The Principle of Neutrality and the Right to Deduct Input VAT in the Jurisdiction of the European Court of Justice and the Federal Tax Court of Germany

The VAT / GST seminar - Input tax deductibility and neutrality

Justice Dr Friederike Grube* 3 August 2016

*Justice at the Federal Tax Court of Germany

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Topic Overview

  • Introduction
  • First ruling of the ECJ concerning the principle of neutrality: Case Rompelman
  • Further development of the principle of neutrality in connection with the right to deduct Input-VAT:
    Case INZO, Case Ghent Coal, Case Fini H.
  • New Developments :
    Case Polski Trawertyn, Case Malburg, Case Sweda
  • Jurisdiction of the Supreme Tax Court (Bundesfinanzhof)

Introduction

  • Art. 113 of the European Treaty of Lissabon: Harmonization of legislation concerning VAT in the European Union – Principle of unanimity
  • VAT-Directive 1. 01. 2007 (more than 400 articles)
  • Provisions of VAT-Directive have to be implemented in the national VAT-Law of each Member State of the European Union
  • Art. 267 European Treaty of Lissabon: Reference of preliminary rulings to the European Court of Justice (Luxembourg)

Two aspects of the Principle of neutrality in VAT-Law

  • The principle of neutrality in VAT-Law is equivalent to the principle of equal treatment
  • The principle of neutrality is connected with the right of taxable persons to deduct Input-VAT
  • Article 168 of the VAT-Directive rules:
    "In so far as goods and services are used for the purposes of the taxed transactions of a taxable person…is entitled to deduct Input-VAT…"

The right to deduct Input-VAT in a MS of the European Union

Output-VAT/Input-VAT Output-VAT

T----- ------- -------A------- --------Private P

  • Taxable person T has the right to deduct Input-VAT and has to pay VAT for his output-supply
  • Taxable person A has the right to deduct Input-VAT and has to pay VAT for his output-supply
  • Private person P has to pay VAT as a final consumer and has no right to deduct Input-VAT

Judgment of the ECJ 14 February 1985
Case C-263/83 Rompelman

I. Facts of the case

V--->--->-->-- R--->---->----TP

R acquired the future title to 2 units in premises under construction (showrooms)

R intended to let the showrooms to traders

R claimed a refund of Input-VAT before the premises in question had been let

The inspector of taxes rejected the claim because the actual exploitation of the purchases had not yet commenced…

II. Decision of the ECJ

  • The taxable person is allowed do deduct Input-VAT in so far as the goods and services on which the tax was paid are used for his taxed transactions (Art. 17 Sixth Council Directive – now Art. 168 VAT-Directive)
  • According to the principle of neutrality this provision applies without distinction to the VAT paid before or after commencing the output supplies of goods or services
  • R is entitled to deduct Input-VAT
  • MS have the possibilities of imposing certain obligations in order to prevent abuses and to ensure that the deduction is limited to the real costs connected to the business activity

Judgment of the ECJ 29 February 1996
Case C-110/94 INZO

I. Facts of the case

INZO was founded in 1974 to develop processes for the treatment of sea water and turn it into drinking water.

To that end INZO acquired goods and commissioned a study on the profitability of a project for the construction. The study of the project identified numerous problems and some of the investors withdrew. In 1988 the project was abandoned and INZO was put into liquidation.

The tax authority realized that INZO had not carried out any taxable transaction. It therefore claimed repayment of the VAT recovered by INZO between 1978 and 1982. INZO contested that claim.

II. Decision of the ECJ

Although the wording of Art. 168 VAT Directive does not allow the deduction since the Input-VAT could not be connected with any output VAT-taxed supplies the ECJ decided that – according to the principle of neutrality - in a situation such as that of INZO the Input-VAT could be deducted – provided that there was no fraud or abuse by the person or entity exercising the right of deduction….

Judgment of the Financial Court of Berlin
25 April 1996 - I 37/94 -

A taxable person, who had tried to run a restaurant on a ship in Berlin on the river Spree is entitled to deduct Input-VAT although he never carried out any output VAT-taxed supplies of services because he had never obtained the approval to use the ship on the river Spree which was not the fault of the taxable person in question.

