Germany: Input VAT deduction on costs incurred on the sale of a company
Daniel Keller, André Henning and Christian Schubert of PwC Germany discuss the VAT perspective of the German Supreme Tax Court in its first decision regarding input VAT deduction for costs incurred for the sale of company shares. They then compare it to the ECJ decision in AB SKF.
It has been a while since the ECJ rendered its decision in AB SKF (C-29/08). We are still aware of this highly anticipated decision and the principles set out therein. The AB SKF decision is a yardstick in determining the VAT implications to holding companies and similar constructs. The VAT position, specifically with respect to input VAT deduction of holding companies and similar constructs, has already been subject to significant ECJ decisions. It all started with the Polysar decision (C-60/90), which was followed by many other cases. .
The VAT implications of purchasing shares/assets and holding administrating shares of a company have finally been resolved. With the AB SKF decision in mind, we are now able to take a deeper look into the treatment of the input VAT deduction of costs incurred in connection with the sale of company shares or assets (whether sold in whole or in part, or in one or a series of transactions).
AB SKF sold shares of two either wholly owned or previously wholly owned companies with the intention to finance the group's business activities. Costs incurred in connection with the sale for which input VAT deduction was in question.
Based on the facts in question, the ECJ came to the following conclusions:
In line with its prior decisions, the ECJ reiterated that the holding and administration of shares does not qualify as an economic activity within the meaning of the EC VAT Directive. If a (holding) company – despite its right as the owner of the shares – actively controls and supervises its affiliated companies and provides services, in exchange for remuneration in the fields of administration, technique, marketing and others, the (holding) company constitutes an economic activity and becomes an entrepreneur. The same VAT treatment applies to companies purchasing and selling shares on a regular basis or in cases where the purchase of shares is designed to promote the continuous widening of the business activity (so-called strategic shares).
According to the ECJ, if a (holding) company qualifies for an economic activity by actively controlling its affiliates, the termination of this relationship by selling the whole shares is covered by this economic activity within the meaning of the EC VAT Directive.
Based on the second question referred to the court, the ECJ came to the conclusion that the VAT exemption of article 135 par. 1f EC VAT Directive is not limited to cases of typical share trading if the sale itself qualifies for an economic activity. According to the ECJ, AB SKF sold the shares as part of its economic activity, and the sale of shares by AB SKF therefore is VAT exempt pursuant to article 135 par. 1f of the Directive.
The third and key question was the deductibility of input VAT incurred by AB SKF for consulting services received in connection with the sale of shares. Following the principles of input VAT deduction, the ECJ held that the costs must be directly connected to the taxable transaction. If such a direct connection cannot be found, the costs may be connected to the general business activity. A possible input VAT deduction is then determined by which type of output transactions exist (such as taxable, zero-rated, exempt).
In lines 61 to 63 of AB SKF, the ECJ describes the necessity of including the consulting costs in the sales price of the shares in order to have a direct connection. Neither the comments raised by AB SKF nor the documentation AB SKF provided to the court supported that.
Therefore, in cases where costs are incurred for the sale of shares which cannot be directly connected to the sales price, the ECJ held that the principle of neutrality requires the possibility of an input VAT deduction for such costs, no matter if the sale is out of scope for VAT, or VAT exempt.
Decision of the German Supreme Tax Court
The facts were as follows: company A was head of a fiscal unity for VAT purposes pursuant to article 11 of the Directive, which Germany implemented as part of its federal legislation. A sold all of its shares, in which it held a 99% stake, in its dominated company B to a company C.
A received various consulting services, which are subject to German VAT, in connection with the sale of the shares. The German tax authorities denied a deduction for the German input VAT as the sale of shares qualified for VAT exemption.
The German Supreme Tax Court also held that input VAT is not deductible as the costs are directly connected to the VAT exempted sale of shares.
At first, the German Supreme Tax Court outlined that the sale of shares qualifies as an economic activity as A actively controlled, supervised and provided services in exchange for remuneration to company B. Despite the fact that Germany had implemented article 19 and 29 of the VAT Directive into national law, the sale of shares did not qualify as a transfer of a going concern. A transfer of a going concern within the meaning of the law requires 100% of the shares to be sold (A sold 99% of the shares). Only the complete sale of all of the outstanding shares of a company meets the requirements of a transfer of all assets and debts of a company.
