Construction-in-Progress in Russia: Legal Regime, Land Rights, Risks, and Taxation

 

May 13, 2022

BRACE Law Firm ©

 

The legal regime governing construction-in-progress (the "CIP") is characterized, on one hand, by the fact that a CIP is a real estate object, and on the other hand, by the necessity to complete the object and the related legal relationships. Although a CIP constitutes real property and, therefore, an asset, this status involves numerous legal issues requiring resolution. These issues relate not only to the need to complete construction but also to risks associated with land relations, particularly when the land plot beneath the CIP was provided under a lease.

Concept and Legal Regime of Construction-in-Progress

Objects classified as construction-in-progress include those: where construction is ongoing; where construction has been suspended, mothballed, or definitively terminated but not decommissioned in accordance with the established procedure; and those in operation for which acceptance certificates have not yet been formalized as required.[1]

Thus, the criteria for a CIP are:

• ongoing construction works on the object;
• the absence of a permit to commission such an object;
• completion of construction to the extent that the law allows the asset to be recognized as construction-in-progress.

When assessing which unfinished construction object qualifies as real estate, it is necessary to determine the percentage of completed works. To recognize a lawfully constructed object as a real thing (construction-in-progress), it must be established that, at a minimum, foundation works or similar activities have been fully completed. Pavement of a land plot that does not meet the criteria for a structure is considered a part of the plot and cannot be recognized as an independent real estate object. [2]

Foundation works that are not completed in the established manner indicate that the construction-in-progress lacks the characteristics of an independent thing, which prevents state registration of ownership rights to such property.

If, during a legal expert appraisal, the registration authority concludes that the construction-in-progress does not exist as an independent real estate object (e.g., foundation works are incomplete), the refusal to register state rights is lawful.

Therefore, to recognize a CIP as real estate, establishing the completion of foundation and similar works is of priority importance. A building foundation is a "load-bearing structure, a part of a building that absorbs all loads from overlying structures and transfers them to the building's base".[3] Furthermore, a foundation is defined as a "structural element of a building recessed below the ground surface, absorbing loads from the building and transferring them to the base".[4]

In one specific case, the court, in qualifying the existence of a CIP, evaluated the completion of foundation works. [5] Based on documents submitted to the case file, including the technical plan of the construction-in-progress, it was established that the disputed object consisted of three piles driven into the ground. The cadastral engineer's report indicated that the CIP comprised three outlines, each representing a circle. The degree of completion was determined at 1% based on the estimate and certificates provided by the customer. Given that the structural elements consisted only of three unconnected piles, the court of first instance recognized this as the initial stage of foundation installation for an apartment building to be constructed. Under such circumstances, this type of work does not constitute a CIP.

As a real estate object, a CIP may be subject to civil law transactions; furthermore, ownership rights to a CIP must be registered in the Unified State Register of Rights to Real Estate.

State cadastral accounting and state registration of rights to construction-in-progress are carried out based on the construction permit for such an object and the title document for the land plot on which the real estate is located. In this regard, an object may be registered as a CIP if it meets the criteria for real estate set forth in Clause 1, Article 130 of the Civil Code (at the current construction stage, the works have resulted in a real estate object on the land plot that is distinct from the plot itself, firmly attached to it, and which cannot be moved without causing disproportionate damage to its purpose).

For example, a landscaped area for which ownership was registered as construction-in-progress may, despite the registration, be recognized as pavement of the land plot based on its specific structural elements (crushed stone, asphalt coating, etc.) and the absence of an inseparable link with the land. In such cases, the area is considered part of the land plot and is not recognized as an independent real estate object. [6]

Given that a CIP is a real estate object, it should be noted that it may be classified as unauthorized construction. The criteria for unauthorized construction are set forth in Article 222 of the Civil Code and include the construction of a real estate object without a construction permit, in violation of building codes and regulations, or on a land plot not belonging to the developer, and/or in violation of the permitted use.