Judgment of the ECJ 15 January 1998
Case C-37/95 Ghent Coal Terminal

I. Facts of the case

In 1980 Ghent Coal purchased land in the harbour area of Ghent and carried out investment work and deducted the Input-VAT. On 1 March 1982 Ghent Coal had to exchange the land in question for other land situated elsewhere in the Ghent harbour area. Therefore Ghent Coal never used the land in respect of which it had carried out the investment work giving rise to the deduction. In 1984 the tax authorities sought repayment of the VAT…

II. Decision of the ECJ

Although a literal application of Article 168 of the VAT-Directive would have let to denying Ghent Coal the right to deduct, because the works in question were never used for the purposes of VAT-taxed transactions the ECJ deviated from the literal interpretation of Article 168 of the VAT-Directive and decided that Ghent Coal was entitled to deduct Input-VAT according to the principle of neutrality

Judgment of the ECJ 3 March 2005
Case C-32/03 Fini H.

I. Facts of the case

Fini H. was created in 1989 with the object of running a restaurant. Therefore it leased premises from 20 May 1988. The lease, which was concluded for a term of 10 years, could be terminated only with effect from 30 September 1998. Fini H. closed the restaurant at the end of 1993 and the premises subsequently remained unused. The landlord refused to consent to terminate the lease. Fini H. continued to deduct Input-VAT without declaration of any Output VAT.

II. Decision of the ECJ

Referring again to the principle of neutrality and relying on precedents such as INZO the ECJ held that the principle of neutrality allowed deduction in this case – provided of course that there was no fraud or abuse involved…

New developments: Judgment of the ECJ 1 March 2012
Case C-280/10 Polski Trawertyn

I. Facts of the case

On 26 Dec. 2006 a court official issued an invoice to the partners for the acquisition of immovable property. On 26 Apr. 2007 the partners founded Polski Trawertyn. The same day a notary issued an invoice to the partnership for drawing up a notarial act.

In relation of the first invoice the tax office stated that Polski Trawertyn did not have the right to deduct Input-VAT since she was not the acquirer of the immovable property. As regards the second invoice the tax office denied the right to deduct Input-VAT, because the invoice had been issued before Polski Trawertyn was registered in the companies register – since the registration was effected the 5 June 2007, the invoice of 26 Apr. 2007 was issued to a non-existent entity….

II. Questions referred to the ECJ by the Court of Poland

  • Is an entity, in the persons of future partners, which effects investment expenditure before formal registration of the partnership…, entitled, following registration of the partnership as an entity… to..deduct Input-VAT incurred in connection with investment expenditure which is used for taxable activities carried out within the framework of the partnership?
  • Does an invoice..which was issued to the partners and not to the partnership, preclude…the right to deduct Input-VAT….?

III. Considerations of the ECJ regarding the 1 question

  • The partners themselves are not entitled to deduct the Input-VAT in question because the contribution of the capital goods at issue is an exempt transaction
  • According to the case-law (Rompelmann, INZO) preparatory acts must be treated as constituting economic activity
  • The principle of neutrality requires that the first investment expenditure must be regarded as an economic activity
  • Anyone who carries out such investment transactions must be regarded as a taxable person
  • Accordingly the partners may be considered as taxable persons for.. VAT and in principle entitled to deduct Input-VAT
  • The fact that the contribution of an immovable property to a partnership by its partners is exempted of VAT cannot have the consequence of burdening them with the cost of VAT in the context of their economic activity
  • The Court has held that – in applying the principle of neutrality of VAT, a taxable person whose sole object is to prepare the economic activity of another taxable person and who has not effected any taxable transaction has a right do deduct Input-VAT in relation to taxable transactions carried out by the other taxable person (Faxworld)
  • Since it is not possible for the partners to deduct Input-VAT according to the national VAT-Law the partnership must be entitled to take account of those investment transactions when deducting Input-VAT in order to ensure the principle of neutrality
  • On the other hand the tax authorities would be entitled to demand repayment of the amounts deducted if the right to deduct had been exercised fraudulently or abusively

IV. Answer to the 1 question

 ..Art. 9, 168 and 169 of the VAT-Directive must be interpreted as precluding national legislation wich permits neither partners nor their partnership to exercise the right to deduct Input-VAT on the investment costs incurred by those partners, before the creation and registration of the partnership, for the purposes of and with the view to its economic activity

V. Answer to the 2 question

…Articles 168 and 178a of the VAT-Directive must be interpreted as precluding national legislation under which, in circumstances such as those at issue in the main proceedings, Input-VAT paid cannot be deducted by a partnership when the invoice, drawn up before registration and identification of the partnership for VAT purposes, was issued in the name of the partners of that partnership.

