On 12 January 2017, the Court of Justice of the European Union (CJEU) ruled that the VAT deductions on procured services by a holding company may be limited if such a holding company does not charge its subsidiaries for those services or for any management services. Below, we analyze the CJEU's ruling (MVM, C-28/16) and the impact it may have on your business.
MVM Magyar Villamos Művek Zrt. (MVM) is a Hungarian State-owned commercial company active in the energy sector. Its activities include (i) leasing power plants and fibre optic networks and (ii) holding a number of companies that mainly generate or sell electricity and (iii) procuring legal, business-management and public-relations services for itself and its subsidiaries (both on an individual level as well as for the MVM group as a whole).
MVM deducted the VAT relating to all the procured services regardless of whether those services were in the interests of the MVM group or related directly to the (taxable) activities of its subsidiaries. Furthermore, nearly all procured services were not recharged to its subsidiaries, nor did MVM impose a general charge on the MVM group for its strategic management. As such, MVM's procurement activity was carried out free of charge. It should be noted that neither MVM nor its subsidiaries were included in a VAT group. MVM's activities, other than its holding of the shares in its subsidiaries, was fully taxable for VAT.
The Hungarian tax authorities (HTA) refused VAT deduction on the services that MVM procured in the interests of its subsidiaries and the services relating to the acquisition of shareholdings. The HTA argued that VAT on the procured services could be deducted only to the extent to which MVM had used them for taxable activities.
MVM, on the other hand, claimed that the services in question constituted general expenses related to its taxable activity (leasing) since it was a taxable person for the purpose of VAT and did not carry out any activities which were exempt from tax. MVM claimed that the fact that it did not charge its subsidiaries did not affect its right to deduct VAT due to its taxable activities.
The Hungarian Supreme Court referred to the CJEU to decide whether a holding company that actively manages its subsidiaries (ie an 'active holding') but that does not charge its subsidiaries for the costs relating to its management services, may be regarded as a VAT taxable person in respect of those services.
Additionally, the Supreme Court questioned whether such an active holding has the right to deduct VAT on services it procured that are directly related to taxable activities of its subsidiaries or to the group of companies as a whole. In this regard, the Supreme Court inquired whether such a right to VAT deduction is impacted in any way if the active holding company charges its subsidiaries for its procured services.
The CJEU began by restating the general rule for input VAT recovery requiring a direct and immediate link between input transactions with (taxable) output transactions in order to have a right of deduction. The CJEU has ruled in several cases that the mere acquisition and holding of shares in a company is not to be regarded as an economic activity. However, this is different when a holding company is directly (or indirectly) involved in the management of its subsidiary/subsidiaries, without prejudice to the rights held by the holding company in its capacity as a shareholder. Such a holding is considered a taxable activity when it involves carrying out transactions which are subject to VAT, such as the supply by a holding company to its subsidiaries of administrative, financial, commercial and technical services. Since MVM did not normally provide management services for consideration, the CJEU found that said services could not be regarded as an economic activity and could not therefore be considered for VAT deduction.
Next, the CJEU explored whether the services in question may be regarded as general costs and have a direct and immediate link to MVM's economic activity as a whole. The CJEU found that the leasing of power plants and fibre optic networks did not appear to have any such link. However, given that this is a factual matter, the CJEU instructed the referring Hungarian court to determine whether the CJEU's assertion was correct. The Hungarian court was also asked to determine what the proper calculation of the proportion of economic activities to non-economic activities (the so-called pre pro rata) should be . It should be noted that member states can use their own discretion on how such calculations are to be made, provided they ensure that such calculations properly reflect the proportion of the input expenditure actually to be attributed to each type of activity.
As a further argument, MVM argued before the CJEU that the services in question served the interests of the group and that, since its subsidiaries engaged in activities conferring a right to deduct, those services have a link to the economic activities of the entire group. This argument was (also) dismissed by the CJEU, as VAT deduction was limited as a result of MVM's decision not to charge its subsidiaries for its management services. In other words: the principle of fiscal neutrality does not mean that a taxable person with a choice between two transactions may choose one of them and benefit from the other.
The CJEU judgment is clear: VAT deduction on procured services by a holding company for the interest of its subsidiaries is limited if such a holding company does not charge its subsidiaries for said services or for any management, administration or other services.
What can we learn from MVM?
First and foremost: for VAT, consideration is a key element. Ideally, MVM should have charged its subsidiaries for the procured services and management services rendered. For corporate income tax purposes, these charges should be at arm's length. For VAT purposes, this is still up for debate, provided (i) the services are actually used by the (second) recipient and (ii) the consideration is not of a nominal amount.
Secondly, neither MVM, nor its subsidiaries were included in a VAT group. Any intracompany transaction within a VAT group is outside the scope of VAT and thereby essentially renders the 'problem' of the remuneration obsolete (note though that intracompany transactions may be required in order to create and maintain a VAT group).
Following the case discussed above, active holding companies should reconsider the VAT implications of their activities and their overall VAT position. Depending on the circumstances at hand, various options may be available to enhance the VAT position of holding companies. DLA Piper would be pleased to assist.