However, if ownership rights to a CIP are registered before a land plot lease agreement is declared invalid, such a CIP will not be considered unauthorized construction.[7]

Pursuant to Article 130 of the Civil Code, the law classifies construction-in-progress as immovable property. Based on Article 222 of the Civil Code, unauthorized construction may include not only residential houses or other structures but also other immovable property. Consequently, construction-in-progress, as immovable property, may also be recognized as unauthorized construction. Ownership rights to a CIP as unauthorized construction may be recognized if the grounds established by Article 222 of the Civil Code are present.[8]

In a specific case, the court, in recognizing rights to a CIP, stated that ownership of an unauthorized structure may be recognized for a developer who owns the land plot under the structure, provided that its construction did not involve material violations of urban planning and building codes and regulations, and that the continued existence of the structure does not pose a threat to the life or health of citizens. The court established the compliance of the disputed CIP with building codes, fire safety requirements, technical regulations, and urban planning rules based on an expert appraisal.[9]

Registration of Rights to Construction-in-Progress

Since the legal regime of a CIP entails several consequences (including, for instance, in the event of its seizure), the registration of ownership rights to a CIP as a real estate object is significant. To formalize rights to a CIP, cadastral accounting is required, which is accompanied by the registration of rights. The documents necessary for registering rights to a CIP include:

• rights to the land plot;
• the technical plan of the CIP;
• the construction permit for the CIP pursuant to Article 40 of Federal Law No. 218-FZ dated July 13, 2015, On State Registration of Real Estate. [10]

The latter document is not required if rights to the CIP are recognized as unauthorized construction (where the absence of a construction permit was the criterion for such a classification).

Land Beneath Construction-in-Progress

If a CIP is erected on a land plot owned by the developer, issues related to land ownership do not cause problems for the owner.

The situation is more complex when a CIP is constructed on a land plot leased from local government authorities or a regional entity.

First, it must be understood that a CIP, including one with registered ownership rights, does not constitute a basis for buying out the land plot on which it is located. Construction-in-progress, including those qualifying as real estate, is not listed in Articles 39.2 and 39.20 of the Land Code alongside buildings and structures as objects for which a land plot may be provided in ownership without an auction. The owner of a CIP may acquire the plot in ownership only after completing construction and commissioning the object.

Second, the presence of a CIP on a land plot may serve as grounds for a one-time extension of the lease agreement without an auction for the purpose of completing construction only in strictly defined cases. Thus, according to Article 39.5 of the Land Code, lease agreements for state or municipal land plots are generally concluded via auctions. Cases for concluding a new lease agreement without an auction upon the expiration of a previous agreement are regulated by Clause 3, Article 39.6 of the Land Code, and the general conditions for exercising the right to conclude a new lease without an auction are set forth in Clause 4, Article 39.6 of the Land Code.

According to Clause 15, Article 39.8 of the Land Code, as of March 1, 2015, a lessee of a state or municipal land plot does not have a preemptive right to conclude a new lease for such a plot for a new term without an auction.

Citizens and legal entities that lease state or municipal land plots have the right to conclude a new lease agreement without an auction if, among other things, the plot was originally provided to them without an auction.

The exercise of the right to conclude a new land plot lease without an auction depends on the presence of the following aggregate conditions:

1. The application for a new lease was submitted by the lessee before the expiration of the previous lease;
2. The exclusive right to acquire such a plot exists in cases provided for by the legislation of the Russian Federation;
3. The previous lease agreement was not terminated on grounds provided for by Article 46 of the Land Code;
4. At the time of concluding the new lease, the grounds provided for the provision of the land plot (the lease of which was concluded without an auction) without an auction are present.

The exhaustive list of grounds for concluding a lease for public land without an auction includes the presence of construction-in-progress on the plot. However, unlike most other grounds, in this case, the plot may be provided only once, only for the purpose of completing the CIP, and only to the owners of said objects.

If a CIP is located on a state or municipal land plot and ownership of said object was registered before March 1, 2015, or such land plot was leased before March 1, 2015, the owner of the object has the right to lease the land plot for a term of three years once to complete construction without an auction. This provision applies if the land plot was not previously provided to any of the previous owners of the specified CIP. Thus, the possibility of a one-time lease extension for completing a CIP depends on when the lease agreement for the land plot was concluded.

If a CIP is located on a state or municipal land plot provided for construction, and the lessee lawfully erected the CIP during the term of the lease based on proper permits, land legislation provides such a person with the right to obtain the plot in lease once to complete the construction of that object. [11]

When a land plot is obtained after March 1, 2015, the owner of a CIP is granted the right to a one-time lease extension without an auction in the following cases:

1. To the owner of a CIP acquired through public auctions following its seizure from the previous owner due to the termination of a state or municipal land plot lease;
2. To the owner of a CIP if the authorized body, within six months of the expiration of the previous land lease, has not filed a court claim for the seizure of the object via public auction, or if the court denied such a claim, or if the object was not sold at public auction due to a lack of bidders.

