Input VAT recovery and planning agreements

The Advocate General has opined that a strict allocation approach must be taken to input VAT recovery, even where there is a necessary causal connection between the incurring of input VAT and the taxable business activity: Iberdrola Immobiliaria Real Estate Investments (Case C-132/16). In particular, in the context of a planning agreement, the Advocate General has suggested that it is not sufficient that the costs incurred on public works were necessary or caused by the taxpayer’s development to allow input VAT recovery. The taxpayer must be able to show that the input VAT can be directly allocated to the development, rather than an intervening supply outside the scope of VAT by the developer to the local authority.

Background

The case involves the development by Iberdrola of a holiday village in Bulgaria. As part of the precondition for planning agreement, Iberdrola agreed to carry out repairs to the municipal waste-water infrastructure. The renovation was carried out by a building contractor at Iberdrola’s expense and Iberdrola sought to recover the input VAT on such costs. The Bulgarian tax authorities rejected the claim on the basis that the input VAT was directly attributable to a service provided free of charge by Iberdrola to the local municipality. The matter was referred by the Hungarian courts to the European Court of Justice (ECJ).

Advocate General opinion

The Advocate General clearly sets out the fundamental nature of the question put to the court. Is it sufficient for a taxpayer to be able to show that costs incurred were beneficial or necessary for the taxpayer’s own supplies? Is the cause of the costs sufficient? Or must the costs be directly and immediately allocated to the taxpayer’s own revenue liable to VAT?

Supported by the EU Commission, Iberdrola argued that, in this case, the costs were clearly sufficiently connected with its taxable business of building and leasing a holiday village. The planning permission for the village was dependent on it carrying out the repair works. In addition, the costs of the repairs were accounted for as costs of the development.

Firstly, the Advocate General argued that the accounting treatment of the amounts by the taxpayer is irrelevant. VAT is not an accounts based tax, it is a transaction based tax. The question is whether the costs can be allocated to the taxpayer’s activity of supplying the holiday village, without reference to how the taxpayer accounted for those amounts.

Secondly, the Advocate General argues that a mere causal link between input VAT and the economic activity of the taxpayer is not sufficient. It is “economic allocation” that is important, not “economic cause”. There must be a direct and immediate link between the use and the economic activity of the taxpayer. A “vague causal link” is insufficient and it is not sufficient merely that the renovation was a condition for the local authority’s agreement to the development.

The Advocate General, of course, notes that there is an exception to the “direct and immediate link” approach, where the costs are part of a taxpayer's general costs and, as such, a cost component of the price of the goods and services he supplies. However, the “residual input VAT” approach cannot be used where there is a direct link with a particular output. In this regard, the Advocate General notes that the only person directly using the repair services was the local authority, for the purposes of providing waste-water facilities.

Ultimately, the Advocate General suggests that it is necessary in this situation to allocate the renovation service directly to the supply by Iberdrola to the local authority. If that supply is, as assumed by the referring court, made free of charge and outside the scope of VAT, then no input VAT recovery is possible.

However, on this point, the Advocate General offers a potential way out. The Advocate General suggests that the granting of permission by the local authority to Iberdrola for the development may be seen as consideration for the supply of renovation services by Iberdrola. On this basis, Iberdrola would be providing a taxable supply for consideration to the local authority (subject to VAT) and would be able to allocate the input VAT to that taxable supply.

Comment

In many ways, it is surprising that so many years after the ECJ decision in BLP (which established that the ultimate purpose pursued by the taxpayer was not determinative of input VAT recovery), VAT can still throw up such “fundamental” questions concerning the recovery and allocation of input VAT.

As in BLP, the Advocate General suggests that the fact that there was an intervening service by the taxpayer (the carrying out of repairs for the local authority who directly consumed those services) is sufficient to prevent there being the necessary “direct and immediate” link to the taxpayer’s economic activity or even allow the input VAT to be treated as residual. In particular, this is the case even though the input VAT in this case was clearly incurred for business purposes, necessary for the carrying out of that activity and was a cost component of onward taxable supplies by the taxpayer.

It should also be noted that the opinion appears to be contrary to current HMRC practice in the UK. Notice 742 paragraph 8.4 currently suggests that the existence of a planning gain agreement will not give rise to taxable supplies for VAT purposes and that input VAT recovery in relation to such planning gain arrangements will be dependent on the nature of the supplies made by the developer in relation to the new development.