CJEU - Recent Developments in Value Added Tax 2016

1. S. 178Why are We where We are

Over the last few decades, the CJEU has ruled in a number of cases that the consideration for a supply of goods or services is of a subjective nature and thus is not a value estimated according to objective criteria. A consideration that is of a subjective nature does not have to reflect the real value of the goods or services supplied. According to this case law, the qualification as consideration for a supply of goods or services only requires that there is a direct link between the consideration and the supply of goods or services. The mere fact that the consideration is under the market value or even under the cost price of the goods or services supplied is not sufficient to deny the existence of a direct link.

The CJEU has repeatedly ruled that the EU VAT Directive provides a minimum assessment base under Art. 80. If Member States fear that the application of standard rules leads to VAT avoidance or evasion, they are entitled to deviate from the standard regime; however, the boundaries are set by Art. 80 of the EU VAT Directive. If a Member State wants to go further than this provision allows in order to prevent VAT avoidance or evasion, it has to send an application for such a measure to the Council under Art. 395 of the Directive.

On the other hand, the CJEU has interpreted the term “supply of goods or services” very widely, so that even those services which a state, municipality or local authority has to provide by law, are capable of falling within the scope of VAT.

With respect to public bodies one may say that it does not really make a difference whether or not they are engaged in an economic activity which may entitle them to an input VAT deduction on their input supplies, since the money merely moves from one pocket to the other. This, however, is not quite true. Within a federal system, the revenue is distributed between the national, federal and local levels. In Germany, for example, 2 % of the total VAT revenue is given to the municipalities; 44,1 % is given to the states and 53,9 % remains with the federal government. Accordingly, it does make a big difference, especially for municipalities, whether or not they are entitled to a VAT credit for the input VAT levied on their input supplies.

S. 179Having said that, the CJEU case law has given rise to tax planning activities. Public bodies have tried and still do try to create taxable supplies which subsequently entitle them to deduct input VAT used for their taxed output transactions. The fact that the consideration is of a subjective value allows them to claim a huge VAT deduction by subsequently charging VAT on output supplies based on an amount that only reflects a fraction of the market value of these goods or services.

In cases where the taxable person is not a public body, the supplies which have a negative impact on the business profits (because the costs of the inputs necessary for providing these output supplies are higher than the price charged on the outputs) are normally compensated by other supplies. Thus, there is generally no overall undervaluing of the business activity. However, as far as public bodies are concerned this might be different. They are typically engaged in activities strengthening the common good, which are less profitable than other activities. Accordingly, public bodies are very likely to produce an input VAT surplus, since they are engaged in a loss-making activity.

2. Borsele - A possible Reaction to the Current Situation

In order to prevent an imbalanced input and output VAT scenario, which creates a significant input VAT surplus, in Borsele, Advocate General, Juliane Kokott, tried to develop further the notion of the income obtaining purpose underlying Art. 9 of the EU VAT Directive. In her view, the income to be obtained from an economic activity under Art. 9 of the EU VAT Directive does not correspond with a consideration for a supply under Art. 2 of the EU VAT Directive. Thus, one has to ask whether the person providing supplies does so for the purpose of obtaining income on a continuing basis, before one asks whether the goods or services are supplied for consideration. According to Advocate General, Juliane Kokott, income can only be obtained on a continuing basis if the person participates in the market; and a person only participates in the market if the “activity [at hand] is carried out in the same way as a corresponding economic activity is usually carried out”.

Accordingly, Advocate General, Juliane Kokott, argued that the municipality organizing the transport of pupils to their schools is not engaged in an economic activity since it does not participate on the market. This can be seen by the fact that the municipality “recovers only a small percentage of the costs of the services it receives by levying a contribution for the services it provides. This is not the typical conduct of a market participant”.

S. 180This means that an economic activity as stated in Art. 9 of the EU VAT Directive requires more than a continuing supply of goods or services for consideration, as stated in Art. 2 of the EU VAT Directive. A person is only engaged in an economic activity if it carries out its activities for the purpose of obtaining income on a continuing basis and this should be examined by the requirement of market participation. The requirement of market participation allows a comparison between the activity at issue and the “usual activities of the traders and professions referred to in the first sentence of the second subparagraph of Art. 9(1)” of the EU VAT Directive.