In addition, the sale of 99% of the shares of company B may still qualify as a transfer of a going concern if the dominated company B will be integrated in a fiscal unity for VAT purposes within the purchasing company's structure. According to the German Supreme Tax Court, all of company B's assets and debts would then be transferred as a whole business to the purchaser.
Regarding the input VAT deduction, the German Supreme Tax Court outlines the direct connection between the consulting costs and the VAT exempted sale of shares. It is not decisive that the money received for the sale of shares is used for taxable business activities as this is just an indirect benefit.
Quoting the ECJ cases Midland Bank (C-98/98) and BLP (C-4/94), the German Supreme Tax Court held the objective nature of a transaction to be decisive when assigning an incoming transaction to an output transaction. Therefore, the German Supreme Tax Court was of the opinion that the consulting costs arose only due to the sale of shares. In other words, the sale of shares caused the consulting costs and can therefore be directly attributed to them.
Before starting with the critical review of the German Supreme Tax Court's decision, it shall be outlined that the position of input VAT deduction of a taxable person cannot be determined solely when selling shares/assets. The yardsticks are set earlier.
In AB SKF (line 35), the ECJ emphasised the determination of the sale as an economic activity to be in the scope of VAT, which allows – under certain circumstances – for an input VAT deduction.
Based on the above, it is therefore important to keep files and documents available for purchases of companies as one never knows when such companies are going to be sold.
Generally speaking, there are two situations to consider when selling affiliates: whether the sale will be structured as an asset deal or share deal.
An asset deal is usually characterised by a sale of a taxable person's assets and/or debts whether in whole or in part, or in one or a series of transactions.
If a member state has opted to implement articles 19 and 29 of the EC VAT Directive, the question arises whether the asset deal qualifies for a transfer of a going concern. According to ECJ decision Zita Modes (C-497/01) a transfer of a going concern that is out of scope for VAT purposes requires, at a minimum, that the key assets be transferred to the acquirer. The question of what constitutes key assets of a concern has not been referred to the ECJ to date. The ability to rent out a key asset (such as real estate) to the acquirer of a business on a long-term basis has been accepted by the German jurisprudence without jeopardising the effects of articles 19 and 29 EC VAT Directive (please refer to the current case pending before ECJ for short-term rental of a key asset, decision of the German Supreme Tax Court as of July 14 2010, XI R 27/08).
If the preconditions of a transfer of a going concern are not fulfilled, each asset and liability being purchased must be considered separately for VAT purposes. Any VAT exemption or zero-rating rule will have to be separately determined for each single asset/debt group.
A share deal is a considerably more complex construct to consider for VAT purposes. Instead of selling assets and/or debts of a taxable person the shares itself are sold.
A sale of shares qualifies as a supply of services (ECJ Swiss RE, C-242/08 and confirmed by the German Supreme Tax Court in its decision as of January 27 2011) as a right of ownership is sold. There are four possible situations to keep in mind when a share deal takes place:
A transfer of a going concern;
A sale of shares of a dominated taxable person within a fiscal unity for VAT purposes;
A VAT-exempt sale of shares;
A non-economic activity.
Unfortunately, the ECJ did not comment on the possibility of a transfer of a going concern in its AB SKF decision. The comments made in lines 35 to 42 are not useful as the ECJ solely refers to article 19 of the Directive (supply of goods). However, it did not consider article 29 (supply of services), which would be the correct article to refer to.
Pursuant to the decision of the German Supreme Tax Court from January 27 2011 a share deal can qualify as a transfer of a going concern if 100% of the shares are sold or if at least more than 50% of the shares are sold and the taxable person being sold qualifies as a dominated taxable person within a fiscal unity for VAT purposes. In addition, the acquirer must intend to include the acquired business into a new fiscal unity for VAT purposes.
It is unclear why the German Supreme Tax Court held that the acquirer must intend to include the business into a new fiscal unity for VAT purposes.
Articles 19 and 29 of the Directive do not require anything more than the acquirer's intent to continue. This is clearly confirmed by comments made by the ECJ in Zita Modes (C-497/01; lines 40 and 42). Additionally, the fact that the acquirer is seen as the successor to the transferor is a logical consequence but not a legal requirement (C-497/01; line 43). Therefore, the German Supreme Tax Court cannot request that the acquirer must have the intention to include the business into a new fiscal unity for VAT purposes.
