Use of services acquired by holding company linked to VAT exempt operating subsidiaries limits input VAT recovery

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Use of services acquired by holding company linked to VAT exempt operating subsidiaries limits input VAT recovery

On September 8, 2022, in the Finanzamt R/W GmbH case, the Court of Justice of the European Union (“CJEU”) denied the right to deduct VAT on costs incurred by an active holding company for services that were contributed to its subsidiaries.

12 September 2022

The CJEU ruled that the services did not have a direct link with the holdings own economic activity and hence, the criteria for VAT deduction are not fulfilled.

The CJEU did not answer the question referred by the German court whether the structuring of the cost on-charge as a contribution in kind constituted abuse of law.

Background

In the Finanzamt R/W GmbH case (C-98/21), the applicant (W GmbH) holds the shares in two subsidiaries to which the company performs management and accounting services against remuneration. Next to these services, W GmbH has agreed to render architectural, engineering and construction services via a contribution in kind in both subsidiaries. The subsidiaries perform largely VAT exempt business activities.

W GmbH has deducted all input VAT on the costs incurred for the contributed services. Deduction has been refused by the German Tax Authorities. The German Tax Authorities argue that the contributed services were not used by W GmbH to obtain an income on a continuous basis nor had a direct link to the other business activities of W GmbH (i.e., the management and accounting services). Hence, the costs would relate to a non-economic activity which does allow VAT deduction.

W GmbH argues that the subsidiaries can only operate their business as a consequence of the contribution of W GmbH and therefore, the costs are part of the ‘general costs’ of the company.

The referring court has requested the CJEU to clarify whether VAT is deductible, even though the services do not directly and immediately relate to the operation of the active holding company (W GmbH), but merely relate to the VAT exempt activities of its subsidiaries. If yes, the referring court requested to clarify whether the structuring of W GmbH as an ‘intermediary’ for the contributed services (which would be irrecoverable if incurred by the subsidiaries itself) gives rise to abuse of law.

Decision of the Court of Justice

The CJEU starts its decision by indicating that W GmbH qualifies as a taxable person for VAT purposes as the acquisition and holding of shares is accompanied by the active involvement in the management of its subsidiaries. As a consequence, W GmbH qualifies as a ‘mixed’ holding company in view of the CJEU and has access to the right to deduct VAT on costs.

For W GmbH to be able to actually deduct the VAT incurred, however, the costs at hand should either (i) directly relate to its economic activities performed at a later stage, or (ii) form part of the ‘general costs’ of the holding company, the latter of which means that the costs are a component in the price of the goods or services supplied by W GmbH.

Regarding the costs incurred for the contribution in kind in the subsidiaries, the CJEU rules that W GmbH is not entitled to deduct VAT. The CJEU reasons that the underlying services do not directly and immediately relate to the economic activities performed by W GmbH, as the services are not used to perform the management and accounting services at a later stage. Moreover, the CJEU indicates that the costs do not qualify as ‘general costs’ since the costs relate to W’s contribution as a shareholder in its subsidiaries. Therefore, the costs were not necessarily incurred to acquire the shares in the subsidiaries, but rather constitute the object of contribution. As this capital contribution (whether in cash or in kind) does not qualify as an economic activity, there is no entitlement to VAT recovery. In view of the CJEU, this is confirmed by the Court’s observation that the costs were actually used for the activities of the subsidiaries and therefore directly relate to these activities only.

As the CJEU took the position that there is no right to deduct VAT in this scenario, the question on abuse of law is left unanswered.

Practical impact

Unfortunately the CJEU did not touch upon what was arguably an interesting part of the earlier opinion of AG Pitruzella: the AG argued that the contribution in kind by the holding company to its subsidiaries performing largely VAT exempt activities should be qualified as abuse of law.

The judgement is a valuable addition to the series of case law on holding companies and (particularly) the passing on of costs incurred by these companies to its subsidiaries in liquidity events (e.g., acquisitions, bolt-on acquisitions, sales of shares and refinancing activities). The case shows that the on-passing of costs by an active holding company via a contribution in kind does not automatically mean that the holding company has the right to recover VAT on those costs. Moreover, it highlights the importance to determine which party qualifies as the recipient of the services supplied and showcases the effect which an inadequate appliance could have to the right to recovery of VAT.

In our view, the case emphasizes the urgency to consider the VAT consequences that may be associated with the set-up of cost on-passing in liquidity events at an early stage.

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