Court of Justice of the European Union

C-374/19: ECJ on the adjustment of input tax for the unsuccessful business if some of the tax-exempt output supplies are continued.

In the Court’s judgment in HF C-374/19, the taxpayer operated a retirement home and constructed a cafeteria in an annex to the home. The cafeteria was accessible to visitors through an outside entrance and to residents of the retirement home via the home’s dining room. Initially, the taxpayer said that it would use the cafeteria exclusively for taxable transactions since it was intended for use solely by external visitors.

The German tax authority, in an audit, took the view that it was unlikely that absolutely no residents at all would visit and use the cafeteria with their visitors and the parties agreed to assume tax-exempt use of the cafeteria at 10%, leading to an adjustment under the capital goods scheme. Following a later audit, the tax authority sought to make a second adjustment having discovered that the cafeteria was not, by then, used at all by external visitors (i.e. there were no taxable supplies). In more detail, the cafeteria operated from 2003 to 2008 with both taxable and exempt sales but taxable sales ceased to exist during the following period from 2009 to 2012 while the tax-exempt sales (i.e. 10% use by the home residents) apparently continued. The taxpayer resisted the second adjustment on the grounds that the cafeteria was not being used simply because it was a bad investment and there was no increase in use by the residents of the home.

The German court asked the ECJ whether the fact of the cafeteria being economically unviable, with the result that only residents of the home used the cafeteria, amounted to a change in circumstance giving rise to a input tax adjustment (either under the capital goods scheme or under the rules for changes in the factors used to determine input tax deduction).

The Court distinguished its case-law in Imofloresmira – Investimentos Imobiliarios (C-672/16) where it had ruled that input tax was deductible in full where the taxpayer, having opted to tax on two properties, was unable to let them despite an intensive marketing campaign. In that type of case, pointed out the Court, no transactions took place at all and the link with the proposed taxable transactions was maintained until the business fully ceased to carried out. In the case at hand, however, the cafeteria did not remain empty but was used (in the later years) exclusively for exempt business. The ‘close and direct’ relationship between the right to deduct input VAT incurred on construction costs and the taxable supplies made at an earlier stage was broken. An input tax adjustment should therefore be made under article 185, notwithstanding that it resulted from circumstances beyond the taxpayer’s control.

DLA Piper comment: The ruling is of relevance for unsuccessful expenses in relation to “hybrid” (taxable and tax-exempt) output supplies. It is the Court’s remark in respect to its previous case law that needs to be put at centre stage: The facts of the main proceedings differ from the facts of the ECJ's case law. In this previous case, the relevant expenses had been incurred for the purpose of executing taxable sales, but these were not actually realized, so that no sales were made at all. In the current case, some tax-exempt supplies have continued. Under these circumstances, there would be a requirement to adjust the input tax deduction. According to the ECJ, the case would only be assessed differently if the applicant had found other taxable uses for the premises giving rise to a right of deduction. Not explicitly being said by the ECJ, but what must be understood from the Court’s reference to the Iberdrola Inmobiliaria case, also no input tax adjustment would have been justified where all use of the cafeteria would have seized.

At first glance, the result seems strange. Those who do not generate any sales at all retain the input tax deduction, but those who continue to generate partial exempt sales must correct the input tax deduction. The result may become understandable if one considers the meaning and purpose of the capital goods scheme. Without, there might be an incentive to acquire capital goods with a declared intention of using them for taxable output supplies and to put them to exempt use shortly afterwards. The capital goods scheme prevents this. The vacancy of a property is not a desirable use so that no provision needs to be made to prevent the unauthorized use of the input tax deduction. Therefore, the deduction of input tax will remain in place. However, if a property which is no longer taxable is used by the tax-exempt business of the taxable person, this must lead to an input tax adjustment, as otherwise the input tax deduction for a tax-free use planned from the outset could be achieved in this way.

Hence, in case of unsuccessful expenses in relation to hybrid (taxable and tax-exempt) output supplies the taxpayer should carefully consider the input VAT cost for a partial continuation of the business with tax-exempt supplies.

C-528/19: Recovery of input tax on the cost of construction works in the public space borne by a private company

In its judgment in Mitteldeutsche Hartstein-Industrie AG (C-528/19) the ECJ has followed the approach taken in the case of Iberdrola Inmobiliaria Real Estate Investments (C‑132/16).

The taxpayer was authorised by a Regional Council to operate a limestone quarry on condition that the taxpayer extend an access road (owned by a municipal authority) to the quarry. The authorisation to operate the quarry was to expire if the extension of the road was not completed by a particular date.

The taxpayer and the municipal authority entered into an agreement relating to the works to extend the access road in so far as that extension was necessary to work the quarry. Under the agreement, the municipal authority undertook to make the road available to the taxpayer for the operation of the quarry so long as the road remained open to the public. The taxpayer agreed to bear all of the costs relating to the works. Following completion of the works, the new section of road was used by the taxpayer’s lorries, as well as by members of the public.

The Court was asked by the German referring court whether the taxpayer was entitled to recover input tax on the costs relating to the works to extend the access road. The Court was also asked whether there was a supply of goods by the taxpayer in the form of the supply of the road works in return for authorisation to operate the quarry and, if not, whether there was a deemed supply of goods.

The Court noted that a right to recover input tax exists where there is direct and immediate link between a particular input transaction and a particular output transaction, or, if there is no such direct and immediate link, where the relevant costs are part of a taxpayer’s general costs and are, therefore, components of the price of goods or services which it supplies (since such costs thereby have a direct and immediate link with the taxable person’s economic activity as a whole). In either case, whether there is a direct and immediate link will depend on whether the cost of the input services is incorporated either in the cost of particular output transactions or in the cost of goods or services supplied by the taxable person as part of its economic activities.