Unfortunately, the German Supreme Tax Court did not decide the question whether a sale of all shares made by all share owners to one taxable person qualifies as a transfer of a going concern pursuant to article 29. The German Supreme Tax Court might have taken this question into account if the claimant had not brought forward this fact too late in the proceedings.
The German Supreme Tax Court has also denied a transfer of a going concern in cases where less than 100% but more than 50% of the shares are sold. Such sitautions are considered as a VAT -exempted sale of shares pursuant to article 135 par 1f of the EC VAT Directive. Therefore, the question remains if and how a transfer of an independent part of a business is possible when there is a sale of shares that is covered by article 29. Coming from the principle of equality, it should not make a difference the way a taxable person chooses to sell a business. In any case, asset deals as well as share deals change the legal ownership to a taxable person.
It could be argued that an independent part of a business within the meaning of article 29 is fulfilled when there is a sale of more than 50% of the total shares. A problem with share deals is the determination of a sale as a business in total (transfer of a going concern) or as an independent part of a business as assets/debts are only indirectly sold. This is an important question for the future, and so far it has not yet been referred to the ECJ. The German Supreme Tax Court has – based on AB SKF – denied this treatment.
Based upon the decision of the German Supreme Tax Court, a sale of shares of less than 100% triggers a VAT-exempted supply of services pursuant to article 135 par. 1f EC VAT Directive if the seller has carried out an economic activity by actively controlling and supervising the company. An option to taxation is possible if the recipient is considered as a taxable person.
Both the ECJ (C-29/08, line 35) and the German Supreme Tax Court very clearly pointed out that a sale of shares only falls within the scope of the EC VAT Directive If the business to be sold was actively controlled and supervised. As a result, if the taxable person just held and administrated its shares in the company to be sold, neither the purchase nor the sale will be considered an economic activity (ECJ Polysar C-60/90, C-102/00 Welthgrove, C-16/00 Cibo Participations). The purchase, the holding and administration, and the sale of such shares take place alongside the business sphere.
Input VAT deduction
This section will focus on the general authorisation to deduct input VAT, but not to the deductibility in and of itself.
The general authorisation to deduct input VAT is a common mechanism within the system of VAT (ECJ BP Soupergaz C-62/93, Uszodaépít C-392/09). The right to deduct input VAT can generally not be limited or threatened.
VAT is due to on every chain of economic value added. It is widely connected to a supply of services rendered or supply of goods carried out.
For this reason, the ECJ points out the general necessity of a direct connection between an input transaction to an output transaction (ECJ AB SKF, C-29/08). The VAT-based qualification of an output transaction (taxed, zero-rated, or exempt) – and, in some cases the intent to perform them – determines the authorisation to deduct input VAT.
Another fundamental ECJ principle is, in case there is no direct connection between an input transaction and an output transaction, the general business activity determines a taxable person's right to input VAT deduction. This is acceptable as long as an economic activity is at hand. A taxable person having both an economic activity (economic sphere) and a non-economic sphere the right to input VAT deduction is to be estimated based on the general qualification of all output transactions as the non-economic sphere is not taxed, and not even deemed to be taxed (ECJ VNLTO; C-515/07).
The key question is: based on which facts can costs be directly attributed to the sale of a business (either as a sale of shares or assets) or can be directly attributed to the general activity of a taxable person?
The German Supreme Tax Court answers that question based on its interpretation of the ECJ decisions Midland Bank (C-98/98), BLP (C-4/94) and AB SKF (C-29/08). Interesting to note is the fact that the German Supreme Tax Court, having cited only AB SKF since that point, is now turning to Midland Bank and BLP.
According to the German Supreme Tax Court, the attribution of costs incurred from the sale of a business has to be done by an objective look at the reasons why such costs incurred. The German Supreme Tax Court is of the opinion that a factual link between the consulting costs incurred for the sale of a business and the sale itself is at hand (supported by ECJ decisions Midland BankC-98/98, line 32 and BLP C-4/94, line 24).
In its BLP decision, the ECJ ruled that a direct and immediate connection to taxed (as well as zero-rated) output transactions is necessary to allow the taxable person's right to input VAT deduction. It further stated that any indirect aim does not have any impact on the determination to which output transaction costs can be attributed (line 19).
In its Midland Bank decision (C-98/98), the ECJ sheds a bit more light on the question of attributing costs to an output transaction. The ECJ stated that, as a general principle, costs can be attributed to a specific output transaction when they qualify as expenditures of the underlying output transaction (line 30). In line 32, the ECJ ruled that the taxable person has the right to document that costs may not be attributed to a specific output transaction but to the economic activity in general.
