Flashback on ECJ Cases – C-496/11 (Portugal Telecom) – Right to deduct VAT if services acquired are directly and directly related to economic transactions

On September 6, 2012, the ECJ issued its decision in the case C-496/11 (Portugal Telecom).

Context: VAT – Sixth Directive – Articles 17(2) and 19 – Deductions – VAT due or paid for services acquired by a holding company – Services having a direct, immediate and unequivocal relationship with taxable output transactions

Article in the EU VAT Directive

Articles 17(2) and 17(5) of the Sixth VAT Directive (Articles 168 and 173 of the EU VAT Directive 2006/112/EC).

Article 168 (Origin and scope of right of deduction)
In so far as the goods and services are used for the purposes of the taxed transactions of a taxable person, the taxable person shall be entitled, in the Member State in which he carries out these transactions, to deduct the following from the VAT which he is liable to pay:
(a) the VAT due or paid in that Member State in respect of supplies to him of goods or services, carried out or to be carried out by another taxable person;
(b) the VAT due in respect of transactions treated as supplies of goods or services pursuant to Article 18(a) and Article 27;
(c) the VAT due in respect of intra-Community acquisitions of goods pursuant to Article 2(1)(b)(i);
(d) the VAT due on transactions treated as intra-Community acquisitions in accordance with Articles 21 and 22;
(e) the VAT due or paid in respect of the importation of goods into that Member State.

Article 173 (Proportional VAT deduction)
1. In the case of goods or services used by a taxable person both for transactions in respect of which VAT is deductible pursuant to Articles 168, 169 and 170, and for transactions in respect of which VAT is not deductible, only such proportion of the VAT as is attributable to the former transactions shall be deductible.
The deductible proportion shall be determined, in accordance with Articles 174 and 175, for all the transactions carried out by the taxable person.
2. Member States may take the following measures:
(a) authorise the taxable person to determine a proportion for each sector of his business, provided that separate accounts are kept for each sector;
(b) require the taxable person to determine a proportion for each sector of his business and to keep separate accounts for each sector;
(c) authorise or require the taxable person to make the deduction on the basis of the use made of all or part of the goods and services;
(d) authorise or require the taxable person to make the deduction in accordance with the rule laid down in the first subparagraph of paragraph 1, in respect of all goods and services used for all transactions referred to therein;
(e) provide that, where the VAT which is not deductible by the taxable person is insignificant, it is to be treated as nil.

Facts

Portugal Telecom is an SGPS. It provides technical administrative and management services to companies in which it has a shareholding.
In the course of its business, Portugal Telecom acquired, under the VAT regime, certain services from consultants. It invoiced its subsidiaries for those services at the same price as that for which it had acquired them, plus VAT.
In the 2000 financial year, Portugal Telecom deducted all the VAT paid by it from the VAT passed on, taking the view that the taxed transactions, namely the technical administration and management services, were in fact covered by the use of the corresponding services acquired.
Following a check carried out by the tax administration, the latter took the view that Portugal Telecom could not deduct all the VAT on the input services, but that it should use the pro rata method of deduction. Accordingly, it issued Portugal Telecom with a notice of assessment setting the deductible percentage of input tax at approximately 25%.
Portugal Telecom brought an action challenging that notice of assessment before the Tribunal Administrativo e Fiscal de Lisboa (Administrative and Tax Court, Lisbon). In substance, that court dismissed the action holding that the fundamental aim of SGPS is to perform exempt transactions. Since, in addition to those transactions, it is possible to allow, as an ancillary activity, the supply of technical administrative and management services for all or some companies in which they have a shareholding, and which are subject to VAT, that court considered that the supplies of technical administrative and management services are indissociable from the management of shareholdings. Consequently, it held that the method to use in order to determine the amount of VAT to be deducted is the pro rata method.
Portugal Telecom brought an appeal against the decision at first instance before the Tribunal Central Administrativo Sul (Administrative Court of Appeal, South). In support of its appeal, it submitted that the legal reasoning in the decision at first instance infringed both national law on VAT and Article 17(2)(a) of the Sixth Directive.
In so far as the taxable transactions made by Portugal Telecom in connection with its shareholdings are, it claims, supplies of services having a direct and immediate link with the services acquired with a view to their supply, that company takes the view that it may deduct all the tax paid when the acquisitions were made using the method of deduction based on actual use.

Questions

(1) Is Article 17(2) of the Sixth Directive … to be interpreted as precluding the Portuguese tax authorities from requiring the appellant, a holding company, to use the pro rata deduction method for all the VAT incurred in its inputs, on the basis of the fact that the main corporate purpose of that company is the management of shareholdings of other companies, even when such inputs (acquired services) have a direct, immediate and unequivocal link with taxable transactions – supplies of services – which are carried out downstream in the context of the complementary activity of supplying legally permitted, technical management services?

(2) May a body that has the status of a holding company and is subject to VAT on the acquisition of goods and services that are thereupon wholly transmitted to companies in which it has a holding, with payment of the VAT, when that institution combines the main activity it carries out (management of shareholdings) with an accessory activity (supply of technical administration and management services), deduct all the tax incurred in respect of those acquisitions by applying the method of deduction based on actual use set out in Article 17(2) of the Sixth Directive?

AG Opinion

None

Decision

Article 17(2) and (5) of Sixth Council Directive 77/388/EEC of 17 May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes – Common system of value added tax: uniform basis of assessment must be interpreted as meaning that a holding company such as that at issue in the main proceedings which, in addition to its main activity of managing shares in companies in which it holds all or part of the share capital, acquires goods and services which it subsequently invoices to those companies is authorised to deduct the amount of input VAT provided that the input services acquired have a direct and immediate link with the output economic transactions giving rise to a right to deduct. Where those goods and services are used by the holding company in order to perform both economic transactions giving rise to a right to deduct and economic transactions which do not, the deduction is allowed only in respect of the part of the VAT which is proportional to the amount relating to the former transactions and the national tax authorities are authorised to provide for one of the methods for determining the right to deduct in Article 17(5). Where those goods and services are used both for economic and non-economic activities, Article 17(5) of the Sixth Directive is not applicable and the methods of deduction and apportionment are to be defined by the Member States which, in exercising that power, must take account of the purpose and general scheme of the Sixth Directive and, on that basis, lay down a method of calculation which objectively reflects the input expenditure actually attributed to each of those two activities.

Summary

A holding company that acquires goods and services additionally to its main activity (management of participations), which it subsequently charges to these participations, may deduct the amount of input tax provided that the services acquired at an earlier stage are directly and directly related to economic transactions at a later stage for which there is a right to deduct.

Where those goods and services are used by the holding company for both economic transactions for which there is a right to deduct and for economic transactions for which there is no right to deduct, deduction is permissible only for the part of the VAT which is proportional to the amount of the first-mentioned transactions and the national tax authorities may apply one of the methods listed in that Article 17(5) for determining the right to deduct.

Where those goods and services are used for both economic and non-economic activities, Article 17(5) of the Sixth Directive does not apply and the methods of deduction and distribution are determined by the Member States, which, in the exercise of that power must take into account the purpose and scheme of the Sixth Directive and must thereby determine a calculation method which reflects objectively what proportion of the costs incurred at an earlier stage is actually attributable to each of those two activities.

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