Flashback on ECJ Cases – C-25/11 (Varzim Sol) – “Grants” used to purchase goods and services — Limitation of right to deduct

On February 16, 2012, the ECJ issued its decision in the case C-25/11 (Varzim Sol).

Context: Taxation — Sixth VAT Directive — Deduction of input tax — Article 17(2) and (5) and Article 19 — ‘Subsidies’ used for the purchase of goods and services — Restriction of the right to deduct)

Article in the EU VAT Directive

Article 17(2), 17(5) and 19 of the Sixth VAT Directive (Articles 168, 173 of the EU VAT Directive 2006/112/EC).

Article 168 (Origin and Scope of the 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);
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(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 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.

Article 174 (Proportional deduction))
1. The deductible proportion shall be made up of a fraction comprising the following amounts:
(a) as numerator, the total amount, exclusive of VAT, of turnover per year attributable to transactions in respect of which VAT is deductible pursuant to Articles 168 and 169;
(b) as denominator, the total amount, exclusive of VAT, of turnover per year attributable to transactions included in the numerator and to transactions in respect of which VAT is not deductible.
Member States may include in the denominator the amount of subsidies, other than those directly linked to the price of supplies of goods or services referred to in Article 73.
2. By way of derogation from paragraph 1, the following amounts shall be excluded from the calculation of the deductible proportion:
(a) the amount of turnover attributable to supplies of capital goods used by the taxable person for the purposes of his business;
(b) the amount of turnover attributable to incidental real estate and financial transactions;
(c) the amount of turnover attributable to the transactions specified in points (b) to (g) of Article 135(1) in so far as those transactions are incidental.
3. Where Member States exercise the option under Article 191 not to require adjustment in respect of capital goods, they may include disposals of capital goods in the calculation of the deductible proportion.

Facts

Varzim Sol operates a casino on the basis of a contract granting a concession to operate games of chance in the permanent gaming area of Póvoa de Varzim, entered into on 14 December 2001. That contract requires it to carry out a certain number of artistic and cultural activities, but also to participate in the promotion of the area where the casino is located.
Varzim Sol simultaneously carries out activities in the gaming sector, which are exempt from VAT, in the sectors of catering and entertainment, where they are subject to VAT, and in the administrative and finance sector, with partial deduction of VAT. In the sectors subject to VAT, VAT paid is deducted under the method of actual use, in accordance with Article 23(2) of the VAT Code.
Furthermore, under the applicable rules and the concession contract, Varzim Sol is bound to pay to the Portuguese State an initial consideration, but also an annual consideration calculated on the basis of income from the gaming sector. It is authorised to deduct from that annual consideration a part of the expenses incurred to fulfil its entertainment and tourism promotion obligations. The amount of that deduction depends on the amount of the expenses incurred and on the amount of the income from the gaming activity.
Following an inspection by the tax authorities, Varzim Sol received demands for additional payment of the amount of EUR 496 697.14 in respect of the years 2002 to 2004. Those corrections are based on a challenge to the method used by Varzim Sol to calculate the deductible amount of VAT paid for the catering and entertainment sectors.
The Fazenda Pública argues that the deduction made from the annual consideration to compensate for the entertainment and promotion expenses must be classified as an operating subsidy for the purposes of Article 23(4) of the VAT Code. It considers that, as that subsidy is not subject to VAT, the catering and entertainment activities must be treated as mixed activities. Consequently, the VAT paid in those sectors must be deducted on the basis of a proportion that allows both exempt and taxable activities to be taken into account.
Varzim Sol paid the amounts claimed but brought a legal action. That action was dismissed by the Tribunal Administrativo e Fiscal do Porto (Administrative and Tax Court, Porto). Varzim Sol appealed to the Supremo Tribunal Administrativo (Supreme Administrative Court).
Varzim Sol claims that, even if the amount deducted must be classified as a subsidy, which is not the case, it cannot affect the deduction of VAT by taxable persons who, in the context of the method of actual use, carry out taxable, non-exempt, transactions only, such as catering and entertainment transactions, which confer the right to deduct the VAT incurred.
Alternatively, Varzim Sol claims that the reasoning of the Fazenda Pública, endorsed by the Tribunal Administrativo e Fiscal do Porto, leads to a distortion in the deduction of VAT, in breach of the Sixth Directive as interpreted by the Court of Justice in Case C‑204/03 Commission v Spain [2005] ECR I‑8389 and in Case C‑243/03 Commission v France [2005] ECR I‑8411.

Questions

(1) Is Article 23 of the [VAT Code] compatible with Article 17(2) and (5) and Article 19 of [the] Sixth Directive …?

(2) [If the answer to Question 1 is in the affirmative], is the establishment of a specific deductible proportion of the [VAT] paid by taxable persons carrying out taxable transactions only, albeit by actual use, based on non-taxable subsidies to that sector (‘inputs’), under Article 23 of the VAT Code, compatible with Article 17(2) and (5) and Article 19 of that directive?

AG Opinion

None

Decision

Article 17(2) and (5) and Article 19 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 precluding a Member State, where it authorises mixed taxable persons to make the deduction provided for in those provisions on the basis of the use of all or part of the goods and services, from calculating the deductible amount, for sectors in which such taxable persons carry out taxable transactions only, by including untaxed ‘subsidies’ in the denominator of the fraction used to determine the deductible proportion.

Personal comments/VATupdate

“Grants” used to purchase goods and services — Limitation of right to deduct

Where a Member State allows mixed taxable persons to apply the deduction of input VAT according to the use of the goods and services or of part thereof, a Member State may not, when calculating the deductible amount in the sectors in which such taxable persons carry out only taxable transactions -Include taxable ‘grants’ in the denominator of the fraction used to determine the pro rata of the deduction.

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