Judgment of the Federal Tax Court
6 September 2007 V R 16/06

  • A partnership is entitled to deduct Input-VAT if it carries out VAT-taxed transactions or has the intention to do so
  • A single partner of a partnership may exercise the right to deduct Input-VAT in relation to the common property of the partnership if he uses this property for economic acitivity or has the intention to do so
  • The single partner of a partnership is not entitled to deduct Input-VAT in relation to the economic activity of a future partnership….
  • Personal remark: This judgment is not in accordance with the judgment of the ECJ Polski Trawertyn…

Judgment of the ECJ 13 March 2014
Case C-204/13, Malburg

I. Facts of the case

Up to 31 December 1994 Mr. Malburg held a 60 % share in the partnership Malburg & Malburg – "old partnership" – while the other 2 partners each held 20 % shares. The old partnership was dissolved on 31 December 1994 with a portion of the client base being transferred to each of the partners. With effect from 1 january 1995 the 2 other partners each operated separately as independent tax advisors.

On 31 December 1994 Mr Malburg founded a new partnership in which he held a 95 % share (the "new partnership"). Mr Malburg made available the client base free of charge to the new partnership for use in its business.

The tax office assessed the old partnership as liable for payment of VAT for 1994 based on the transfer of the client base. The tax due was paid.

The old partnership issued an invoice dated 16 august 2004 and addressed to Mr. Malburg the amount of 1, 5 million € for the division of assets on 31 December 1994 including a separate itemisation for VAT.

Mr Malburg deducted Input-VAT which had been invoiced to him in respect of the acquisition of the client base. The tax authorities refused that VAT deduction.

II. Question referred to the ECJ:

Having regard to the principle of neutrality, must …Article 168 of the VAT-Directive interpreted as meaning that a partner in a partnership of tax advisors who acquires from the partnership a client base for the sole purpose of transfer it directly thereafter and free of charge to a newly founded partnership, in which he is the principal partner, for it to use such client bases in its business, may be entitled to deduct the Input-Tax paid on the acquisition of the client base?

III. Considerations of the ECJ

  • The situation in the case Polski Trawertyn was unique
  • The existence of a direct and immediate link between a particular Input-Transaction and a particular Output-Tansaction or transactions giving rise to entitlement to deduct is in principle necessary before a taxable person is entitled to deduct Input-VAT
  • In the case Polski Trawertyn the output-transaction fell within the scope of VAT, but constituted a transaction exempt from VAT
  • In the case Malburg the provision of the client base for use by the new partnership free of charge does not fall within the scope of VAT, because this cannot be considered as an economic activity
  • Consequently there is not a direct and immediate link between an Input – and Output-transaction
  • Although this immediate link is missing, there might be a right to deduct Input-VAT, where the costs of the services in question are part of the general costs of the taxable person and are, as such, components of the prize of the goods or services he supplies….
  • That might be the case if Mr. Malburg had acquired the client base at issue in the course of his activity as a managing director…but the referring Court had excluded that possibility from his reasoning…
  • The principle of neutrality does not apply to a situation such as that at issue in the case Malburg where the provision of the client base for the use of a partnership free of charge is not a transaction falling within the scope of VAT
  • Moreover the principle of neutrality is not a rule of primary law but a principle of interpretation to be applied concurrently with the principle on which it is a limitation

IV. Answer to the question

..Art. 168 VAT-Directive must be interpreted as meaning that a partner in a partnership of tax advisors who acquires…..a client base for the sole purpose of making that client base available directly and free of charge to a newly founded partnership of tax advisors, in which he is the principal partner, so that that partnership can use that client base in its business, without that client base however becoming part of the capital assets of the newly founded partnership, is not entitled to deduct Input-VAT paid on the acquisition of the client base concerned.

Judgment of the Federal Tax Court
22 August 2014 XI R 26/10

  • It is possible that Mr Malburg had acquired the client base at issue in the course of his activity as a managing direktor of the "new partnership" and that the costs resulting from that acquisition had to be considered as forming part of the general costs relating to his activity as managing director
  • Then Mr Malburg might be entitled to deduct Input-VAT
  • To investigate the relevant facts for this assumption the Federal Tax Court had to give the case back to Financial Court of Saarland….

