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Raphaël Glohr and Michel Lambion Deloitte Tax & Consulting, Luxembourg
Raphaël Glohr is a Partner and Michel Lambion is a Director with Deloitte Tax & Consulting Luxembourg
Recent decisions by the CJEU reducing the scope of the VAT exemption for services to an independent group of persons will have an impact on the financial sector when sharing costs and resources. However, Article 11 of the VAT Directive provides an alternative measure for managing VAT costs.
In different decisions, the Court of Justice of the European Union (“CJEU”) has dramatically reduced the scope of application of the exemption of services of independent groups of persons (“IGP”s) by denying that the financial sector could benefit from it. This should encourage EU member states which have not yet introduced the VAT unity in their legislation to do so, even if it would not solve all difficulties caused by these decisions, especially due to the absence of cross-border effect.
One of the basic principles of VAT is that it should not be a cost for businesses, with businesses acting only as the collectors of the tax on behalf of their national tax authorities. Nevertheless, like all general principles, this is subject to numerous exceptions. One of these exceptions results from the exemption from VAT, provided for within Directive 112/2006/EC (the “VAT Directive”), of a number of different operations, the most important and well known of which are financial services and insurance, and public interest activities. The exemption of certain operations from VAT results in the businesses undertaking such operations being denied, wholly or partially, the right to recover VAT incurred on their costs. While the denial of such VAT recovery is a deliberate part of the overall VAT regime, it becomes particularly burdensome for businesses operating in the exempted sectors which group together to share their costs.
Acknowledging this burden, Article 132 (1)(f) of the VAT Directive exempts from VAT, under some conditions, services rendered by IGPs to their members. The services should be “directly necessary” for the activities of the members and these activities must be either VAT exempt, or not fall within the scope of VAT (i.e., non-business activities such as those of public bodies or holdings). The remuneration of the services should be limited to the reimbursement of the costs incurred by the IGP. Lastly, the exemption must not be likely to cause distortion of competition. Unlike the VAT unity measure, the transposition of this exemption is not within the discretion of the EU member states, but forms an indivisible part of the EU VAT regime.
Where the member states do have discretion, however, is the manner in which they implement this exemption. The drafting of the exemption in the VAT Directive is rather vague, and it is left to the individual member states to determine how best to adapt the practicalities of the exemption to their national VAT regimes. As is often the case, this lack of detail in the VAT Directive has led to a number of decisions of the CJEU.
Luxembourg adopted pragmatic rules around the application of the IGP regime. Despite providing a clear and precise legal framework, and being well justified by economic reasons, three of these rules were found to be contrary to the VAT Directive by the CJEU on May 4, 2017 (C-274/15, May 4, 2017, European Commission v Luxembourg: http://src.bna.com/vQV).
The first of these provisions relates to the activities undertaken by the members of an IGP.
One of the conditions of the application of the exemption provided for within the VAT Directive is that the members undertake an activity which is either exempt from VAT (such as, for example, financial services or insurance), or in respect of which it does not have the status of taxable person (i.e., “non-business” activities, for example, public bodies undertaking governmental activities or charities). It is often the case, however, that businesses predominantly undertaking such VAT-exempt or non-business activities also undertake some taxable activities alongside these. For example, a finance company might have a sideline in private wealth management, or a hospital could generate revenue from its car park and cafeteria.
The CJEU, however, ruled that the services rendered to a member by the IGP should only be used by that member in the furtherance of VAT-exempt or non-business activities. The Court was concerned that the 30 percent taxable threshold foreseen by the Luxembourg VAT law enabled the members to use the VAT-exempt services rendered by the IGP in the furtherance of their taxable activities. It seems to us, however, that there is little foundation for such a fear. Where an entity undertakes taxable activities there would be no advantage to be gained by its incoming costs being exempted from VAT, as any VAT otherwise incurred on such costs could be recovered by the entity as a result of the normal operation of the VAT regime. On the contrary, receiving VAT-exempt supplies could be expected to disadvantage the entity, as its supplier could be expected to include the amount of non-deductible VAT it incurred on its own costs in the calculation of the net value of its services (“embedded VAT”).
The second provision overturned by the CJEU enabled the members of the IGP to recover the VAT incurred by the IGP on its costs. To the extent that the IGP only made VAT-exempt supplies of services to its members, it had no right to deduct the VAT it incurred on goods and services purchased in the course of making those supplies. Under the Luxembourg regime, however, some of the members of the IGP could have activities giving the right to deduct input tax on their costs. Therefore, the incoming costs being borne by the IGP rather than the members themselves results in a loss of that right of deduction. It was with this loss in mind, and the desire to maintain fiscal neutrality, that the Luxembourg legislator granted the right to a member to deduct input tax, in line with its general input tax deduction right, borne by the IGP on the proportion of its costs used to make services to that member in particular.