In one specific case, the court established that a CIP was constructed and registered by the applicant on the disputed land plot based on a corresponding permit. Since the applicant has the right to conclude a state or municipal land plot lease without an auction once to complete construction, and the Administration had not exercised its right to file a court claim for the seizure of the CIP via public auction at the time the application was considered, the courts correctly concluded that the claims should be satisfied. [12]

Furthermore, pursuant to Clause 33, Article 34 of Law No. 171-FZ, it was established that the provisions of Article 239.1 of the Civil Code do not apply if the state or municipal land plot lease was concluded before the effective date of said Federal Law (March 1, 2015). According to these legal norms, Article 239.1 of the Civil Code may apply if the owner of a CIP has already exercised the right to a one-time provision for completion purposes via a lease without an auction after March 1, 2015, as provided by Clause 21, Article 3 of Law No. 137-FZ. Thus, a collective interpretation of these norms allows for the conclusion that current land legislation provides the owner of a CIP — lawfully constructed during the lease term based on proper permits — the right to conclude (prolong) a lease once after March 1, 2015, without an auction for three years, provided that after said date, the land plot was not provided for the completion of that object to any of its previous owners. [13]

Seizure of Construction-in-Progress

Pursuant to Article 239.1 of the Civil Code, in the event of the termination of a lease for a state or municipal land plot provided via auction, objects of construction-in-progress located on such plot may be seized from the owner by court decision and sold via public auction.

The provisions of Article 239.1 of the Civil Code do not apply if the state or municipal land plot lease was concluded before March 1, 2015. [14]

Pursuant to Part 14, Article 1 of Law No. 171-FZ, Clause 3, Article 22 of the Land Code — which previously granted a lessee a preemptive right to conclude a new lease upon expiration — lost its force as of March 1, 2015.

The exhaustive list of grounds for concluding a lease for public land without an auction, established by Clause 2, Article 39.6 of the Land Code, includes the presence of construction-in-progress on the plot. Unlike most other grounds, in this case, the plot may be provided only once, only for the purpose of completing construction, and only to the owners of said objects.

However, if a land plot was previously provided for completion based on Clause 21, Article 3 of Federal Law No. 137-FZ dated October 25, 2001 and Subclause 10, Clause 2, Article 39.6 of the Land Code, the repeated provision of the plot to the owner of a CIP for up to three years may create preferential conditions for business activity and may constitute a violation of antimonopoly legislation. [15]

Upon the expiration of the lease term, the owner of the land plot has the right to sell the CIP at public auction. The procedure for conducting auctions for the sale of a CIP is established by the Government of the Russian Federation. [16] Funds received from the auction of a CIP are deposited into the auction organizer's account and transferred to the former owner of the CIP within ten days after the state registration of the winner's ownership right, minus the costs of preparing and conducting the auction. [17]

A notable conflict arises regarding the sale of a CIP under the seizure procedure when the owner of the CIP is declared bankrupt. In this case, the norms governing the seizure of a CIP are special relative to bankruptcy norms.

Based on the principle of the "unity of the fate" of land plots and the objects firmly attached to them, the legislation of the Russian Federation provides legal mechanisms allowing for the compulsory alienation of construction-in-progress and a special procedure for formalizing land relations related to such objects. This indicates the specific nature of the legal regime for CIPs and the provision of state or municipal land plots.

The fact that the owner of a CIP is in bankruptcy proceedings (liquidation stage) does not prevent the application of the procedure established for the sale of construction-in-progress and does not nullify the effect of special norms. In this regard, the property is seized for sale under the procedure provided by land and civil legislation, which are special in relation to bankruptcy legislation.

Selling the disputed object based on Article 239.1 of the Civil Code may be more beneficial for the debtor's creditors, as the potential provision of the land plot lease to a new owner for completion purposes pursuant to Clause 5, Article 36 of the Land Code indicates the economic value of acquiring such property. This prospect of completion and eventual status as a building is likely to increase the sale price compared to a sale conducted by a bankruptcy trustee under standard bankruptcy rules.

Thus, the CIP must be excluded from the bankruptcy estate and sold through the procedure provided for by Article 239.1 of the Civil Code.[18] It should also be noted that if a CIP is acquired through bankruptcy auctions conducted under bankruptcy legislation, the possibility of extending the land lease (provided it was previously extended for completion) will be precluded.

The situation is similar if a CIP is located on a land plot for which the lease agreement has been extended for an indefinite term. Since, under an indefinite lease, the lessor has an unconditional right to terminate the agreement unilaterally.

Completion of Construction-in-Progress

Although a CIP is a real estate object, its full use is possible only after the completion of construction and its commissioning. To complete a CIP, a valid construction permit or a permit for the reconstruction of the CIP is required.

