VAT: meaning of economic activity

The CJEU has handed down two judgments concerning the scope of economic activity for VAT purposes in circumstances where a public authority arranges supplies for local residents which are subsidised by government funds. In both cases, the Court has held that uneconomic nature of the arrangements from the public authority's viewpoint mean that there is no economic activity taking place: Gmina O (Case C-612/21) and Gmina L (Case-616/21).

It is notable that in both cases the Court has highlighted the importance of comparing the activities of the public authority with an entrepreneur acting in the same area seeking to derive income of a permanent nature from such activities (and not by reference to the acts being carried out by a public authority acting as such). In doing so, the Court's decision may indicate further restrictions on the scope of the concept of economic activity more generally.

Background

Gmina O concerned arrangements under which a Polish local authority organised the installation of renewable energy systems (RES) for local residents. The local authority received funding of 75% from a provincial authority and received a contribution of 25% of the cost from the owners of properties benefiting from the project. The Polish tax authority considered this amounted to supply of services by the local authority and sought to collect VAT on the activities.

Gmina L involved another Polish local authority which arranged to remove asbestos from local residents' homes. These arrangements involved (a) affected homeowners requesting removal of asbestos, (b) the local authority obtaining tenders for carrying out the removal and (c) the local authority recovering between 40 and 100% of the cost from an Environmental Protection Fund. The residents benefiting from the asbestos removal made no contribution to the cost. Again, the Polish tax authorities considered that Gmina L acted as a taxable person in arranging the asbestos removal and was required to account for VAT.

Decision of the Court: Gmina O

The Court emphasised that for there to be a supply, it is merely necessary for there to be a direct link between the supply and the consideration. It is irrelevant that any consideration is less than the cost of performing the supply. As such, the transfer of ownership of RES to local residents constituted a supply of goods and the installation a supply of services. The fact that those residents only contributed 25% of the cost and the local authority recovered 75% of the subsidisable costs from the fund did not stop there being a supply for consideration.

However, it was also necessary to consider whether that supply was carried out by the local authority in the course of an economic activity. An activity is generally considered "economic" where it is permanent and carried out for remuneration. In this case, it was necessary to take all the circumstances into account and "make a case-by-case assessment, referring to the typical conduct of an active entrepreneur in the field concerned, here, an RES installer".

Whilst an RES installer might expect to derive income of a permanent nature from their activity, it was clear here that the local authority did not intend to provide RES installation services on a regular basis or employ workers for that purpose. The Court also noted that:

"The Court has already had occasion to rule that, when a municipality recovers, through the contributions it receives, only a small part of the costs which it has incurred, the balance being financed by public funds, such a difference between those costs and the amounts received in return for the services offered suggests that these contributions must be regarded more as a fee than as consideration..."

Moreover, the fact that the local authority would recover only 75% of subsidisable costs from the fund meant that it would recover an amount in total lower than the total costs actually incurred by it in paying a market rate to an installer. As such, the activity did "not correspond to the approach that would have been taken, where applicable, by an RES installer, which would have endeavoured, by setting its prices, to absorb its costs and to make a profit. Conversely, that municipality bears only risks of loss, without any prospect of profit."

In addition, the Court noted that it would not be economically viable, for an RES installer, to act in this manner ie to make the recipients of its supplies of goods and services bear only one quarter, at most, of the costs which it has incurred, while awaiting compensation, by way of a subsidy, for the remaining three quarters of those costs. "Not only would such a mechanism place its cash flow in a loss-making situation, but, in addition, it would place an unusual uncertainty on it for a taxable person, since the question whether, and to what extent, a third party will reimburse such a significant part of the costs incurred remains in fact open until the decision of that third party, subsequent to the transactions at issue."

As a result of these factors, the Court suggested that the activities of the local authority in this case did not  appear to have the character of an activity of an economic nature within the meaning of the Article 9(1) of the Principal VAT Directive.