This argumentation basically means that if one decides to supply goods or services for a consideration which does not reflect the real market value of the goods or services then one supplies the goods or services for consideration in the meaning of Art. 2 of the EU VAT Directive, but one is not carrying on any economic activity and thus is not a taxable person because the activity is not carried out in the same way as a corresponding economic activity is usually carried out. Such a view disregards one single transaction and looks at the overall business performance and asks whether another market player would stay on the market when preforming the same activity under the same conditions.

This already highlights where the opinion of Advocate General, Juliane Kokott, is heading: the requirement of market participation implements an arm’s length principle within the EU VAT regime for public bodies and other persons who are carrying on a loss-making activity and are heavily financed though state or EU resources. Such persons may thus no longer act as taxable persons, if they supply goods or services for consideration constantly below their market value.

In the following paragraphs, the focus is placed on the requirements established by the EU VAT Directive for carrying on an economic activity and their interpretation by the CJEU. Specific attention will be drawn to the CJEU case law allowing for a comparison between the circumstances in which the activity at hand is performed and the way in which such an activity is usually carried out. A deeper analysis of this case law will reveal whether the Court’s direction only applies to specific scenarios or whether it is of a general nature.

3. The Elements of an Economic Activity

Art. 9(1) subsection 2 of the EU VAT Directive defines “economic activity” for the purposes of VAT. According to this provision, “[a]ny activity of producers, traders or persons supplying services, including mining and agricultural activities and activities of the professions, shall be regarded as ‘economic activity’. The exploitation of tangible or intangible property for the purposes of obtaining income therefrom on a continuing basis shall in particular be regarded as an economic activity”.

S. 181The history of this provision shows that the professions form the core of the definition of an economic activity. However, the scope of the economic activity gets extended by the second sentence of this provision, the exploitation of tangible or intangible property, since the mere use of property would, as such, not qualify as an activity a profession stated in the first sentence would perform.

Despite the fact that these professions implicitly require an activity which is permanent in nature and performed for the purpose of obtaining income, the CJEU has ruled that the requirement of obtaining income on a continuing basis applies not only to the exploitation of property, but to all the activities referred to in Art. 9(1) subsection 2 of the EU VAT Directive. Accordingly, an “activity is thus, generally, categorised as economic where it is permanent and is carried out in return for remuneration which is received by the person carrying out the activity”.

Contrary to most income tax regimes, the EU VAT system does not require that a person intends to realize any profits. For the purpose of carrying on an economic activity, the EU VAT system only requires that the person is engaged in an activity and obtains income on a continuing basis. Thus, the economic activity, as laid down in Art. 9(1) of the EU VAT Directive, does not require that the income exceeds the cost for providing the supply of goods or services. Even a loss-making activity is capable of obtaining income as required for carrying on an economic activity.

4. Market Participation and the Economic Activity

According to Advocate General, Juliane Kokott, the requirement that income be obtained on a continuing basis, as set out by Art. 9(1) subsection 2 of the EU VAT Directive, can only be fulfilled if the person supplying goods or services participates in the market. The requirement of market participation, on the other hand, can only be satisfied, if the circumstances in which the activity is carried out can be compared with the circumstances in which the activity is usually carried out by other market players.

The ruling of the CJEU is not very clear with regard to the requirement of market participation. The Court acknowledged that there is a difference between supplying goods and services for consideration and obtaining income on a continuing S. 182basis. However, with regard to the facts of the case, it ruled that there was no direct link between the supply of the transport services and the consideration paid by the parents of the pupils and thus the supply of these services was not subject to VAT. The Court then went on to state that “the conditions under which the services at issue [...] are supplied are different from those under which passenger transport services are usually provided, since the municipality of Borsele, as the Advocate General observed in point 64 of her Opinion, does not offer services on the general passenger transport market, but rather appears to be a beneficiary and final consumer of transport services which it acquired from transport undertakings with which it deals and which it makes available to parents of pupils as part of its public service activities”. This paragraph also allows for a different reading. It can be argued that the Court ruled, irrespective of the direct link between the transport service and the consideration, that the municipality was not carrying on an economic activity since the transport services were not supplied in a way which was comparable with the activity of a non-public transport service provider. However, the paragraph can also be read in the light of the missing direct link between the transport service and the consideration in which case it could be taken to mean that in such a case (where the supply of services is not directly linked to the consideration), the activity is not carried out in the way that an undertaking on the general transport market would usually provide these services.

