellable real estate and do not participate in the aggregation and allocation of costs. The audit and settlement conclusion states that the ordinary standard residential areas have allocated land costs of 700 million yuan (7.5 billion / 75,000 square meters   70,000 square meters), while other types of real estate have allocated land costs of 50 million yuan (7.5 billion / 75,000 square meters   5,000 square meters).

According to the tax authorities' audit and settlement conclusions, the value-added rate of ordinary standard housing is 22.73%, which does not meet the tax-free conditions. Therefore, a tax supplement of 44.79 million yuan should be paid. Other types of real estate should also pay a tax supplement of 19.04 million yuan. In total, a tax supplement of 63.84 million yuan should be paid.

In the following section, we will use this case as a reference to discuss the handling of underground civil air defense parking spaces in the settlement of land value-added tax.

II. Should Defense Shelter Parking Spaces Be Included in the Land Value-Added Tax Settlement Unit? Are They Considered Sellable Real Estate?

In the preceding case, the enterprise included defense shelter parking spaces within the scope of the settlement and counted them as sellable area. Is this legal? This issue should be analyzed in combination with tax policies and regulations governing the ownership of defense shelter parking spaces.

(1) Defense Shelter Parking Spaces Should Be Included in the Land Value-Added Tax Settlement Scope

According to the "Notice of the State Administration of Taxation on Issues Relating to the Management of Land Value-Added Tax Settlement for Real Estate Development Enterprises" (Guoshui Fa [2006] No. 187), Article 1, "Land value-added tax is settled on a project-by-project basis approved by relevant national departments. For projects developed in stages, the settlement is conducted on a stage-by-stage basis." Therefore, the land value-added tax settlement is managed on a project-by-project basis, and the specific settlement unit is determined by the registered project. Due to varying regulations on settlement projects in different regions, some are based on approval by the National Development and Reform Commission, while others are based on engineering planning permits. Regardless, the determination of the land value-added tax settlement unit does not depend on whether the developer owns the property rights. All real estate within the registered project scope belongs to the settlement unit, and defense shelter parking spaces are an integral part of the registered project and a component of the settlement unit.

(2) Defense Shelter Parking Spaces Belong to Non-Sellable Real Estate

According to Article 254 of the Civil Code, "Defense assets belong to the state," and Article 2 of the Law on Civil Air Defense states that "civil air defense is a component of national defense." Thus, defense shelter engineering is an important part of China's national defense construction and belongs to the state.

Article 5 of the Law on Civil Air Defense stipulates that "civil air defense projects shall be used and managed by the investors during peacetime, and the proceeds shall belong to the investors." Article 22 states that "newly constructed civil buildings in cities shall be equipped with basements that can be used for air defense during wartime in accordance with relevant national regulations." Article 48 states that "for newly constructed civil buildings in cities that fail to comply with relevant national regulations and do not construct basements that can be used for air defense during wartime, the competent civil air defense authorities at or above the county level shall give a warning to the parties involved, order them to make corrections within a prescribed time limit, and may impose a fine of not more than 100,000 yuan." Therefore, it is the legal obligation of real estate enterprises to construct defense shelter projects in new projects, and failure to do so will result in administrative penalties. After the completion of defense shelter projects, the ownership belongs to the state, and the developer enjoys the right to use them during non-wartime and receives benefits in accordance with the principle of "whoever invests benefits."

In the present case, since the legislation clearly states that the property rights of defense shelter parking spaces belong to the state, developers cannot obtain property rights and cannot sell them. They only have the right to use them. Therefore, regardless of whether the defense shelter parking spaces are transferred to the government, they are considered non-sellable real estate for developers. It is not legally sound for taxpayers to include the area of defense shelter parking spaces in the sellable construction area. It is legally compliant for tax authorities to exclude defense shelter parking spaces from the sellable construction area.

It should be noted that if, after completion, defense shelter parking spaces are ultimately converted for other uses due to planning adjustments or other reasons, and the developer can obtain property rights certificates, they can be adjusted to be considered sellable real estate and included in the sellable construction area.

