Briefing Document & Podcast: C-207/23 (Finanzamt X) – VAT Implications of Free-of-Charge Supplies of Heat

Briefing Document: VAT Treatment of Free Heat Transfers (Y KG vs. Finanzamt X)

Subject: Analysis of CJEU Judgment C-207/23 on VAT Implications of Free-of-Charge Supplies of Heat

Executive Summary

This briefing analyzes the judgment of the Court of Justice of the European Union (CJEU) in Case C-207/23, concerning the VAT treatment of free-of-charge supplies of heat by Y KG to other taxable persons. The ruling provides crucial clarification on two key aspects of the EU VAT Directive (2006/112/EC):

Article 16 (Application of Goods): Confirms that the free-of-charge transfer of business assets, for which input VAT was deductible, constitutes a taxable supply, irrespective of the recipient’s tax status or their right to deduct input VAT. The primary goal is to prevent untaxed final consumption by the initial taxable person.
Article 74 (Taxable Amount – Cost Price): Clarifies that when determining the “cost price” for such applications (in the absence of a purchase price), it must include both direct and indirectly attributable costs, such as financing costs, regardless of whether input VAT was paid on those specific cost components. This ensures the taxable amount reflects the full value of the goods.

The judgment reinforces the principle of VAT neutrality and aims to prevent undue advantages for taxable persons who have benefited from input VAT deductions on goods subsequently disposed of free of charge.

I. Case Background and Factual Summary

Parties: Finanzamt X (Tax Office X, Germany) vs. Y KG. Subject Matter: Imposition of Value Added Tax (VAT) on free-of-charge supplies of heat by Y KG.

Y KG’s Business: Y KG operates a biogas production facility. This facility generates both electricity and heat through a cogeneration plant. While the majority of the electricity produced was sold to the general grid (and was subject to VAT, allowing Y KG to deduct input VAT on the plant’s construction and operating costs), the heat generated was partly reused internally and partly transferred free of charge to other entities.

Disputed Transactions: In 2008, Y KG entered into contracts to transfer “free of charge” the majority of its excess heat to:

Contractor A: for the purpose of drying wood in containers.
Company B: for the purpose of heating asparagus fields. Although the contracts vaguely mentioned that payment would be determined “on an individual basis according to the economic situation of the user,” no specific payment was outlined or invoiced.

Tax Authority’s Position (Finanzamt X): The tax authority argued that these free heat transfers constituted an “application for purposes other than those of its business” or a “free-of-charge transfer of goods” under German VAT law (Paragraph 3(1b) of the UStG), comparable to Article 16 of the VAT Directive. Since Y KG had deducted input VAT on the cogeneration plant, the tax authority considered these transfers subject to VAT. In the absence of a clear purchase price for the heat, it calculated the taxable amount based on the “cost price” as per German law (Paragraph 10(4) of the UStG), similar to Article 74 of the VAT Directive.

Referral to CJEU: The German Federal Finance Court (Bundesfinanzhof) referred three questions to the CJEU for a preliminary ruling to interpret Articles 16 and 74 of the VAT Directive, particularly concerning:

Whether free-of-charge transfers to other taxable persons for their economic activities fall under Article 16, and if the recipient’s input VAT deduction right is relevant.
How the “cost price” under Article 74 should be calculated, specifically whether it’s limited to costs subject to input VAT, and if it includes indirect costs like financing costs.

II. Legal Context: Key EU VAT Directive Provisions (2006/112/EC)

Article 2(1)(a): Establishes that “the supply of goods for consideration within the territory of a Member State by a taxable person acting as such” is subject to VAT.
Article 14(1): Defines “Supply of goods” as “the transfer of the right to dispose of tangible property as owner.”
Article 15(1): Crucially clarifies that “Electricity, gas, heat, refrigeration and the like shall be treated as tangible property,” thus bringing heat within the scope of goods for VAT purposes.
Article 16 (Taxable Transactions – Application of Business Assets):First Paragraph: Treats “The application by a taxable person of goods forming part of his business assets for his private use or for that of his staff, or their disposal free of charge or, more generally, their application for purposes other than those of his business” as a supply for consideration, provided “the VAT on those goods or the component parts thereof was wholly or partly deductible.”
Second Paragraph: Provides specific exceptions for “samples” or “gifts of small value.”
Article 73: Sets the general rule for the taxable amount as “everything which constitutes consideration obtained or to be obtained.”
Article 74 (Taxable Amount – Specific Cases): This article is a derogation from Article 73. It dictates that for applications/disposals under Article 16, the taxable amount shall be:
“the purchase price of the goods or of similar goods”
or, “in the absence of a purchase price, the cost price, determined at the time when the application, disposal or retention takes place.”

III. CJEU’s Rulings and Rationale

The CJEU’s judgment addressed the three referred questions, providing definitive interpretations:

A. First Question: Interpretation of Article 16 VAT Directive (Free Transfer to Other Taxable Persons)

Core Question: Is the free-of-charge transfer of heat from a taxable person’s business assets to another taxable person for economic operations considered a “disposal free of charge” under Article 16, and is the recipient’s input VAT deduction right relevant?