From this it follows that it is not clear whether the Court applied the comparison test in the Borsele case or whether the reference to other market players was merely to highlight the missing direct link between the supply of the transport services and the consideration paid by the parents of the pupils.

It is worth noting, however, that the CJEU has already used the requirement of market participation to distinguish between an economic activity and an activity which is outside the scope of VAT. From the entire CJEU case law it is possible to deduce two scenarios in which the Court applies a comparison between the circumstances in which the activity is actually performed and the circumstances under which the activity is usually performed: first, a comparison is applied in cases where a person claims to carry out an economic activity by obtaining income through the exploitation of property which is also used for a purely private purpose and; second, the CJEU allows a comparison in cases where the mere exercise of the rights of ownership has to be distinct from an economic activity. Besides these two scenarios, the CJEU uses the absence of any market to which the goods or services can be supplied to emphasize the nature of these transactions and the fact that they are not subject to VAT. If there is no market in which the person can participate, no distorting effects can follow from not taxing these transactions.

S. 183In order to be able to deduce conclusions from the CJEU case law for public bodies and their economic activities, the case law has to be analysed in more detail:

4.1. Exploiting Property which is also used for Private Purposes

The CJEU makes a comparison with other market players if a person claims to carry on an economic activity solely through the use of property that can be used for both an economic and a private purpose. If the property is suitable only for economic exploitation, it is “normally sufficient to find that its owner is exploiting it for the purposes of his economic activities and, consequently, for the purpose of obtaining income on a continuing basis”. In cases where the property - by reason of its nature - can be used both for private and economic purposes, it has to be examined whether the property is used for the purpose of obtaining income on a regular basis. In that regard, the circumstances in which the property is used have to be taken into account. However, the Court only refers to the comparison with other market players in cases where the property to be exploited is actually used for economic and private purposes.

The first time the CJEU emphasized the possibility of a comparison between the circumstances in which the activity is actually carried out and the circumstances in which the activity is usually carried out was in the case of Enkler. Mrs. Enkler claimed to carry on an economic activity because she hired her motor caravan to her husband. The motor caravan was, however, also used for her own private purposes. Since the motor vehicle was supposedly used partly for taxed output transactions, Mrs. Enkler claimed an input VAT deduction for the vehicle. The CJEU ruled that the property to be exploited can be used both for private and economic purposes. In order to ascertain whether or not the property is sufficiently used to obtain an income on a continuing basis and thus for an economic activity to exist, a comparison between the circumstances in which the person concerned actually uses the property with the circumstances in which the corresponding economic activity is usually carried out should be drawn. This approach allows a closer look at the number of customers, the amount of earnings as well as the actual length of the period for which the property is hired. In a later judgment, the CJEU ruled that such a comparison could also be drawn where a person used a photovoltaics system because the energy generated was used both for consumption and sold to the energy operator.

S. 184This clearly shows that the comparison of a certain activity with the activities of other market players tries to distinguish between an activity that is purely private and activities which are of an economic nature. It is quite clear from the facts of the cases that these items of property were used for private purposes to a large extent and the question was therefore raised as to whether each item was used sufficiently enough to conclude that an economic activity was being carried out. Accordingly, the comparison is not a tool to determine whether income is obtained nor is it intended to determine whether the income is obtained on a continuing basis. It is, however, a tool to determine whether a person, who uses property both for obtaining income and for consumption, exploits this property in a way that amounts to the carrying out of an economic activity.

