VAT and contributions by a holding company to a subsidiary

The CJEU has held that a holding company is not entitled to recover input VAT incurred on services contributed free of charge to a subsidiary and ultimately used for that subsidiary’s exempt activities: Finanzamt R v W-GmbH (Case C-98/21) (8 September 2022) (note that the case is not currently available in English). The Court rejected the argument that the input VAT was connected with the overall economic activities of the holding company and has distinguished the case from earlier cases concerned with input VAT connected with the acquisition of the relevant holding.

Background

W was the holding company of two subsidiaries, X and Y, which were involved in the construction industry. In both cases, it owned a 90% plus interest in those subsidiaries and provided management services to them for a fee which was subject to VAT. There was no VAT group in place.

Under agreements with the minority owners, W agreed to provide services to X and Y in the form of planning, building and marketing services free of charge. W incurred input VAT on the acquisition of goods and services used for the purposes of providing those services to its subsidiaries and sought to deduct that VAT. The German tax authorities considered that W's shareholder contributions to X and Y had to be classified as non-taxable activities on the ground that they had not been used to generate revenue and were therefore not attributable to W's commercial activity. The amounts of input VAT paid in connection with those activities were therefore not deductible.

On appeal, the Finance Court held that the provision of the services by way of contribution to W’s subsidiaries fell within the commercial activity of the active management of its shareholdings and, as such, W was entitled to deduct the input VAT. In addition, the Court rejected the argument that the arrangements were abusive on the basis that W had shown there were also non-tax reasons for the arrangements. The German tax authorities appealed that decision and the matter was referred to the CJEU.

Decision of the CJEU

The Court noted that it was clear in this case that W qualified as a taxable person due to the provision of management services to its subsidiaries in return for a fee which was subject to VAT. W was not a pure holding company. However, it was also necessary for W to show that there was a link between the inputs and the economic activities of W in order to recover input VAT.

Clearly there was no direct and immediate link between the inputs and the management services supplied by W. Equally, the Court rejected the argument that the making of the contribution in kind to the subsidiaries amounted to an economic activity. A contribution – whether in cash or in kind – from a holding company to its subsidiaries is, by its nature, useful for the receipt of dividends, but that does not amount to an economic activity for VAT purposes. “Such a contribution by a holding company to its subsidiaries, whether in cash or in kind, falls within the holding of shares which… does not constitute an economic activity within the meaning of the VAT Directive and does not, therefore, give rise to the right to a deduction".

More generally, the Court stressed that "it is important to take into consideration all the circumstances in which the transactions concerned took place" and "account must be taken of the actual use of the goods and services acquired by the taxable person". Expenditure which is linked not to taxable transactions carried out by the taxable person but to transactions carried out by a third party cannot give rise to a right of deduction for that taxable person. That was the position in this case. "Since the actual use of the services acquired by W shows that they are directly linked to the operations of its subsidiaries, that link precludes the grant of a right of deduction by W for those services. Accordingly, the objective content of the transaction reveals that there is no direct and immediate link between the costs of the services acquired by W and its economic activity. These costs are not, as overheads, part of the constituent elements of W's management and accounting services".

The Court also rejected the argument that the services provided by W enabled its subsidiaries to operate and therefore enabled it to provide its management services to them. Any such link between the services W received and its supplies of management was too remote.

In conclusion, the CJEU held that a holding company, which carries out taxable management for its subsidiaries, is not entitled to deduct input tax on supplies which it acquires from third parties and which it provides free of charge to subsidiaries where: (i) the acquired services have direct and immediate links not with the holding company's own operations but with the subsidiaries' largely exempt activities; (ii) those services do not fall within the price of the taxable transactions carried out in favour of the subsidiaries; and (iii) those services do not form part of the general costs of the holding company's own economic activity.

Comment

The application of the VAT system to holding companies is not subject to any special rules, but has been built up over a period of time based on judgments of the courts. Nevertheless, the subject continues to raise questions due to the multiplicity and complexity of factual situations that arise in practice.

This latest case is another which sets limits on the recovery of input VAT by holding companies by emphasising the point that not all VAT incurred by a holding company supplying management services can automatically be treated as connected with the overall business of that holding company. There must remain an objective link between the acquired services and the taxable activities of the holding company for input VAT to be recoverable.

Whilst the case can be viewed as a straight-forward application of an input tax block on costs directly linked to a non-economic activity, it does raise two important questions:

• HMRC in its guidance is clear that the requirement for a direct and immediate link prevents any form of “look through” to the ultimate purpose of the transaction. The repeated references to the exempt activities of the subsidiary are therefore somewhat confusing, especially the inclusion of this point in the operative part of the judgment. The Court in Paragraph 54 refers to a direct link with the activities of the subsidiary and that it is important to take into account the actual use of the same services. Would it have made a difference had the subsidiaries been undertaking taxable activities? Despite these references, it seems unlikely – it would be necessary for W to show that there was a direct link with its own taxable business, not that of its subsidiaries.

• There would be no debate as to whether the input tax would have been recoverable had W charged a market rate for its services and charged VAT on those services. But what if W had charged a nominal amount for those services? At what level of consideration does the existence of an economic activity occur in this situation? This is a difficult question as to which there is no clear answer.