The CJEU opposes the granting of such a deduction right to the member based on a strict reading of the provisions of the VAT Directive addressing the right to deduct input tax, which require that only the actual recipient of the cost itself has the right to recover the VAT charged thereon. Where an IGP, as a distinct taxable person from its members, is the recipient of a cost, the right to deduct the input tax incurred by the IGP cannot be transferred to the member.
The final provision deemed to be in breach of the VAT Directive was the Luxembourg interpretation that members' pooling of their resources into the IGP by transferring their goods and services thereto should not be seen as supplies of those goods and services within the scope of VAT. This interpretation allowed the papering over of certain difficulties the IGP—without legal personality—faced in acquiring goods and services and, moreover, in respect of employing staff. The CJEU pointed out, however, that the desire for practicality caused Luxembourg to ignore the requirement that the IGP be seen as a distinct taxable person from its members, and the fundamental principle that the transfer of goods and services between two taxable persons falls within the scope of VAT.
The decision of the Court implies some limitations to the application of the IGP regime but these limitations are not restrictive to the extent that they would make impossible or excessively difficult the setting up and the running of an IGP.
The story does not end here, as the CJEU delivered three further cases addressing the scope of the IGP exemption on September 21, 2017. The first addresses infraction proceedings brought by the European Commission against Germany (C-616/15, September 21, 2017, European Commission v Germany: http://src.bna.com/vQW), challenging the exclusion from the scope of the exemption in the German legislation of members operating in any industry other than the medical industry (primarily, but not solely, hospitals). Advocate General Wathelet's opinion in this case argued that such a restriction was not justifiable within the scheme of the VAT Directive and the Court followed this opinion, ruling that for the German legislature to restrict the scope of the IGP exemption to the medical industry was too strict and thus contrary to the Directive.
In this case and two other cases, namely DNB Banka (C-326/15, September 21, 2017: http://src.bna.com/vQY) and Aviva (C-605/15, September 21, 2017: http://src.bna.com/vQZ), the CJEU restricted the scope of the IGP to the public interest activities.
Advocate General Kokott developed her conclusions in the Aviva case regarding the exclusion of financial and insurance activities from the IGP exemption. The reasoning of the Advocate General is based on the wording and purpose of the exemption and a schematic interpretation of the exemption.
Advocate General Kokott states that the purpose of the IGP exemption is to
(…) ensure that an undertaking which must buy services because, for example, it is not large enough to provide them itself is not placed at a competitive disadvantage by comparison with an undertaking which is able to have the services supplied by its own employees or as part of a VAT group. (Paragraph 20 of the conclusions in case C-605/15)
The result of this exemption is to avoid an undertaking suffering from non-recoverable VAT when it had to use some services that it could not produce with its own resources, because this unrecoverable VAT would have to be supported by the final consumer.
The Advocate General also points out that the tax exemptions are to be interpreted strictly and that the interpretation adopted must nonetheless be guided by the purpose and intended effect of the provision in question. She considers that the purpose of the IGP exemption is to extend other exemptions and that the question arises, what are these exemptions?
Advocate General Kokott completes her reasoning with a schematic interpretation of Article 132 (1)(f). She points out that Article 132 (1)(f) is not a general provision applicable to all exemption and does not appear under the “General provisions” heading to Chapter 1 of Title IX (“Exemptions”). She emphasizes that the European legislature decided instead to put this exemption under the heading “Exemptions for certain activities in the public interest” which are intended to relieve consumers on public interest grounds: these activities are typically social welfare, medical activities, and education.
The Advocate General also refers to the drafting history of the VAT Directive, which does not support the inference that groups of banks or insurance companies were also to be included. She found a further argument in the efforts of the European Commission to have this exemption extended by the legislature to the banking and insurance sectors and the fact that, as the Commission conceded at the hearing, the Council did not take up this option. Consequently, she concludes that in light of the schematic position of Article 132(1)(f), it is not possible to extend by a broad interpretation the scope of application of the exemption to financial activities.
Furthermore, the Advocate General examined the question of the principle of tax neutrality. She found that refusing the IGP exemption to insurance and financial activities does not infringe this principle. She stated that the difference of treatment of an IGP in the public interest sector (VAT-exempt services) and in the financial sector (VAT taxable services) results from the activities pursued by the members of these groups and is justified by these activities. She thus considers that the type of activities is a differentiation criterion that is sufficient to prevent any objection from the point of view of the principle of neutrality.