4.2. Distinction between an Economic Activity and the Mere Exercise of the Right of Ownership

The CJEU makes a comparison between the circumstances in which an activity is carried out and the circumstances in which a producer, a trader or a person supplying services, as stated in Art. 9(1) subsection 1 of the EU VAT Directive, usually supplies these services for the purpose of examining whether a person is carrying on an economic activity or is merely exercising the right of ownership. Whether a person is merely exercising the right of ownership or is carrying out an economic activity becomes especially relevant where property is sold. In transactions consisting solely of the sale of property, the consideration for those transactions consists of a possible profit on the sale of these assets due to an increase in their value. There is, however, no supply of value added that should be subject to VAT. Only in cases where a person is doing more than simply selling property can the property actually be exploited and thus the person may potentially be carrying out an economic activity. In order to determine when a person is doing more than simply exercising ownership rights, the CJEU compares the person who is the subject of the case, with a person professionally engaged in such activities. Thus, a person is no longer simply exercising ownership rights, if that person “takes active steps to market property by mobilising resourcessimilar to those deployed by a producer, a trader or a person supplying services within the meaning of the second subparagraph of Article 9(1) of the VAT Directive”.

From this it follows that a person is not engaged in an economic activity if it merely sells its property and thus exercises ownership rights. Only if the circumstances in which the property is sold can be compared with the circumstances in S. 185which the property is sold by a person actually engaged in this activity professionally, is the person carrying on an economic activity. Accordingly, the comparison is not used to describe the threshold of exploitation that is necessary to carry out an economic activity as in cases of partly privately used assets; rather it is used to establish the threshold of engagement that is necessary to qualify property to be exploited.

4.3. Missing Market in which one can participate

Two scenarios have been identified where the CJEU applies a comparison between the circumstances in which the activity is actually carried out and the circumstances in which other market players usually carry out their professional activities. Despite these two scenarios, there are a number of cases in which the Court has ruled that an entity carrying on a non-economic activity is not participating in any market. These cases form a separate and distinct category. They have in common that the entity does not provide any supplies of goods or services in the meaning of the VAT Directive. The activities provide a benefit to the public at large, however, there is no single recipient consuming the benefit as is required for the activity to constitute a supply under the EU VAT regime. These entities are engaged in activities that benefit the common good and thus the CJEU argues that there is no market for the activity.

In SPÖ, the Court ruled that an activity that is aiming to develop informed political opinion with a view to participation in the exercise of political power is an activity of a non-economic nature. An entity carrying on such an activity cannot participate in any market because there is no market for such an activity. Likewise, in 3G and T-Mobile Austria the CJEU ruled that an entity carries out a non-economic activity in cases where the activity consists of allocating, by auction, rights to use certain frequencies in the electromagnetic spectrum to an economic operator for a specified period. The Court found that this activity is necessary to establish a market in this field and the allocation of the rights grants operators access to this very market. The entity establishing the market does not operate on the market.

This case law highlights that there are certain activities of an entity which benefit the general public. A stable agrarian sector, an efficient and undisturbed use of the S. 186frequency spectrum, as well as the existence of political parties serve the general interest and thus there is no single recipient that obtains a benefit from these activities. Due to the nature of these activities, there is no actual market in which such services can be traded and therefore entities carrying on such activities cannot participate in any market. In this regard, emphasizing the non-existence of any market for a specific activity aims at highlighting the activity’s specific nature. In addition, it endorses the view that certain activities are not subject to VAT. If there is no market for such activities, not taxing these activities has no distorting effects.

4.4. Conclusions to be drawn for Public Bodies

What can be deduced from the CJEU case law? First, a comparison with other market players allows a distinction to be made between the mere exercise of ownership rights, not being subject to VAT, and the carrying out of an economic activity. This approach also applies to public bodies, unless the goods to be sold have already been used in the course of the public body’s economic activities.

Second, a comparison between the actual circumstances in which property is used and the circumstances in which a professional usually exploits such property can be made in scenarios in which the property is not only exploited for remuneration but also partly for private purposes. Thus, the CJEU case law tries to determine the threshold that is required for an activity to constitute an economic activity through the exploitation of property which is partly used for private purposes by applying a comparison between the activity at hand and other market players which carry on such an activity in the general market for the services or goods in question.

