Is There Such a Thing as a VAT-Free Lunch?

Businesses usually provide goods or services against a payment. However, it sometimes happens that they do things free of charge, for example, to promote their sales or motivate their employees. It also happens that a supply benefits both—the purchaser and a third party. In this article, we look at the value-added tax (VAT) consequences of incurring costs for services when a third party (also) benefits free of charge from those services.

Basic VAT Rules

Under the EU VAT rules, a business/entrepreneur (VAT payer) may in principle deduct input VAT in so far as the costs are incurred for the purposes of its business activities. The purpose of the right to deduct VAT is to relieve businesses of any VAT costs (neutrality principle of VAT for business) and that right in principle may not be limited.

Input VAT is deductible if there is:

• a direct and immediate link between the expenditure and the economic activity of the VAT payer; or
• the expenditure forms part of general costs (overheads) and is not directly linked to any VATable supply.

It sometimes happens that an entrepreneur incurs expenses that (also) benefit a third party. If these costs do not benefit the entrepreneur itself but only a third party, then, in principle, input VAT is not deductible.

The VAT may nevertheless be deductible, for example, if those costs are regarded as:

• reimbursements (treated as own costs which are passed on to the third party);
• qualifying disbursements (certain payments made on behalf and in name of customers).

Businesses could become liable for VAT even if the expenses are not re-charged to a third party. For example, in case C-707/18, the Court of Justice of the European Union (CJEU) found that when a VAT payer incurs expenses that are under the legislation an obligation of another person, the VAT payer is deemed to provide services to this other person and will be liable to pay VAT, even if it does not recharge those expenses.

It also happens that incurred costs benefit several parties. Can the VAT payer deduct the VAT paid on these expenses if a third party also benefits? The CJEU answered questions on VAT consequences of spillover effects of services in its various decisions, most recently in the Vos case, C 405/19.

Facts

A property developer (Vos) builds flats on land owned by third-party landowners. The land shares are sold by the landowners themselves. This so called “split sale” is common practice in Belgium where the sale of buildings is subject to VAT and the sale of corresponding land (or land shares) is VAT exempt.

Vos pays publicity, administration and estate agency costs that also benefit the landowner. The question is whether Vos can (fully) deduct VAT if it bears all the costs itself, while a third party (also) benefits.

Decision

The CJEU is, in the Vos case, of the opinion that VAT is deductible on the condition that the advantage that the third party derives from these expenses is ancillary to the interests of the VAT payer. In order to qualify as ancillary, the benefit to the third party must flow from a supply of services made in the VAT payer’s own interest. There must also be a direct and immediate link between that expenditure and the VAT payer’s economic activity.

If payment is made for services or goods that are not used for the VAT payer’s own taxable activities but only for those of a third party, the VAT payer may not deduct the VAT. According to the CJEU, the VAT paid on the expenses not linked to the transactions of the VAT payer, but to those of a third party, is not deductible.

The CJEU states that if a VAT payer incurring the expenses has a possibility to pass the costs on to the third party (even if this possibility is not used), this is an indication that the expenses also relate to the transactions of that third party. However, this circumstance alone is not sufficient to conclude that the VAT is not (partly) deductible.

The CJEU concludes that the part of the expenses that is not related to the transactions of the VAT payer but to those of the third party is not deductible if the VAT payer does not pass the expenses on to the third party. This means that the VAT paid by Vos on estate agents’ commission in connection with the sale of land is only deductible if the expenses are passed on to the landowners.

Previous Rulings

The CJEU confirms its previous rulings (e.g. in Sveda, C-126/14 and Iberdola, C-132/16) that, in principle, a VAT payer can deduct input VAT even if a third party benefits free of charge from its activities.

In Iberdola, the CJEU decided that, in principle, the right to deduct input VAT may exist for a supply of services consisting of building and renovating a property owned by a third party. This applies if that third party also benefits from those services free of charge. The CJEU imposes a condition that those services may not go beyond what is necessary to enable the VAT payer to carry out its own taxable transactions and their cost should be included in the price of those transactions.

In Sveda, the CJEU decided that VAT on costs relating to services provided free of charge is deductible if those services are a means of selling goods and services for consideration. A company (Sveda) constructed a recreational trail, roads, car parks and other facilities. Ninety percent of the costs were paid by the local government, which subsidized the creation of the trail on the condition that the VAT payer made the trail available to the public free of charge. Sveda planned to perform taxable supplies in the future, such as sale of souvenirs and food.

The CJEU found the costs made for the construction of the trail were included in the services which were later performed to the visitors of the trail. If the services are provided free of charge this does not mean that those activities are non-economic for VAT purposes and VAT related to those services is not deductible. The CJEU found that a VAT payer can deduct VAT paid on the acquisition and production of capital goods which are used free of charge by the public since they are used to attract visitors in order to provide them with taxable supplies of goods or services.

The CJEU stated that a right of deduction arises immediately when the (investment) costs are made, even if the investments made are not immediately used for a taxable economic activity. The CJEU also stated that the costs made by the VAT payer give rise to a right to deduct VAT immediately, even if the path would only be used for VATable transactions after five years.

In addition, the CJEU found that although the trail was not used for transactions subject to VAT during a period of five years, the trail could be regarded as a means of attracting visitors to purchase goods and services subject to VAT which Sveda offered on that site. This trail was consequently a means for Sveda to attract visitors to the shops and swimming facilities and to sell souvenirs, food and drink at that location.

According to the CJEU, the fact that acquired (capital) goods are not used directly for VATable activities does not prevent there being a direct link between its incoming and outgoing transactions, nor does it prevent there being a link with its overall economic activity.

Conclusion

In Vos, the CJEU confirms its earlier decisions (e.g. Sveda and Iberdola) that VAT is deductible on expenses if they benefit a person other than the entrepreneur itself. The VAT payer may deduct the VAT in full if, first, there is a direct and immediate link between that expenditure and the VAT payer’s economic activity, and second, the benefit to the third party is ancillary to the VAT payer’s business purposes.

From the case law of the CJEU it follows that in order to deduct input VAT in situations with spillover effects, the costs made should be “objectively necessary”’ and “not unreasonable.”

The VAT payer may only deduct VAT where those services are used for its own taxable transactions. If costs are incurred that only benefit a third party, input VAT is only deductible if those costs are passed on (with VAT) to the third party.

What are the Practical Consequences?

Entrepreneurs must ensure that the following conditions for VAT deduction are met when a third party benefits free of charge from their activities/costs:

• Costs are made for their own taxable transactions—there is a direct and immediate link between these expenses and the taxable person’s economic activity or the costs are part of their overheads.
• If a third party benefits from the costs free of charge, the benefit to the third party should be ancillary to the VAT payer’s own business purposes.
• VAT on costs related to services provided free of charge is deductible when there is a close link between the taxed and the free services and the free services are ancillary to or an extension of the business activities subject to VAT.
• The services provided free of charge may not go beyond what is necessary to enable the VAT payer to carry out its own taxable transactions and their cost should be included in the price of those transactions.

Entrepreneurs must ensure that the above conditions for the deduction of VAT are met if a third party/parties (also) benefit(s) free of charge.

Businesses should also keep in mind that the EU member states apply the VAT rules in different ways. In practice, the right of deduction and the provision of services free of charge should therefore be analyzed on a case-by-case basis. Some member states apply a very formalistic approach with respect to the input VAT deduction, contrary to settled CJEU case law.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Aiki Kuldkepp is Senior Manager, Tax, with Grant Thornton Netherlands.

The author may be contacted at: aiki.kuldkepp@nl.gt.com