This document summarises the key findings of the European Court of Justice (ECJ) in a preliminary ruling concerning the interpretation of EU VAT law, specifically Directive 2006/112/EC, regarding the right of a taxable person to deduct input VAT for services relating to the construction or improvement of a property owned by a third party. The case involves a dispute in Bulgaria between the tax authority and Iberdrola, a real estate investor, concerning the deductibility of VAT incurred on works to reconstruct a waste-water pump station owned by the municipality, which benefited both the municipality and Iberdrola’s development project.
Main Themes and Important Ideas:
- Right to Deduct Input VAT: The core of the case revolves around the principle of the right to deduct input VAT as established in Article 168(a) of Directive 2006/112/EC. This right is considered an “integral part of the VAT scheme and in principle may not be limited.” It is intended to ensure “neutrality of taxation of all economic activities.”
- Direct and Immediate Link: The ECJ reiterates the established principle that the right to deduct input VAT generally requires the existence of a “direct and immediate link” between a specific input transaction (the acquired goods or services) and a specific output transaction or transactions giving rise to the right to deduct. The expenditure incurred for the input transaction must be a “component of the cost of the output transactions.”
- General Costs: The Court also confirms that a right to deduct exists even without a direct link to a specific output transaction if the costs are part of the taxable person’s “general costs” and are thus “components of the price of the goods or services which he supplies.” In this scenario, the costs have a “direct and immediate link with the taxable person’s economic activity as a whole.”
- Services on Third-Party Property and Free Supply: The case specifically addresses the scenario where a taxable person incurs costs for services performed on a property owned by a third party, and this third party benefits from the service free of charge. The Bulgarian national law (Article 70(1)(2) of the ZDDS) in question appeared to deny the right to deduct solely because the services were supplied free of charge or for activities other than the taxable person’s economic activity. The ECJ contrasts this with Article 26(1)(b) of Directive 2006/112, which requires both a free supply and use for purposes other than the business for a transaction to be treated as a supply of services for consideration (which is not directly relevant to the input tax deduction issue).
- Dual Use of the Service: A key aspect of the case is that the service (reconstruction of the pump station) was used by both the taxable person (Iberdrola, for connecting its buildings) and the third party (the municipality).
- Objective Content of the Transaction: When assessing the direct link, tax authorities and national courts “should consider all the circumstances surrounding the transactions concerned and take account only of the transactions which are objectively linked to the taxable person’s taxable activity.” The link must be assessed “in the light of the objective content of the transaction in question.”
- Necessity for Economic Activity: The ECJ highlights that, in this specific case, the reconstruction of the pump station was “essential for completing that project” and that, without it, Iberdrola “would not have been able to carry out its economic activity.” This strongly suggests a direct and immediate link.
- Proportionality: The Court introduces the concept of proportionality in such cases. The right to deduct exists “in so far as those services do not exceed that which is necessary to allow that taxable person to carry out the taxable output transactions and where their cost is included in the price of those transactions.” If the works go beyond what is necessary for the taxable person’s activity, the right to deduct is limited to the portion objectively necessary for that activity.
Most Important Ideas/Facts:
- The central question was whether a taxable person has the right to deduct input VAT for services on a third party’s property, even if the third party benefits free of charge, when the services are used in the taxable person’s economic activity.
- The ECJ ruled that Article 168(a) of Directive 2006/112/EC precludes national law that solely restricts the right to deduct based on the free supply to a third party, without considering whether the services are used in the taxable recipient’s economic activity.
- A taxable person does have the right to deduct input VAT in such circumstances, provided there is a direct and immediate link between the input services and the taxable person’s economic activity or output transactions.
- This link can exist if the services are essential for the taxable person’s economic activity or if the costs are part of their general costs that contribute to the price of their output supplies.
- Crucially, the right to deduct is limited to the extent that the services are objectively necessary for the taxable person to carry out their taxable output transactions and their cost is included in the price of those transactions. If the services exceed this necessary scope, the deduction is proportionally limited.
- The fact that a third party also benefits free of charge does not automatically negate the right to deduct for the taxable person, provided the services are linked to the taxable person’s economic activity.
Quote from the Original Source:
The concluding paragraph of the judgment encapsulates the ruling:
“Article 168(a) of Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax must be interpreted as meaning that a taxable person has the right to deduct input value added tax in respect of a supply of services consisting of the construction or improvement of a property owned by a third party when that third party enjoys the results of those services free of charge and when those services are used both by the taxable person and by the third party in the context of their economic activity, in so far as those services do not exceed that which is necessary to allow that taxable person to carry out the taxable output transactions and where their cost is included in the price of those transactions.”
See also
- Join the Linkedin Group on ECJ/CJEU/General Court VAT Cases, click HERE
- VATupdate.com – Your FREE source of information on ECJ VAT Cases