The Advocate General proposes a further argument that could be considered somewhat contradictory. She considers that an exemption without right to recover input VAT should be interpreted restrictively because such an exemption creates an incentive for an undertaking to minimize its own input VAT burden by “insourcing”, that is to say, absorbing activities into its own organization. We found this argument difficult to understand. The aim of the IGP is, precisely, to avoid an additional VAT burden when a person who cannot recover VAT “outsources” some activities. By its nature, such an exemption creates a difference of treatment. Moreover, Advocate General Kokott recognizes that this situation might be at odds with the principle that operators must be able to choose the form of organization without running the risk of having their operations excluded from an exemption.
Despite a slightly different wording, the CJEU in both cases followed the opinion of the Advocate General. The Court focused, in particular, on the objective of the IGP exemption, which is to avoid undesired additional VAT cost for activities in the public interest.
Taking the position that the IGP exemption is limited to public interest activities, the Court did not answer the questions raised by the referring courts in the two cases; unlike the Advocate General, who made some interesting comments.
In the Aviva case, Advocate General Kokott answered questions regarding the condition that the IGP should not lead to distortion of competition. Interestingly enough, she sets as a rule that the IGP exemption should not give rise to distortion of competition because these services are limited to the public interest activities, and that it is not required that the national law should foresee criteria or procedures with respect to this condition. She also considers that the criterion of a provision for the avoidance of abuse must be interpreted restrictively.
Lastly, the Advocate General considers that an IGP may supply exempt services only to those of its members which are subject to the same legal system as itself. She thus denies any cross-border effect to the IGP. She justifies this position by the history of the exemption that was in the sixth EU VAT Directive included in the heading “Exemptions within the territory of the country.” She adds as a further argument that only Chapters 4 to 8 and 10 of Title IX of the VAT Directive relative to the VAT exemption deal with special exemptions for cross-border transactions. She also made a comparison with the VAT unity regime of Article 11 of the VAT Directive, which is strictly limited to persons closely bound established in the same member state. She considers that this regime is based on more stringent requirements than the IGP exemption and that it will thus be inconsistent to give a cross-border effect to the less stringent regime (IGP) and to deny this effect to the more stringent one (VAT unity).
Advocate General Kokott also offered answers to several interesting questions in the DNB Banka case. She considers that an IGP does not have to be a legal person but should be a taxable person. Consequently, a group of related companies could not be seen as an IGP. She also rejects that a simple flat-rate cost uplift required under the legislation on direct taxation could be applied on the price of the services of the IGP. The consideration paid to the IGP should be limited to the expenses incurred by the IGP.
Unfortunately, the decisions of the CJEU in these two cases are limited to stating that the IGP could be set up only by the public interest sector, and the Court did not answer any of the questions raised by the referring courts. We believe that this is a pity, because some of these questions remain of interest even if the scope of the IGP is limited to the public interest sector. In particular, the possibility to set up an IGP with members established in different member states is certainly relevant to persons engaged in public interest activities. It is difficult to predict what would be the answer of the Court should the question be raised again. However, we believe that a negative answer is more than likely. Indeed, as mentioned above, the Advocate General's opinion is that the members of an IGP should be established in the same member state. Her reasoning is based on the purpose and intended effect of the exemption as well as the place of Article 132 (1)(f) in the VAT Directive and the Court has adopted the same reasoning to limit the IGP regime to public interest activities. A further argument could be found in the fact that the member states have the power to define the beneficiaries of several of the exemptions of Article 132 (1)(f) or to limit the exemption to beneficiaries duly recognized by them. Based on these elements, we thus believe that the most reasonable interpretation is that the members of an IGP must be established in the same member state.
The decisions of the CJEU came as a surprise to most professionals and to the financial sector.
The first reason for this is that Advocate General Kokott had the opportunity to raise the question of the application of the IGP exemption to insurance and financial services in her conclusions regarding the Luxembourg case. Moreover, the referring courts did not raise the question in the Aviva and DNB Banka cases. It was thus a surprise to see Advocate General Kokott delivering an opinion on this unasked question and to see two Advocates General, Mrs. Kokott, and Mr. Wathelet in the German case, taking opposite views.
Moreover, the CJEU, in its previous jurisprudence, never took this position. In its Taksatorringen case (C-8/01, November 20, 2003: http://src.bna.com/vQ0), the Court answered different questions related to an IGP set up by insurance companies and did not consider that the IGP exemption was not available for the insurance and financial services. It would have been possible for the Court to already adopt this position in the case relating to the Luxembourg regime ruled on May 4, 2017.
In this respect, Advocate General Kokott mentioned that the circumstance in which the judgment in Taksatorringen was delivered with respect to insurance companies does not preclude her interpretation that the IGP exemption should be limited to the public interest sector, because the question presented to the CJEU in that case related only to the risk of distortion of competition and the Court's answer was confined to that issue. However, at the risk of repeating ourselves, we do not see that the question was put to the CJEU in the Aviva and DNB Banka cases or that this position of the Advocate General was necessary to address any of the questions raised to the Court.