During state registration of rights upon the commissioning of a CIP for which rights were previously registered in the EGRN, the section of the EGRN related to the CIP is closed. A new section in the EGRN is opened for the real estate object that has been commissioned. [19]

Thus, upon the state registration of rights to a created real estate object resulting from the commissioning of construction-in-progress, ownership rights to that CIP terminate.

Furthermore, upon registration of the developer's ownership of the commissioned object, ownership of the CIP must be terminated, and the CIP must be removed from cadastral accounting. A refusal by the registration authority to terminate ownership of a CIP on the grounds that a demolition certificate was not provided is unlawful. [20]

Additionally, the failure to obtain a permit to commission an object for reasons beyond the developer's control cannot serve as grounds for seizing the object.

Pursuant to Article 39.6 of the Land Code, a state or municipal land plot lease is concluded without an auction once to complete construction for owners of a CIP located on that plot.

This norm corresponds to the restrictions provided for by Article 10 of the Civil Code, which establishes the limits for exercising civil rights, and serves as a guarantee for protecting the rights and legitimate interests of bona fide persons who took appropriate measures but violated construction deadlines through no fault of their own.[21]

In one specific case, the courts established from the documents provided that the object was 100% complete. Construction was finished before the lease expired, but the object was not commissioned in time due to a low-pressure gas pipeline running beneath a part of the building. The defendant planned to move the pipeline at their own expense and had obtained the technical specifications for the relocation. These circumstances indicated the defendant's good faith in attempting to obtain the necessary commissioning documents. As the courts correctly noted, the defining characteristic of construction-in-progress is the fact that construction works are not finished, rather than the mere absence of commissioning documents. [22]

When acquiring a CIP for the purpose of completing construction, a developer must consider that obtaining a permit for the construction (reconstruction) of the CIP requires, among other things, the submission of an urban planning land plot plan (the "GPZU") pursuant to Article 51 of the Urban Planning Code. If significant time has passed since construction began, leading to changes in urban planning regulations, the new GPZU may reveal a discrepancy between the CIP and current regulations, requiring the CIP to be brought into compliance with the GPZU.

The greatest difficulty arises when a CIP is under the joint ownership of several persons. Pursuant to Article 252 of the Civil Code, the possession, use, and disposal of an object owned by several persons are carried out jointly. Under Article 51 of the Urban Planning Code, all owners must apply for a construction or reconstruction permit. This creates significant complications if the owners of the CIP cannot reach an agreement.

Taxation of Construction-in-Progress

1. CIPs are objects of corporate property tax. As of January 1, 2020, pursuant to Article 374 of the Tax Code, immovable property recorded on an organization's balance sheet as fixed assets in accordance with accounting procedures is recognized as an object of corporate property tax.

Accounting Regulation PBU 6/01, On Accounting for Fixed Assets, establishes that an asset is accepted as a fixed asset if the conditions of Clause 4 of PBU 6/01 are simultaneously met — i.e., when the object is intended for use in the organization's activities.

Thus, for real estate objects owned by organizations or held under the right of economic management, recorded on the balance sheet either as fixed assets or other assets, the tax base for corporate property tax is determined pursuant to Clause 2, Article 375 of the Tax Code based on the cadastral value.

According to Article 378.2 of the Tax Code, such objects include:

• residential premises, garages, parking spaces, and construction-in-progress;
• residential buildings, garden houses, and outbuildings or structures located on land plots provided for private subsidiary farming, gardening, or individual housing construction.

Consequently, for residential premises, garages, parking spaces, and construction-in-progress, the tax base is determined as the cadastral value regardless of the land's designated purpose. The list of construction-in-progress objects is open. For objects not specifically named in Article 378.2 of the Tax Code, and in the absence of regional laws expanding the list of objects taxed at cadastral value, the tax base is determined in the general manner as the average annual value of the property (Article 376 of the Tax Code).

Based on the foregoing, construction-in-progress objects are subject to corporate property tax based on their cadastral value.

2. CIPs are objects of individual property tax. Pursuant to Article 400 of the Tax Code, individuals who own property that is an object of taxation are recognized as taxpayers of individual property tax.

Both completed construction objects (e.g., a residential house) and construction-in-progress objects are recognized as taxable objects. Thus, as a general rule, CIPs are subject to taxation from the moment state rights to the property are registered.

3. Construction costs for a CIP cannot be accounted for until it is commissioned. The list of expenses accounted for when determining the tax base under the simplified tax system is established by Clause 1, Article 346.16 of the Tax Code. This list of expenses is exhaustive.

Expenses related to the construction of an unfinished object incurred during both the general tax system and the simplified tax system, in the absence of commissioning, as well as land acquisition expenses, are not included in the aforementioned list.

