Background
A business may in principle deduct input VAT in so far as the costs are incurred for the purposes of its taxable economic activities. The purpose of the right to deduct VAT is to relieve businesses of any VAT costs.
If goods are disposed or services are provided free of charge (FOC), then the VAT paid on costs used for these free-of-charge (FOC) supplies is generally not deductible since such activities are considered to be non-economic activities which do not give a right to deduct any input VAT.
Alternatively, a business could become liable for VAT on so-called “deemed supplies” if it deducted input VAT on the costs. Article 16 of the EU VAT Directive (VD) provides that VAT should be charged on disposal of goods FOC or, more generally, their application for purposes other than those of business if VAT became deductible on those goods.
ECJ Case C-207/23 (Y KG)
The ECJ in its decisions has explained how VAT applies if the goods or services are disposed FOC. In its recent decision in Case C-207/23 (Y KG), the ECJ further clarified how VAT applies on FOC supplies.
Facts
Company Y produces biogas from biomass, converting it into electricity for the grid and heat for industrial use. Y had recovered VAT in full on the facility which produced the heat, and Y made that heat available FOC to neighboring asparagus farmers. The German tax authorities assessed Y for VAT on a deemed supply of goods because it had given away the heat FOC. Y should pay VAT on supply of heat FOC, based on the heat's cost price. Y contested this, and the Federal Finance Court referred the case to the ECJ.
Questions
The German Federal Finance Court referred the following questions to the ECJ:
- Does the application of Article 16 of the VD — concerning disposals of goods FOC — depend on whether the recipient uses the heat in a VAT-deductible manner?
- How should the cost price of goods be calculated for VAT purposes?
Main conclusions of the decision
Is supply FOC taxable if the customer uses goods for its VATable transactions?
The ECJ clarified that Article 16 VD applies regardless of the recipient's use of the goods.
The conclusions of the ECJ in the case C-528/19 (Mitteldeutsche Hartstein-Industrie) were not applicable, as in that case the extension of the public road benefited the taxable person making the disposal FOC and had a direct and immediate link with its overall economic activity and, second, the cost of the input services received and linked to those works formed part of the cost elements of that taxable person’s output transactions.
By contrast, there was nothing to suggest that the heat was also used by Y. Costs were not made for economic activities of Y but for economic activities of farmers who received the heat FOC. Therefore, VAT became payable on deemed supplies although nothing was paid by the farmers.
How should the cost price of goods disposed FOC be calculated for VAT purposes?
The taxable base for VAT (when no purchase price is available) is the cost price, including direct and indirect (e.g. financing expenses) costs, irrespective whether those costs were subject to input VAT or not. The taxable value of deemed supplies should be as close as possible to a market value of similar goods.
Previous ECJ rulings
If the goods or services are disposed FOC this does not mean that VAT always becomes payable on deemed supplies or that VAT related to those services is non-deductible.
The ECJ has rules in its rulings (e.g. in Sveda (C-126/14), Iberdola (C-132/16) and Mitteldeutsche Hartstein-Industrie (C-528/19) that in principle, a VAT payer can deduct input VAT even if a third party benefits FOC from its activities.
In Sveda, the ECJ found the costs made for the construction of the trail made accessible FOC were included in the services which were later performed to the visitors of the trail. In Iberdola, the ECJ decided that, in principle, the right to deduct input VAT may exist for a supply of services consisting of building and renovating a property owned by a third party.
The ECJ imposes a condition that FOC supplies from which third parties benefit (‘spillover effects’), may not go beyond what is necessary to enable the VAT payer to carry out its own taxable transactions and their cost should be included in the price of those own transactions. From the case law of the ECJ it follows that in order to deduct input VAT in situations with spillover effects, the costs made should be “objectively necessary”’ and “not unreasonable.”
Conclusion
VAT can be deductible on expenses if they benefit a person other than the entrepreneur itself.
The VAT payer may deduct the VAT in full if, first, there is a direct and immediate link between that expenditure and the VAT payer’s economic activity, and second, the benefit to the third party is ancillary to the VAT payer’s business purposes.
If costs are incurred that only benefit a third party, input VAT is only deductible if those costs are passed on (with VAT) to the third party.
However, if the VAT has been deducted on costs made for the goods or services disposed FOC, then the VAT may become payable on deemed supplies, if the costs are not re-charged; and the goods do not benefit the business itself.
What are the practical consequences?
Entrepreneurs must ensure that the following conditions for VAT deduction are met when a third party benefits FOC from their activities/costs:
- Costs should be included in the price of its own output transactions.
- If a third party benefits from the costs FOC, the benefit to the third party should be ancillary to the VAT payer’s own business purposes. Such costs should be unavoidable and reasonable.
- The goods disposed FOC may not go beyond what is necessary to enable the VAT payer to carry out its own taxable transactions.
- If the output transactions only benefit third parties and the costs are not re-charged, then either the input VAT is not deductible or VAT becomes payable on deemed supplies.
When goods are disposed FOC, then the taxable of deemed supplies includes all costs including those on which input VAT was not deductible.
Businesses should also keep in mind that the EU member states apply the VAT rules in different ways.
Every case is different, and the facts and circumstances of it should be analyzed on a case-by-case basis in the light of legislation and ECJ case law. Please contact us if you have any questions or need any VAT advice.
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