In this case, it was clear to the Court that without the works for the extension of the access road, it would have been impossible for the taxpayer to operate the limestone quarry, from both a practical and legal point of view; the extension of the road was required to adapt it to the heavy goods traffic generated by the operation of the quarry and the taxpayer’s authorisation to operate the quarry would have expired had the works not been carried out within the specified time limit.

The fact that the public could also use the extended access road did not mean that the direct and immediate link with the taxpayer’s economic activities was severed and the taxpayer was therefore allowed to recover the input tax on its costs so long as, or to the extent that, those costs were incurred on works objectively necessary to allow the taxpayer to operate the carry.

The ECJ said that the grant of permission to work the quarry in return for the road works did not amount to a supply of goods by the taxpayer in the form of an improved road. This was because the authorisation to work the quarry came from one public body whereas the access road belonged to another and because a unilateral act by a public authority cannot, in principle, impose a legal relationship entailing reciprocal performance; the works were not consideration for the right to operate that quarry but a condition for the exercise of that right.

Finally, the Court rejected the suggestion that there could be a deemed supply. In order to assess this question, the use of the road on the part of the municipality and the associated free opening to public access should not be taken into account. The decisive factor is the use of the road by the taxable person which, however, does not lead to an untaxed final consumption.

DLA Piper comment: The ruling has immediate importance for the recovery of input tax on the cost borne by a private company for construction works in the public space (such as for development measures). For example, in Germany, if building contractors are obliged to construct development facilities and to provide these to a municipality free of charge, the building contractor has been regularly denied the right to deduct input tax. However, as of now, for the VAT assessment of the cost of development measures by taxable persons, the taxation of the actual "final" output transaction should now be the decisive factor (i.e. decisiveness of the actual "final consumption" of the costs). If costs for received construction works have a direct and immediate connection with the economic activity of a taxable person leading to taxable output transactions, those costs which are connected with the construction works can be considered as already included in the output supplies subject to VAT. This means that the transfer to public ownership has no value added tax significance and a fictitious supply is deprived of its basis.

Given that in the relevant industry sector often the volumes of input tax incurred on construction works are significant, the importance of the ruling appears obvious.

C-312/19: Qualification as taxable person for VAT in the case of a (dormant or internal) partnership without legal personality: Partnership or partner?

In XT (C-312/19), the Court was required to examine in detail who the taxable person was where a silent partnership was involved. The taxpayer XT, an individual, entered into an ‘silent’ agreement with another individual for the construction of several buildings. The taxpayer contributed 30% of the funding and his partner contributed the remaining 70%. However, it was only the taxpayer who dealt with third parties while the ‘silent’ partner discussed project decisions with him and enjoyed his share of the profits of the projects.

After the sale of one of the buildings, the partners terminated their joint venture and agreed how future proceeds of sale of the remaining pieces of land would be split between them. The taxpayer sold the remaining pieces of land at various times following the termination of the joint venture. The issue was whether the individual taxpayer or the partnership was liable to account for the output tax on the sales.

Referring back to the Advocate General’s opinion, the Court noted that the question before it affected not just which party was liable to account for output VAT but also whether the recipient of each supply could recover its input tax since this is dependent on holding an invoice from the correct party.

The Court went on to agree with the Advocate General that the significant factors in this case were that the plot of land was purchased by XT alone, in his own name. XT also applied for and obtained the construction permit as well as concluding the property development agreement in his name alone. Further, XT’s name was entered in the land register as sole owner and XT concluded all of the contracts of sale in his name both before and after the decision to terminate the partnership. Although the partnership agreement permitted XT to deal with third parties on behalf of both partners, XT did not make third parties aware of the existence of the silent partnership.

It was therefore clear to the Court that the activities carried out by XT could not be said to be by or for the partnership even though the ‘silent’ partner provided significant finance for the purchase of the land, was entitled by the dissolution agreement to a share of the assets of the partnership and had taken part in the decisions to buy the land and to pursue a building contract. The Court pointed out that even where a person is acting on behalf of another, he or she can still be a taxable person, such as when he or she is a commission agent. (The VAT concept of a commission agent creates a fiction under which the first person is deemed to have received the supply herself.) XT therefore had to be regarded as the taxable person whether he was acting on his own behalf or on behalf of another person and must therefore be solely liable to account for output tax.

DLA Piper comment: The previous decisions of the ECJ did not concern the case in which another person participated in the background (i.e. quietly) in an activity that another person carried out alone in his own name. Only the question of (proportional) input tax deduction by a co-owner's partnership by means of an invoice addressed to both co-owners has already occupied the Court. In this respect, the case offered the opportunity to further develop the fundamental issue of the determination of the taxable person in the event that third parties are also involved in his activities. The decision, however, should not come as a surprise. Mere internal partnerships, e.g. a silent partnership, which do not appear externally as a majority of persons in their own name, are not taxable persons according to the predominant opinion, but (as a company) irrelevant for VAT purposes because they lack entrepreneurial status due to their lack of external appearance (see also ECJ of 12 October 2016, Case C-340/15 - Nigi, para. 26). The performing taxable person (legal entity for VAT purposes) is not the internal partnership as such, but the person participating in it, in whose name the transactions are carried out. Another question is, of course, whether the partners are in an exchange of services with each other, which must be examined in each individual case.