III. Should the Income and Costs of Defense Shelter Parking Spaces Be Included in the Land Value-Added Tax Settlement Scope?

As previously analyzed, defense shelter parking spaces belong to the settlement scope. Then, should the income and costs derived from the operation of defense shelter parking spaces be included in the settlement project?

(1) The Rental Income from Defense Shelter Parking Spaces Is Not Subject to Land Value-Added Tax

According to Article 2 of the Provisional Regulations on Land Value-Added Tax, "Units and individuals who transfer state-owned land use rights, above-ground buildings, and affiliated facilities (hereinafter referred to as the transfer of real estate) and obtain income shall be taxpayers of land value-added tax (hereinafter referred to as taxpayers) and shall pay land value-added tax in accordance with these Regulations." Therefore, the tax object of land value-added tax is the act of transferring real estate. The leasing behavior described in the above case is evidently not a real estate transfer, and the rental income received by the taxpayer does not fall under the taxation scope of the land value-added tax. Therefore, it is not included in the income for the settlement of land value-added tax.

An extension of the discussion is necessary regarding the situation where some developers, for the sake of convenience, deliver civil air defense parking spaces to homeowners through the signing of permanent usage rights transfer agreements. The determination of such situations varies among different regions. Most provinces consider the change of ownership registration as the criterion for paid transfers. Even if a consideration is received for the transfer of permanent usage rights, it is not treated as transfer income. However, some places hold the view that the transfer of permanent usage rights should be regarded as a paid transfer of real estate. For example, on January 23, 2021, the official response from the Inner Mongolia Tax Bureau stated: "According to Article 4, Paragraph 3 of the 'Notice of the State Administration of Taxation on Issues Relating to the Management of Land Value-Added Tax Settlement for Real Estate Development Enterprises' (Guo Shui Fa [2006] No. 187), the transfer of permanent usage rights for non-ownership underground parking spaces should be included in the scope of land value-added tax settlement and the income should be calculated." Developers need to carefully pay attention to the tax risks associated with such transactions.

(2) Cost Deduction for Civil Air Defense Parking Spaces Only upon Transfer to the Government

According to Article 4, Paragraph 3 of the "Notice of the State Administration of Taxation on Issues Relating to the Management of Land Value-Added Tax Settlement for Real Estate Development Enterprises" (Guo Shui Fa [2006] No. 187), the following principles apply to the handling of public facilities such as community committee and police station buildings, clubs, parking spaces (garages), property management premises, substations, heating stations, water plants, sports and cultural venues, schools, kindergartens, nurseries, hospitals, and telecommunications facilities developed and constructed by real estate development enterprises in conjunction with the settlement project:

1. If the property rights belong to all the homeowners after completion, their costs and expenses can be deducted.

2. If they are transferred to the government or public utility units for non-profit social public undertakings after completion, their costs and expenses can be deducted.

3. If they are transferred for compensation after completion, the income should be calculated, and the costs and expenses are allowed to be deducted.

In summary, since civil air defense parking spaces belong to the supporting parking facilities (garages) within the project planning, they should be subject to the above policies. Civil air defense parking spaces are owned by the state and are non-saleable real estate. By law, they cannot belong to either the category of being owned by all homeowners or the category of being transferred for compensation after completion. If the civil air defense parking spaces are transferred to the government without compensation and used for non-profit social public undertakings, even if no income is received, their costs and expenses can still be included in the total deductible project amount. If they are not transferred to the government, the costs and expenses are not allowed to be deducted during the settlement. Whether the transfer to the government is made without compensation mainly depends on the documents such as the transfer inventory.