Having read the arguments of the German Supreme Tax Court and quotes from the ECJ decisions Midland Bank (C-98/98) and BLP (C-4/94), you may be convinced of the denial of input VAT deduction.
We would say that the ECJ concretises and even waives in AB SKF its early comments raised in Midland Bank from 2000 and BLP from 1995.
This becomes readily apparent in line 63, where the ECJ is of the opinion that the ultimate goal of the sale of shares by AB SKF was to gain money to support the remaining taxed business. In the same context, the ECJ points out that a direct connection of costs to the sale of shares can be seen when such costs influence the sales price of the shares (line 63).
"Costs being likely incorporated in the prices of the shares" is an interesting quote by the ECJ.
The German Supreme Tax Court may be driven by a common direct tax principle that costs causally incurred for a sale are to be deducted there. As mentioned earlier, VAT is a transactional based tax being due on every chain of economic value added.
From our perspective, any factual connection should not be decisive for VAT purposes when trying to attribute costs to a specific output transaction. This opens a wide range of interpretations for any involved party. I would rather agree with the ECJ in AB SKF that a direct connection can only exist if the costs will not only likely be incorporated in the price, but actually are. Only then would I see the fundamental principle of a transactional based tax such as VAT being completely fulfilled.
Not being able to establish a direct connection between such expenditures and the sale of a business leads to the conclusion that any input VAT deduction is based on the general qualification of the overall output transaction. The principle of neutrality is assured if this manner of determination were to be used (ECJ AB SKF, C-29/08, line 67). And what would be a better attribution method than that?
What remains in the end? In Germany, we now have the first decision by our highest Tax Court on the issue of the input VAT deduction of costs incurred in relation to a sale of shares.
Interpreting the ECJ's decision in Midland Bank (C-98/98), BLP (C-4/94) and AB SKF (C-29/08), the German Supreme Tax Court is of the opinion that a factual connection between consulting costs surrounding the sale and the sale of share is decisive. Therefore, the qualification for VAT purposes of the sale of shares is decisive for the determination whether input VAT is deductible for sale-related costs.
An input VAT deduction – whether in total or in parts – of sale-related costs will be possible in cases where the sale qualifies as a transfer of a going concern or a sale of a dominated company within a fiscal unity for VAT purposes and the intention of the acquirer to include it in a fiscal unity for VAT purposes of its own.
Keeping in mind the principle of neutrality and the principle that VAT is a transactional based, we feel the German Supreme Tax Court's decision to be wrong. ECJ's decision in AB SKF cements in more detail the way costs are to be attributed. An attribution may then not be done on a factual basis but on the fact whether costs are included in the sales price.
Still unclear is the question whether an input VAT deduction of costs related to a sale of shares that do not qualify as an economic activity (purely holding and administrating shares) is possible if the money received for the sale is used for taxed business purposes. In other words, is an input VAT deduction through a back door possible?
Still pending with the German Supreme Tax Court is the question whether input VAT can be limited to the value of output transactions in the year in which shares are sold.
Tel: + 49 89 5790 6354
Daniel Keller is a tax partner and head of the VAT department of PwC Munich. He specialises in German and European VAT. He has 15 years of professional experience in advising domestic and multinational companies in national and international VAT affairs. He serves a large number of subsidiaries of international corporations in Munich as well as domestic company groups.
He is a lawyer, certified tax adviser and holds a masters in fiscal affairs. He studied law at the University of Constance and joined the tax department of PwC in 1996, qualifying as a tax adviser (Steuerberater) in 2000.
Tel: + 49 89 5790 6726
Christian Schubert is a senior manager and member of the PwC VAT department in Munich. He advises national and international companies in all areas of VAT law and specialises in VAT questions in the area of financial services. He studied law at the University of Bayreuth and joined the tax department of PwC in 2002. He is a lawyer and qualified as a tax adviser in 2007.
Tel: + 49 89 5790 6365
André Henning is a manager and member of the VAT department of PwC Munich. He advises domestic and multinational companies in national and international VAT affairs. He serves a large number of subsidiaries of international corporations in Munich as well as domestic company groups.
Henning holds a Masters in Fiscal Affairs and became a Certified Tax Advisor in 2011. He has, according to his former work in German tax authorities a very solid and widespread relationship and experience with the German tax authorities.