A recent European Court of Justice (ECJ) case could potentially constitute another important milestone in the jurisprudence of the ECJ regarding the transfer of a going concern, which is outside the scope of value-added tax (VAT). At the same time, it serves to put an end to a VAT evasion scheme used in Romania.
A company purchased services carried out on a building in which it operated a restaurant. It deducted the input VAT from those services. Some time later, the company concluded a lease contract with another entrepreneur, according to which it leased out the building and other capital equipment, including the equipment needed to operate the restaurant.
The lessee continued operating the restaurant, retained the restaurant’s name and its original suppliers. The parties considered the lease as being exempt from VAT.
Normally this situation should have triggered a revision of the input VAT previously claimed, but the lessor refrained from doing so. Once this was detected, it led to the criminal prosecution of the couple operating the company.
In their defense, they claimed that the leasing contract was not exempt from VAT but rather constituted a transfer of a going concern, which was outside the scope of VAT. Apparently, under Romanian law, this would have meant no revision of input VAT previously claimed was required.
The Romanian court asked the ECJ, in a preliminary ruling, whether a transaction, by which a building used for commercial purposes is let with its entire capital equipment and inventory, could be considered as a transfer of a going concern outside the scope of VAT.
Further, the Romanian court (the “court”) also wanted to know, if this were to be denied, whether the leasing contract was indeed exempt from VAT.
The purpose of keeping a transfer of a going concern outside the scope of VAT is to avoid difficulties that would entail taxing the sale of an entire business.
Determining the correct tax base for each individual asset, the correct place of supply, as well as the correct VAT debtor and VAT rate can be, at the very least, burdensome or sometimes even impossible. It can also mean a significant, albeit temporary, cash out for the parties if the acquirer is entitled to a full refund of input VAT.
Hence, EU member states have the option of treating these supplies as being outside the scope of VAT (Articles 19 and 29 of the VAT Directive). While Articles 19 and 29 of the VAT Directive are optional, most member states have chosen to keep transactions, where an active business is transferred and carried on by the acquirer, outside the scope of VAT.
The court provided its conclusions on both questions in the absence of an opinion from the Advocate General.
On the question of whether the transaction at hand constituted a transfer of a going concern, the court recalled its two landmark cases dealing with Articles 19 and 29 of the VAT Directive.
The Zita Modes case was the first landmark decision of the court around the question of a number of transactions that would normally each trigger VAT but which were deemed to be outside the scope of VAT altogether as a transfer of a going concern.
In the Zita Modes case, the court stated that the sale of all business assets is outside the scope of VAT even if the acquirer had not initially had the necessary permissions to carry on the business.
The next step in the evolution was the Schriever case.
In this case the court had to decide whether a transfer of a going concern is also given if some business assets are transferred, and other assets, that were needed to carry on the business, were only leased to the recipient.
Schriever had sold its business with almost all of the assets but had kept the business premises for which it had concluded a rental contract with the acquirer of the business assets.
The court concluded that even though not all assets were ultimately sold, there was enough continuity to consider such a transaction as being a transfer of a going concern where an economic activity does not require the use of particular premises.
The case at hand had the potential to take this jurisprudence a step further. A building in which a restaurant operated was leased out. In addition to the premises, the capital equipment needed to run the restaurant was also leased. The restaurant continued to be operated under the same name by the lessee.
Moreover, the lessee employed the same staff, kept the same suppliers and clearly had no intention of liquidating the business but rather intended to carry it on.
In addition, the lessor apparently also sold some inventory to the lessee but that appeared to be nothing of significant value or importance. The vast majority of assets needed to operate the business were merely let. In other words, the previous business was, more or less, continued. This would make it quite plausible to consider the transaction as constituting a transfer of a going concern.
The court, however, was rightly not convinced and ruled against an out of scope transaction. The lessee never obtained a position that would have allowed it to exercise full discretion over all assets. Simply put, the rights obtained as a lessee are inferior to those of ownership rights and are not sufficient to provide the acquirer with the necessary power to change the nature of the business, such as liquidating the business.
In my view, the solution of the court is exactly right on this question. Were it otherwise, we would be presented with the situation where any lease that consisted of more than just bare land or bare equipment would have to be considered as being a transfer of a going concern. This would overstretch the concept of the transfer of a going concern.
Admittedly, in this specific case, a totality of assets was leased but this did not serve to put the counterparty in a sufficient position to qualify the transaction as an out of scope transfer of a going concern.
What the court is essentially stating is that, without the transfer of the right to dispose (similar to transferring the ownership) of those items considered essential to carry on a business, a transfer of a going concern does not take place. It is interesting to note that the court also states that, in order to qualify a transaction as a transfer of a totality of assets, it is irrelevant whether the acquirer continues the operation under the same name.
As the ECJ decided that no transfer of a going concern was given, it was then required to deal with the second question.
Based on Article 135 (1) (l) of the VAT Directive the letting of immovable property is generally exempt from VAT. Initially, the parties had treated the leasing of the restaurant premises as being exempt.
As the transaction involved more than just the letting of property, the court had to determine whether this constituted a single composite supply which was still covered by the tax exemption.
Alternatively, the additional items leased out could be considered as being several distinct and independent supplies that must, from a VAT perspective, be assessed separately.
The ECJ relied on settled case law when it came to the definition of leasing and letting of immovable property. Based on this and the fact that the additional items let were all considered to be necessary for the lessee’s better enjoyment of the immovable property, the court concluded that the letting of the property was the principal supply and all additional items let were merely ancillary.
In this case, the principal supply determined the VAT treatment. This was bad news for the couple in charge of the lessor as it was now clear that the previously recovered input VAT should have been revised.
Leasing out an entire operation to a customer is not considered to be a transfer of a going concern. The VAT treatment changes if (the majority) of assets are sold rather than let.
In this case, a transfer of a going concern may be given in accordance with previous case law if the assets retained are made available through a leasing agreement and, thus, place the recipient in a position to carry on the business. The name under which the transferee continues the business is irrelevant.
Even if significant other equipment or inventory is leased out together with immovable property, this has to be considered as an exempt transaction because the letting of the additional items will likely only be considered as being ancillary in nature. Naturally, these issues have to be evaluated on a case-by-case basis.
Dr Stefan Maunz is a Specialist Tax Lawyer and Consultant, Germany