Therefore, when determining the tax base under the simplified tax system, these expenses are not accounted for. [23]

The tax authorities hold a similar position regarding the reflection of CIP construction expenses under the general tax system for the purpose of reducing the corporate income tax base.

However, an analysis of judicial practice reveals that courts allow for the inclusion of expenses to reduce the income tax base if the object (the CIP) met the criteria for fixed assets and was being operated; in such cases, construction (repair) expenses may be accounted for in the tax base. [24]

_____________________________

References

[1] Methodological Recommendations on Accounting for Investments Carried Out in the Form of Capital Investments in Agricultural Organizations (approved by the Ministry of Agriculture of Russia on October 22, 2008).

[2] Clause 38 of the Resolution of the Plenum of the Supreme Court of the Russian Federation No. 25 dated June 23, 2015, On the Application by Courts of Certain Provisions of Section I of Part One of the Civil Code of the Russian Federation.

[3] Methodological Recommendations on Forming the Scope of Works for the Capital Repair of Apartment Buildings Financed via Funds Provided by Federal Law No. 185-FZ dated July 21, 2007, On the Fund for Assisting the Reformation of the Housing and Utilities Sector (approved by the State Corporation "Fund for Assisting the Reformation of the Housing and Utilities Sector" on February 15, 2013).

[4] STO NOSTROY 2.33.120-2013. Organization Standard. Organization of Construction Production. Capital Repair of Apartment Buildings Without Eviction of Residents. Rules for the Performance of Works. Rules for Acceptance and Control Methods (approved and put into effect by Protocol No. 48 of the Association "National Union of Builders", "NOSTROY", dated November 15, 2013).

[5] Resolution of the Arbitration Court of the Volga-Vyatka District No. F01-4920/2021 dated October 18, 2021 in Case No. A39-8468/2020.

[6] Review of Judicial Practice of the Supreme Court of the Russian Federation No. 1 (2016) (approved by the Presidium of the Supreme Court of the Russian Federation on April 13, 2016).

[7] Ruling of the Supreme Court of the Russian Federation No. 32-KG15-3 dated May 13, 2015.

[8] Clause 30 of the Resolution of the Plenum of the Supreme Court of the Russian Federation No. 10 and the Plenum of the Supreme Arbitration Court of the Russian Federation No. 22 dated April 29, 2010, On Certain Issues Arising in Judicial Practice During the Resolution of Disputes Related to the Protection of Ownership Rights and Other Property Rights.

[9] Resolution of the Arbitration Court of the East Siberian District No. F02-1002/2022 dated April 6, 2022 in Case No. A33-16805/2020.

[10] Federal Law No. 218-FZ dated July 13, 2015, On State Registration of Real Estate.

[11] Ruling of the Supreme Court of the Russian Federation No. 305-ES17-2608 dated June 27, 2017.

[12] Resolution of the Arbitration Court of the Far Eastern District No. F03-2483/2021 dated July 16, 2021 in Case No. A04-8950/2020.

[13] Ruling of the Supreme Court of the Russian Federation No. 308-ES19-25765 dated April 16, 2020.

[14] Federal Law No. 171-FZ dated June 23, 2014, On Amending the Land Code of the Russian Federation and Certain Legislative Acts of the Russian Federation.

[1] Clarification of FAS Russia, On the Procedure for Leasing a Land Plot Burdened with Construction-in-Progress.

[16] Decree of the Government of the Russian Federation No. 1299 dated December 3, 2014, On Approval of the Rules for Conducting Public Auctions for the Sale of Construction-in-Progress.

[17] Clause 21 of Decree No. 1299.

[18] Resolution of the Arbitration Court of the West Siberian District No. F04-7376/2019 dated March 18, 2022 in Case No. A75-17376/2018.

[19] Methodological Recommendations on the Procedure for State Registration of Rights to Created, Reconstructed Real Estate Objects, approved by Order of Rosregistratsiya No. 113 dated June 8, 2007.

[20] Resolution of the Arbitration Court of the Moscow District No. F05-16698/2021 dated July 15, 2021.

[21] Ruling of the Supreme Court of the Russian Federation No. 304-ES20-19559 dated December 21, 2020.

[22] Resolution of the Arbitration Court of the Volga-Vyatka District No. F01-2276/2021 dated June 23, 2021 in Case No. A82-20341/2019.

[23] Letter of the Ministry of Finance of Russia No. 03-11-06/2/2841 dated January 21, 2020.

[24] Resolution of the Federal Arbitration Court of the Urals District No. F09-2432/13 dated April 22, 2013 in Case No. A07-15094/2012.