Moreover, the European Commission has published a number of documents where it clearly considers that the IGP should be available for the insurance and financial sectors. For example, in the frame of its review of the exemption applicable to the insurance and financial sectors, the texts proposed by the Commission always contained this exemption as applicable to these sectors, and the Commission has always defended that the IGP exemption should be available for the public interest sector and for the insurance and financial sectors (see e.g., document taxud.d.1. (2019) 12337-EN, March 3, 2010, VAT Committee, Working paper n°654, article 132 (1)(f)—Scope of the exemption).
The most recent example of the Commission's views is the infringement action lodged by the Commission against Germany. The position of the Commission in this case is extremely clear:
According to the Commission, the exemption laid down in that provision is not limited to IGPs whose members carry on activities in the public interest, but covers all IGPs whose members carry on activities exempt from VAT. (Paragraph 25 of case C-616/15)
The CJEU itself seems to realize the impact of its decision and seems willing—to a certain extent—to soften it when it stipulates that:
(…) it should however be noted that national authorities could not reopen tax periods which have been definitively closed” (…). As regards tax periods which have not yet been definitively closed, it must be recalled that (…), a directive cannot of itself impose obligations on an individual and cannot therefore be relied on as such against that individual (…). Thus, national authorities cannot rely on Article 132(1)(f) of Directive 2006/112, as interpreted in paragraph 37 above, in order to withhold that exemption from IGPs made up of entities such as credit institutions and, therefore, in order to refuse to exempt the supply of services by those IGPs from VAT. In addition, the obligation on a national court to refer to the content of a directive when interpreting and applying the relevant rules of domestic law is limited by general principles of law, particularly those of legal certainty and non-retroactivity, and that obligation cannot serve as the basis for an interpretation of national law contra legem (…). (Paragraphs 36 and 37 of case 605/15 and 41 and 42 of case C-326/15)
Even if these legal considerations are not new, it is quite exceptional that the Court expressly and so clearly repeats them.
The culmination of these decisions of the CJEU drastically reduces the potential benefits of establishing an IGP. This exemption now appears to be available only for groups of members undertaking activities in the public interest, with players in the financial and insurance sectors finding themselves wholly excluded from an instrument that had previously proved highly useful in managing costs.
We should be grateful therefore, that Article 11 of the VAT Directive foresees an alternative measure for managing VAT costs, which could arise in respect of intra-group transactions; namely, the VAT unity regime. The basic principle of a VAT unity is that a number of legally independent entities which are closely linked from an economic, operational and organizational viewpoint could be considered to form a single taxable person, meaning that all intra-group transactions fall outside the scope of VAT.
Whilst this measure broadly seeks to obtain the same outcome as the IGP regime, i.e., to enable the sharing of costs between a group of entities without resulting in additional VAT costs, there are a number of differences in scope and application between the IGP exemption and the VAT unity regime.
The first of these differences is the scope of activities the members of a VAT unity may undertake. VAT unity members can operate in any sector, undertaking any type of activity, whereas, further to these recent CJEU rulings, activities of the members of an IGP must be in the public interest. Another difference is that members of a VAT unity must be established in the same member state, while it was possible for members established in different member states to set up an IGP (even if, as mentioned above, the Court did not answer this question). A last important difference is that the VAT unity regime, unlike the IGP regime, is not limited to services “directly necessary” to the activities of the members but includes all supply of goods and services between the members.
In conclusion, the decisions of the CJEU came as a surprise to the professionals and the financial sector who have used the IGP regime since the introduction of the sixth Directive in 1977. The financial outcome is difficult to evaluate at the EU level. However, it is worth mentioning that the impact for the French insurance and financial sectors is estimated to be 2 billion euros, or 13 percent of the VAT supported by these sectors (“ Banquiers et assureurs aux prises avec leur régime de TVA,” Sharon Wajsbrot, Les Echos, October 5, 2017).
In view of the IGP regime being rendered essentially inapplicable for the financial sector, the need to establish a VAT unity regime has become inescapable for member states, such as France or Luxembourg, that have not yet implemented this regime (at December 31, 2017, 17 member states had implemented it). Such a regime should be adopted as soon as possible to minimize the damage to taxable persons who will now face a compounding VAT charge as a result of the elimination of their IGP arrangements.
Another alternative would be to change the VAT Directive to make the exemption also available for the insurance and financial sectors. However, as with any change of the Directive, this implies the unanimous agreement of the member states including Germany, which, before the decisions of the CJEU, had an even more restrictive interpretation of the scope of the exemption. Taking into account its efforts to make the IGP exemption efficient, the Commission would more than likely support such initiative and so would member states where the IGP exemption was commonly used: however, it would without any doubt be a long process.
Copyright © 2018 The Bureau of National Affairs, Inc. All Rights Reserved.
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