Judgment of the ECJ 22 October 2015
Case C-126/14, Sveda

I. Facts of the case

Sveda is a for profit legal person whose activities consist in the organisation of trade fair, conferences, leisure activities etc. On 2 March 2012 Sveda concluded an agreement with the National Paying Agency under a Ministry. Under that agreement Sveda undertook to implement the project entitled "Baltic mythology recreational (discovery) path" and to offer the public access to it free of charge. The agency payed a share of up to 90 % of the costs of implementing the project, with the remaining expenses to be covered by Sveda. Sveda deducted the Input-VAT relating to the construction work of the path.

The taxoffice denied the deduction of the Input-VAT….

II. Question referred to the ECJ

Can Article 168 of the VAT-Directive be interpreted as granting a taxable person the right to deduct Input-VAT paid in producing or acquiring non-current assets intended for business purposes, which….are directly intended for use by members of the public free of charge, but may be recognized as a means of attracting visitors to a location where the taxable person, in carrying out his economic activities, plans to supply goods and/or services?

III. Considerations of the ECJ

  • A person who incurs investment expenditure with the intention, confirmed by objective evidence, of engaging in economic activity must be regarded as a taxable person who has the right to deduct Input-VAT
  • Whether a taxable person acts as such for the purposes of an economic activity is a question of fact which must be assessed by the referring court
  • Here the recreational path concerned may be regarded as a means of attracting visitors with a view to providing them with goods and services, such as souvenirs, food and drinks as well as access to attractions etc.
  • Therefore Sveda acquired or produced the goods with the intention of carrying out an economic activity….
  • The finding is not put into question by the circumstance that those goods will have to be made available to the public at no cost, because this will not prevent Sveda from carrying out economic activities
  • The acquisition or production of the capital goods is directly intended for use by the public free of charge but at the same time it is part of the taxable person's objective of carrying out subsequent taxed transactions
  • Furthermore the use of capital goods free of charge does not affect the existence of the direct and immediate link between Input and Output transactions, because the activities of Sveda are not exempt of VAT nor do they fall outside the scope of VAT…

IV. Answer to the question

…A taxable person is entitled to deduct Input VAT… for the purposes of a planned economic activity related to rural and recreational tourism, which are (i) directly intended for use by the public free of charge, and may (ii) enable taxed transactions to be carried out, provided that a direct and immediate link is established between the expenses associated with the Input transactions and Output transactions giving rise to the right to deduct or with the taxable person's economic activity as a whole, which is a matter for the referring court to determine on the basis fo objective evidence.

Judgment of the Federal Tax Court
14 Mai 2008 XI R 60/07

I. The facts of the case

In 1999 the plaintiff built a restaurant and a petrol station on his premises. The restaurant was let – not exempt from VAT – to another taxable person. The same happened to the petrol station.

To get access from the premises to the public roads it was necessary to change the crossing of the streets in a roundabout building. According to a treaty concluded with the Fed. Rep. of Germany the plaintiff was obliged to establish the roundabout circulation on his own costs. The fulfilment of this contract was the condition to get the building permission for the restaurant and the petrol station.

According to the lease-agreement with the operator of the petrol station the plaintiff was obliged to establish the roundabout circulation and should receive a payment of 8, 25 % per year of the building costs besides the houserent.

The taxoffice decided that the plaintiff had a right to deduct Input-VAT but also had to pay VAT for a taxable supply of goods free of charge – the supply of the roundabout circulation to Germany – for business use. The plaintiff lodged a complaint against the decision of the taxoffice. The taxoffice rejected the complaint. The Financial Court decided in favour of the taxoffice.

II. Decision of the Court

The Federal Tax Court decided that the plaintiff had a right to deduct Input-VAT but at the same time had to pay VAT for a supply of goods to the Federal Republic of Germany free of charge for purposes of his business (§ 3 Abs. 1b Satz 1 Nr. 3 UStG; Article 16 of the VAT-Directive).

The Federal Tax Court did not see any problem with "double-taxation" because the plaintiff had the right to deduct Input-VAT…

Judgment of the Federal Court
13 January 2011 V R 12/08

(1) If the taxable person has the intention – right from the start – to use the acquired goods or services not for his economic activity and for supplies free of charge he is not entitled to deduct Input-VAT

(2) Nor is he entitled to deduct Input-VAT if he establishes development measures and has the intention – right from the beginning - to supply these infrastructure works free of charge to a local community for public use

(3) Nor is he entitled to deduct Input-VAT if he supplies the premises including the established development measures not free of charge to a local community for public use, because the supply of land in principle is exempt of VAT in Germany.