Hello, this is Attorney Ki-hyung Bae of Cheongchul Law Firm.

When defects occur in an apartment complex and the residents' council claims damages in lieu of defect repair against the developer or the contractor, one issue is disputed very frequently in practice: whether the 10% value-added tax (VAT) can be included in the damages on top of the pure repair cost calculated through a court-appointed appraisal.

In total defect repair costs that often reach billions of won, the 10% VAT is a key issue that makes a difference of tens of millions to hundreds of millions of won.

Today, I would like to explain clear standards, drawn from Supreme Court precedents and the Value-Added Tax Act, on when damages can be fully recovered including VAT and when VAT is deducted (excluded) from the award.

Whether VAT Is Deducted from Defect Repair Costs – Standards for Taxable and VAT-Exempt Businesses

[Question] When claiming apartment defect repair costs, can we recover the full amount including VAT as damages? I heard the outcome differs depending on whether the project owner is a taxable business or a VAT-exempt business.

[Answer] If the project owner (such as the developer or a reconstruction association) is a 'VAT-exempt business' under the Value-Added Tax Act, or is a 'taxable business' but, due to exceptional circumstances, a deduction or refund of the VAT is practically impossible, damages can be recovered including VAT. Conversely, if the project owner is an ordinary taxable business, the rule is that the VAT amount is reduced (deducted) from the damages.

The Supreme Court's established legal principles and specific criteria on this issue are as follows.

1. Taxable Businesses (VAT Deducted as a Rule)

The Supreme Court holds that where the project owner is a business liable for tax under the Value-Added Tax Act (a taxable business) and the defect repair services are used for its own business, the VAT paid in repairing the defects constitutes input tax that can be deducted from its own output tax or refunded by the state (Supreme Court Decision 2014Da219279, March 24, 2016, among others). In other words, since the VAT is ultimately recovered through tax settlement, it does not actually end up as a burden on the project owner. Adding VAT on top of the damages would give the project owner a double benefit, so in this case the VAT equivalent must be deducted from the damages.

2. VAT-Exempt Businesses (VAT Included)

However, if the project owner is a 'VAT-exempt business', the conclusion changes completely. The Supreme Court holds that the business of constructing and selling national housing-scale apartments with an exclusive residential area of 85㎡ or less is a VAT-exempt business under the Restriction of Special Taxation Act and related laws (Supreme Court Decision 2015Da218570, December 10, 2015). Under Value-Added Tax Act Article 39(1)7 (부가가치세법 제39조 제1항 제7호), a VAT-exempt business cannot deduct from its output tax or obtain a refund of the VAT incurred on the defect repair costs. Since there is no way to recover it, the VAT effectively becomes the project owner's loss (burden), and therefore the VAT equivalent can also be claimed as damages from the contractor (construction company).

3. Exceptional Cases Where a VAT Refund Is 'Practically Impossible' (VAT Included)

Even if the project owner is a taxable business or the apartment complex includes units exceeding the national housing scale, exceptions exist. In its recent Decision 2021Da210195 of August 12, 2021, the Supreme Court drew a clear line, holding that "where a deduction or refund of the VAT has become practically impossible for reasons not attributable to the project owner, the VAT shall not be deducted from the damages in lieu of defect repair." In that case, the reconstruction association had already completed its dissolution registration after the completion approval and had been insolvent for several years. The Supreme Court held that it was practically impossible to expect such an association to newly enter into a defect repair service contract in its own name and obtain a VAT refund, so the VAT should not be deducted but included in the damages even for the units exceeding the national housing scale.

Key Point – Proactively Prove VAT-Exempt Status and the Impossibility of a Refund

When the residents' council (plaintiff) claims defect repair costs from the contractor by subrogation of the developer or the reconstruction association, a well-crafted legal argument is a crucial precondition for fully recovering the substantial VAT, which amounts to 10% of the appraised sum.

The plaintiff should actively establish, with supporting evidence, that the apartment complex consists mainly of national housing-scale units (85㎡ or less) so that the project owner has VAT-exempt status, or that the project owner (such as the association) has already gone through dissolution and liquidation and is effectively unable to obtain an input tax deduction or refund of the VAT.

Conversely, since the contractor (defendant) can significantly lower the damages simply by removing VAT from the repair costs for hundreds of units, its defense strategy should be to show that the project owner, as a taxable business, still has the possibility of obtaining a refund, and thereby secure the 10% VAT deduction.

Whether VAT is included in defect repair costs is an area where complex tax rules such as the Restriction of Special Taxation Act intersect with construction law, and the outcome can vary greatly from case to case, so a concrete legal review is needed from the early stages of litigation.

Based on a deep understanding of large-scale apartment defect disputes and their tax issues, Cheongchul Law Firm provides optimal solutions to prevent unjustified reductions and protect clients' legitimate rights on issues such as VAT, where hundreds of millions of won are at stake. If you are facing difficulties with the calculation of damages in an apartment defect lawsuit, please consult the experts at Cheongchul Law Firm.

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Attorney Ki-hyung Bae has worked at the Defense Installations Agency and in the construction/real estate team of a major law firm, providing legal advice on every stage of government contracts and construction projects, including large-scale construction works, government-contracted construction, defense facility projects, and SOC construction projects, and resolving related litigation. With this extensive experience and expertise, Attorney Bae welcomes inquiries at any time regarding government-contracted construction, private construction, public procurement contracts, state property, local government property, and public property.

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Cheongchul Law Firm is composed exclusively of attorneys from Korea's top five major law firms, the prosecution, and the in-house legal teams of large corporations. Rather than a single attorney, a team of specialists in the relevant field responds to each case. Going beyond resolving specific issues, Cheongchul provides comprehensive solutions for the business as a whole, offering legal consulting focused on ultimately achieving what the client wants. If you need help reaching your goals, please do not hesitate to contact Cheongchul.