Input tax deduction despite an acquisition ultimately not having been carried out (ECJ from 12.11.2020)
In a case that reached the ECJ, the issue was whether or not a holding company should be allowed to deduct input tax even if the acquisition of a subsidiary that was originally planned is ultimately not carried out. The holding company operated in the telecommunications sector and provided taxable management services to some of its subsidiaries. This was also the plan for a subsidiary that would have been newly acquired. In preparation for the intended acquisition the holding company purchased external consultancy services relating to market research. In order to finance the planned acquisition, the holding company issued a bond in order to the raise necessary funds. In this connection, the holding company paid a fee to the investment bank that had been commissioned to arrange and execute the bond. However, the acquisition of the subsidiary fell apart and so the capital that had been raised via the bond issue was made available to the parent company as a loan. The holding company claimed an input tax deduction not only in respect of the expenditure for the consultancy services but also the fee paid to the investment bank. In a recent, ruling from 12.11.2020 (case: C-42/19), the ECJ had to decide whether or not this input tax deduction had been rightful and proper.
The ECJ allowed the respective amount of VAT payable for the consultancy services to be deducted as input tax. The decisive factor was that the services received were linked to the acquisition of an associated company for which the holding company had intended to provide management services in return for payment. In principle, the existing entitlement to deduct input tax remains unaffected even for preparations that ultimately were to no avail, insofar as such activities can be attributed to future business activities.
The situation is different in the case of the VAT paid in respect of the fee. Here, the ECJ considered it to be relevant to the issue that, by deviating from its original intention, the capital that had been raised via the bond was used for a tax-exempt activity, namely, extending a loan, free of tax, to the parent company. Consequently, as the fee expenses thus had to be attributed to excluded transactions that are ‘harmful’ to input tax deductibility, the ECJ refused to allow the respective deduction of the applicable amounts of input tax.
The Federal Fiscal Court’s order for reference with respect to structuring models that enable input tax deduction (Vorschaltmodellen)
The Federal Fiscal Court (Bundesfinanzhof, BFH), in its ruling from 23.9.2020 (case reference: XI R 22/18), referred to the ECJ for a preliminary ruling the issue of whether or not a functional holding company should be allowed to deduct input tax even in the constellation of circumstances outlined in the overview below, which are considered to constitute a structuring model that enables input tax deduction (referred to in German as a Vorschaltmodell).
The holding company, as a German limited partner, held stakes in two German limited partnerships for which it provided taxable management services in return for payment; as a functional holding company it was therefore basically engaged in business activities. The limited partnerships acquired plots of land on which they then put up residential buildings with the aim of selling the developed plots (VAT-exempt activity of real estate development). While the other partners made their equity contributions in cash, the holding company contributed its share of the equity by providing architectural services. In order to fulfil its obligation to make an equity contribution, the holding company also purchased services from third parties and sought to deduct the input tax from their invoices. Unlike the tax office, the tax court allowed the input tax deduction. Providing benefits in kind as an equity contribution can also be classed as a business activity.
The BFH however considered it to be doubtful that the incoming supplies that the holding company had passed on to the limited partnership as the partner’s equity contribution had been purchased for its business. In particular, the BFH also saw the risk of misuse because, by artificially putting in place a managing holding company, it could be possible to achieve an input tax deduction that would not be compatible with the system and to which neither the subsidiary nor the holding company would otherwise have been entitled.
Recommendation: In this respect, until there is a ruling from the ECJ, such structuring models should be avoided. Furthermore, it remains to be seen if the ruling discussed could also give rise to a new discussion of the issue of whether the (first-time) input tax deduction has to be based on the planned or on the subsequent actual use of the incoming supplies.