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CJEU rules against Luxembourg’s 70% threshold

On 4 May 2017, the Court of Justice of the European Union (“CJEU”) has ruled that the Luxembourg implementation of the cost sharing exemption (“CSE”) was incorrect, as it permitted the CSE to apply the exemption to services relating to members’ taxable and exempt activities.

8 May 2017

Dutch version

Cost sharing exemption

Based on the VAT Directive the EU Member States are obliged to implement the CSE, subject to certain conditions. The CSE exempts services from a designated provider to its members, which must be taxpayers with exempt and/or non-business activities. These services must be directly necessary for each member’s exempt/non-business activities and must also be delivered at cost under the exact reimbursement criterion, provided that the application of the CSE does not cause distortion of competition.

The Commission/Luxembourg case is one of four current cases concerning the scope of the CSE. The other cases are Aviva (C-605/15), DNB Banka (C-326/15), and Commission/Germany (C-616/15), and between all four, the CJEU will rule on all of the key tests concerning the application of the CSE. This is the first judgment to be published by the CJEU, following the Advocate Generals’ Opinions being published for all four.

The Commission/Luxembourg case

The Commission/Luxembourg case concerns infraction proceedings brought against Luxembourg’s implementation of the CSE. In particular, it considers how Luxembourg implemented the “directly necessary” test, which states that the supplies from an independent group of persons (“IGP”) to its members are exempt only where they are directly necessary for the members’ own exempt or non-taxable activities.

The Commission considered that Luxembourg’s implementation was too wide. Luxembourg accepted that members with at least 70% exempt or non-taxable turnover should automatically be treated as if they were services from the IGP were directly necessary for their exempt activity.

The case also addresses some matters regarding VAT recovery on costs of the IGP, and the VAT liability of contributions by the members.

Details of the judgment

The CJEU has found that Luxembourg incorrectly transposed the VAT Directive into domestic law by permitting taxpayers with up to 30% taxable activity automatically to receive exempt services from an IGP.

Luxembourg argued that the CSE should not be reserved to members exclusively carrying out activities which are exempt or not subject to VAT. This was accepted by the CJEU, but only to an extent. An IGP can apply the exemption to services to a member who only carries out limited exempt activities, provided that the services relate specifically to those activities. However, the CJEU considered that there was no justification for applying a general 70% threshold.

The CJEU suggests that the “directly necessary” test can be satisfied if the IGP can identify which services relate only to members’ non-taxable activities, and which are more general or relate to taxable activities. However, in many instances there may be significant challenges in isolating part of an IGP’s services in this way.

The CJEU also confirms that the IGP is independent of its members. Therefore, members of a cost-sharing group are not entitled to deduct VAT on goods or services which are provided to the IGP – the PPG case does not affect this conclusion. Furthermore, any supplies between a member and the IGP are within the scope of VAT.


Practical consequences

It is clear that the CJEU is interpreting the “directly necessary” test of the CSE strictly, such that the exemption can only apply on supplies from an IGP to its members where it can be demonstrated that those services do not relate to any taxable activities.

Aside from the direct implications for Luxembourg, a number of other Member States have adopted a similar approach to applying the “directly necessary” test, which are likely to be impacted.

For example, in the Netherlands, the Dutch Tax Authorities announced a widening of the CSE in February 2016. In response to MP questions on municipal mergers, it was stated that the CSE applies to services of merged organizations that are mainly (for more than 70%) used for non-taxable government activities or exempt activities of the participating municipalities. Possibly, the widening of the CSE was not limited to municipal mergers but also in other situations.

It appears likely that as a result of the judgment the application of the CSE will narrow in the Netherlands and rest of the EU such that it will only apply to services supplied by an IGP which are directly attributable to its members’ exempt or non-taxable activities.

Next steps for the CSE

It is apparent that a number of Member States will need to take action to move in line with the judgment in the Commission/Luxembourg case.

However, there are still three more cases for the CJEU to provide its judgment on regarding cost sharing – Aviva, DNB Banka, and Commission/Germany. Judgments are expected in these three cases later this year and, as such, there may be a number of further developments on how the CSE applies.

These cases will address a number of points:

  • whether IGPs and their members can be in different jurisdictions within, or potentially outside, the EU; 
  • whether the underlying exempt activities of a cost sharing group must be restricted to an Article 132 “public interest”
    exemptions (or even more narrowly to healthcare); 
  • whether transfer pricing mark ups create a profit that breaches the “exact reimbursement” test; and 
  • what legal form the IGP can take.

The dates for the judgments in these cases have not yet been announced.

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