CJEU Ruling: “The first paragraph of Article 16 of the VAT Directive must be interpreted as meaning that the transfer free of charge of heat produced by a taxable person to other taxable persons for the purposes of their economic activities constitutes an application…in the form of a disposal free of charge…that is to be treated as a supply of goods for consideration, and whether or not those other taxable persons use that heat for purposes giving them a right to deduct VAT is irrelevant in that regard.” (Paragraph 48, point 1 of the operative part)

Rationale:

Wording: The Court emphasized that the wording of Article 16 does not impose an additional condition related to the tax status or input VAT deduction rights of the recipient.
Objective of Article 16: The primary goal of Article 16 is “to ensure equal treatment between, on the one hand, a taxable person who applies goods for his own private use or for that of his staff and, on the other hand, a final consumer who acquires goods of the same type.” It aims to “avoid situations of untaxed final consumption” by the initial taxable person who benefited from input VAT deduction. The disposal free of charge itself, by a taxable person who deducted input VAT, is the trigger for taxation, irrespective of the recipient.
Strict Interpretation of Exceptions: The exceptions for “samples” or “gifts of small value” (Article 16, second paragraph) are to be interpreted strictly. The heat transfer did not fall under these.
Practical Difficulties: Considering the recipient’s tax status would create significant administrative burdens for the transferring taxable person, who would be “obliged to carry out investigations in order to verify that status.”
Distinction from Mitteldeutsche Hartstein-Industrie: The Court differentiated this case from Mitteldeutsche Hartstein-Industrie (C-528/19), where works carried out by a taxable person for a municipality (a public road) were not treated as a taxable supply. In that case, the works also benefited the taxable person directly in connection with its economic activity, and the input costs formed part of its output transactions. In contrast, there was “nothing to suggest that the heat applied and disposed of free of charge by Y was also used by Y.”

B. Second and Third Questions: Interpretation of Article 74 VAT Directive (Elements of “Cost Price”)

Core Question: When determining the “cost price” under Article 74, should it be calculated solely on costs subject to input VAT? Should it include only direct production/generation costs, or also indirect costs like financing costs?

CJEU Ruling: “Article 74 of the VAT Directive must be interpreted as meaning that the cost price, within the meaning of that provision, includes not only direct manufacturing or production costs but also indirectly attributable costs, such as financing costs, whether or not those costs have been subject to input value added tax.” (Paragraph 59, point 2 of the operative part)

Rationale:

Derogation from Article 73: Article 74 is a specific rule, used only “in the absence of a purchase price for the goods or similar goods.”
Aim of Cost Price: The cost price should be “as close as possible to the purchase price” of similar goods, accurately reflecting the value of the goods “at the time the application was made.”
Wording of Article 74: The wording does not explicitly limit the cost price to only costs subject to input VAT or only direct costs.
Article 79 (Exclusions): Article 79, which lists items not to be included in the taxable amount, does not mention indirect costs like financing expenses.
Comprehensive Approach: To ensure the cost price accurately reflects the full value, it must encompass “both direct production and manufacturing costs and indirect costs such as financing costs.” This comprehensive approach applies “whether or not those costs have been subject to input VAT.”

IV. Implications of the Judgment

This judgment has several significant implications for taxable persons within the EU:

Broad Scope of Article 16: It reinforces a broad interpretation of “disposal free of charge” under Article 16, extending to situations where goods are transferred to other taxable persons for their economic activities. The key trigger for VAT liability is the initial deduction of input VAT by the transferring taxable person and the subsequent non-consideration disposal, designed to prevent “untaxed final consumption.”
Recipient’s Status Irrelevant: Businesses making free transfers of goods (e.g., promotional items, samples, or, as in this case, by-products) need not assess the recipient’s VAT status or their ability to deduct input VAT to determine if the transfer is taxable under Article 16. This simplifies compliance for the transferring entity.
Comprehensive “Cost Price” Calculation: When a purchase price cannot be determined for goods subject to Article 16, the “cost price” calculation under Article 74 must be comprehensive. It requires including all direct and indirect costs, including financing costs, whether or not input VAT was initially paid on those specific cost components. This ensures a more accurate reflection of the goods’ value and prevents an undervaluation that could lead to an “undue advantage.”
Alignment with VAT Neutrality: The rulings align with the overarching objective of the common system of VAT to ensure neutrality and prevent taxable persons from gaining an undue advantage by deducting input VAT on goods that are then disposed of free of charge without subsequent output VAT.

V. Glossary of Key Terms (Relevant to this Case)

Application of Goods: Refers to a taxable person using or disposing of goods from their business assets for non-business purposes (e.g., private use, disposal free of charge).
Article 16 VAT Directive: Key provision treating certain “applications” or free disposals of business assets as taxable supplies.
Article 74 VAT Directive: Key provision determining the taxable amount for applications/disposals under Article 16, prioritizing purchase price, then cost price.
Business Assets: Property owned and used by a taxable person for their economic activity.
Cogeneration Plant: A facility that simultaneously produces electricity and useful heat.
Cost Price (VAT Directive): The value of goods determined at the time of application/disposal, including direct and indirect costs (e.g., financing costs), regardless of input VAT. Used when a purchase price is absent.
Disposal Free of Charge: Giving away business assets without consideration.
Input VAT: VAT paid by a taxable person on goods/services acquired for their taxable economic activities, generally deductible.
Preliminary Ruling: A procedure where a national court asks the CJEU for an interpretation of EU law, whose ruling binds the national court.
Purchase Price (VAT Directive): The primary basis for the taxable amount under Article 74; refers to residual value or market price of similar goods.
Taxable Amount: The value on which VAT is calculated.
Taxable Person: Any individual or entity independently carrying out an economic activity subject to VAT.
Untaxed Final Consumption: A situation Article 16 aims to prevent, where input VAT is deducted, but goods are then consumed or disposed of without output VAT.
VAT Directive 2006/112/EC: The main EU legal instrument governing the common VAT system.

Briefing Document & Podcast: C-207/23 (Finanzamt X) – VAT Implications of Free-of-Charge Supplies of Heat

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