Decision of the Court: Gmina L

The Court noted that the first question was to determine who was the supplier and who the recipient of the supply in circumstances where a local authority instructs an undertaking to carry out removal of asbestos for its resident following an application by residents. The Polish tax authorities viewed the arrangements as involving the local residents instructing the local authority to act as agent for them in arranging the services. However, in this case, the Court noted that residents merely put in an application and hope to benefit from being selected. This was not a case where the owners of property entrusted the local authority to remove asbestos on their behalf - apart from the submission of an application, the owners had no influence on the provision of services.

Nevertheless, did the local authority supply services for consideration in this case? Was there a supply by the local authority to local residents for which the consideration was the subsidy provided by the Environmental Protection Fund? Whilst there was no contract between the local residents and the Fund reimbursing the cost, the Court held that there was a direct link between the asbestos removal and the reimbursement as "one is only carried out on condition the other is also supplied". As such, the conditions for a supply being made were met.

However, was such a supply made in the course of an economic activity? Again, as in Gmina O, the Court emphasised that, given the difficulty of establishing a precise definition of economic activity, all the circumstances in which the supply takes place need to be examined, by making a case-by-case assessment, referring to the typical conduct of an active entrepreneur in the field concerned, namely asbestos removal. As in the Gmina O case, the Court concluded by referring to the occasional nature of the service, the lack of staff employed for the purpose, the uneconomic nature of the activity, involving only risk of loss with no prospect of profit and the cash flow disadvantages of incurring the costs whilst awaiting partial compensation by way of a subsidy. As such, the activities of Gmina L in arranging asbestos removal did not amount to an economic activity.

Comment

It is notable that in both these decisions the Court has held that the services carried out by the local authority did not amount to an economic activity, even though they did involve the making of supplies for consideration. This highlights the dual nature of the enquiry when deciding if there are taxable supplies for VAT purposes.

It is becoming increasingly difficult to holistically interpret the CJEU's case-law on economic activity. The wording of Article 9(1) seems clear, "[a]ny activity of ... traders or persons supplying services ... shall be regarded as an 'economic activity" (emphasis added). Recent jurisprudence has focused on the subsequent sentence that "[t]he exploitation of tangible or intangible property for the purposes of obtaining income therefrom on a continuing basis shall in particular be regarded as an economic activity" (emphasis added). A particular strand of recent CJEU case-law seems to interpret the term "in particular" to mean "exclusively" by making it a mandatory condition for economic activity to exist rather than an extension of the scope. This has required the development of the concept of "remuneration" as opposed to "consideration".

Remuneration is not a concept defined in the legislation or adequately in case-law. In particular, it seems objectively impossible to assess the difference between remuneration and consideration without considering the subjective intentions of the taxpayer. This contradicts a long strand of CJEU case-law stretching back to the Commission of the European Communities v. Kingdom of the Netherlands (Case-235/85) [1987] E.C.R. 1471 where in para 8, it states that the "scope of the term 'economic activities' is very wide, in as much as it covers all the services provided by the liberal professions and that the term is objective in character, in the sense that the activity is considered per se and without regard to its purpose or result" (emphasis added).

It is also notable that the Court reached its decision without considering whether the activities of the local authorities were in any event outside the scope of VAT on the basis that the activities were carried out as public authorities pursuant to Article 13 of the Principal VAT Directive.  This is because it had already determined that a supply had not been made and so therefore did not need to consider whether Article 13 applied. Given the preponderance of case-law in this area concerns governmental bodies and local authorities, it would seem more reasonable to follow the specific wording of Article 9 (which would lead to the conclusion that an economic activity had occurred where something is provided in return for the objectively determined consideration rather than the subjective remuneration) and then consider the application of Article 13.

At present though, this case highlights the case-by-case nature of the analysis on this aspect of the VAT rules and a possible restriction in the scope of economic activity where carried out occasionally and without any prospect of profit (even by businesses which otherwise carry on an economic activity).