In this case, the taxpayer did not transfer the completed civil air defense parking spaces to the government or use them for non-profit social public undertakings. Therefore, it is not against tax law regulations for the tax authorities to adjust and reduce the cost of the civil air defense parking spaces from the deductible project amount. However, regarding the method of adjusting and reducing the cost of the civil air defense parking spaces, we believe that the tax authorities' simple operation based on the "building area proportion coefficient method" is inappropriate. The specific amount of land cost borne by the civil air defense parking spaces should be determined according to the land transfer contract and related documents regarding land acquisition. If it is clearly stated in the land transfer contract that the civil air defense area does not bear the land transfer fee, or if the underground building area is not included in the project's plot ratio, and the land transfer price is calculated based on the plot ratio area multiplied by the unit price, then the underground civil air defense actually does not bear any land cost. If the land price is calculated based on the total building area, or based on the unit price and respective building area of each property type, the underground civil air defense part should share the land cost according to the building area; if the land price is calculated based on the height coefficient, the underground civil air defense department should confirm the borne land cost according to the proportion of the height. Therefore, the tax authorities in this case should further investigate and verify the confirmation method of the land transfer fee, and cannot simply determine it based on the proportion of the building area.

It should be noted that due to the failure of relevant government departments to strictly enforce the inspection standards for civil air defense projects, they refuse to inspect and accept the civil air defense projects, resulting in the taxpayer being unable to transfer the civil air defense projects. Since the failure to inspect by government departments is not caused by the taxpayer, the taxpayer should not bear the responsibility. In such cases, it is recommended that the taxpayer actively communicate with the tax authorities and request relevant government departments to take the lead in resolving the issue of civil air defense project inspection, striving for appropriate and proper handling of the civil air defense projects, and deducting the costs during the land value-added tax settlement in accordance with the law.

IV. How Are Civil Air Defense Parking Spaces Involved in the Collection of Deduction Items?

According to Article 21 of the "Notice of the State Administration of Taxation on Printing and Distributing the 'Regulations on the Settlement and Management of Land Value-Added Tax'" (Guo Shui Fa [2009] No. 91), "The review of deduction items shall comply with the following requirements: ... (5) For taxpayers developing projects in stages or simultaneously developing multiple projects, or constructing different types of real estate within the same project, a reasonable allocation method shall be adopted to apportion common costs and expenses according to the beneficiaries." In summary, there is no requirement for the aggregation of land costs to select a specific method, but a reasonable method should be chosen based on the principle of beneficiaries.

If the cost of civil air defense parking spaces has already been included in the total amount of deduction items, it is still necessary to further discuss whether and how civil air defense parking spaces participate in the aggregation of deduction items. Some tax authorities believe that the costs incurred for civil air defense parking spaces can be directly attributed to those parking spaces and do not require cost apportionment. We believe that this view does not comply with the principle of beneficiaries. Civil air defense parking spaces benefit the entire sellable construction area of the project. Therefore, according to the principle of beneficiaries, their costs should be apportioned among all types of real estate in the settlement unit.

In this case, if the civil air defense parking spaces have been legally transferred to the government, and the corresponding land costs are included in the deduction item amounts, then a reasonable allocation method such as the sellable construction area method should be used to apportion the land costs corresponding to the civil air defense parking spaces among the ordinary standard residential and other types of real estate in the project, and they should be deducted during the settlement of land value-added tax in accordance with the law.

Conclusion

In summary, the underground civil air defense facilities involved in this case are an integral part of national defense construction and are necessary supporting facilities that real estate enterprises must construct. After completion, they have no ownership but only have usage rights and obtain operating income through rental. In the settlement of land value-added tax, due to the refusal of the government department to accept them, the enterprise has not reasonably planned and disposed of the underground civil air defense facilities, resulting in difficulties in deducting the related costs. In order to reduce tax burden, the enterprise has fully apportioned the land costs to other properties, but this apportionment method lacks factual and legal support, leading to tax-enterprise disputes as described in the case.

Here, we offer the following suggestions to real estate enterprises regarding underground civil air defense parking spaces: (1) Familiarize yourself with relevant policies and management regulations of local civil air defense departments, and advance analysis and prediction based on land value-added tax policies; (2) During the land acquisition process, take into account the cost allocation of public supporting facilities represented by civil air defense, and determine whether it is necessary to clearly stipulate the prices for various beneficiaries in contract clauses; (3) After the completion of the project, advance the arrangement of the disposal of public supporting facilities such as civil air defense to avoid unreasonable cost allocations at the time of settlement; (4) Maintain good communication with tax authorities, protect your own rights and interests in a reasonable, forceful, and measured manner, and seek assistance from professional teams when necessary.