In the light of the Borsele case, one may ask whether the principles of the Enkler and Fuchs case should be extended to scenarios in which the property is used for a non-economic purpose and partly exploited for remuneration. If this were the case, the exploitation of the property for remuneration would only be economic in nature when the comparison test was met. On the one hand, one could argue in favour of a generalized application of the comparison test since this test is supposed to establish a general threshold for deciding whether a person is carrying on an economic activity. Therefore, it would make no difference in the application of the test whether the property was used for private or non-economic purposes. If the comparison test was understood in such a generalized way, any person would be required to overcome a certain threshold of acting in the general market for the purpose of carrying on an economic activity through the exploitation of property.

S. 187On the other hand, however, one may also argue that the CJEU case law is only meant to apply to scenarios where goods are used for private purposes and partly exploited for obtaining income. The systemic of the EU VAT Directive suggests such a perspective: under the EU VAT system, it does make a difference whether property is generally used for a non-economic purpose or for pure consumption (purely private use). In the case of purely private usage, the property is not used for the purpose of creating value added. If such a property is made available to another person, the consideration may be purely a compensation payment for the lost consumption. Thus, the person does not provide any services for consideration which are subject to VAT; since, the person would only supply services if the value added created in the hands of this very person were actually supplied. The consideration for a supply reflects the value added received through the supply in the hands of the recipient. The CJEU applies the comparison test to allow a distinction between the scenario in which a person receives compensation merely for lost consumption and the scenario in which a person supplies services. The comparison test allows for such a distinction since a person only supplies services if that person is carrying on an activity which requires more than simply allowing somebody else to consume the property instead of consuming it themself.

In cases where the property is used both for a non-economic activity and partly for obtaining income, the property is generally used for creating value added. When carrying on a non-economic activity, the value added is not subject to tax because it is not supplied in the form of a good or service to an identifiable person. Since the property is not used for private purposes but for the purpose of creating value added, it is not necessary to distinguish between whether the property is used for a supply of goods or services or whether the person decides to forego the right to consume the property and allows another person to consume the property. Accordingly, the requirement to overcome a certain threshold of general market participation is not required when the property is used both for non-economic purposes and for the purpose of obtaining income.

If one wants to deduce a general market participation requirement in the form of a comparison test from the Boresele case, it is not enough to extend the principles of the Enkler and Fuchs case to public bodies. Instead, a general comparison test would apply to any economic activity. Such a requirement would be contrary to the CJEU case law on the direct link between the supply of goods or services and the consideration. According to this case law, goods and services can be supplied for a consideration below their market value. If a person consistently supplies these goods or services at below their market value or their cost price, the activity of this person may not be comparable with the economic activity of other market players and thus the person may not act as a taxable person. The reason for S. 188supplying goods or services below their market value or their cost price is the fact that this person is heavily financed through state or EU resources. If such behaviour were to be considered distorting, it would be necessary to reconsider whether the current definition of an economic activity needs to be amended since Art. 9(1) of the EU VAT Directive does not require that a person intends to realize any profits. Instead of amending the definition of an economic activity, it would also be possible to implement a special minimum assessment base for those persons who usually carry on a loss-making activity since they are financed through state and EU resources.

The subsequent CJEU case law shows that the comparison test is not generally applied. One may argue that this case law does not concern the economic activity of the person but rather the right to deduct input VAT. However, economic activity is a necessary requirement to decide whether or not the person is entitled to an input VAT credit and thus it cannot be argued that the Court has fully ignored the relevant activity and has decided on the right to deduct in a very isolated way.

The right to deduct input VAT is, of course, the reason for the reluctance of many tax authorities when it comes to deciding whether a public body qualifies as a taxable person. One should, however, not forget that the mere fact that a public body is carrying on an economic activity does not mean that the entity is entitled to a full input VAT credit. The public body can only deduct the input VAT which is linked to its taxed output transactions. Thus, qualifying the partial exploitation of property for obtaining income as an economic activity only entitles the entity to a partial input VAT credit.

5. S. 189Conclusion

Within the EU VAT system, public bodies can act as a taxable person and thus are able to provide taxed output transactions and are entitled to claim an input VAT deduction. Public bodies are, however, different from other market players since they are capable of engaging extensively in a loss-making activity. This loss-making activity is, at least partly, financed through state or EU resources. As a result, public bodies claim a huge input VAT deduction while levying VAT on an amount which does not even reflect a fraction of the market value of the goods or services supplied.

At present, the EU VAT Directive does not explicitly deal with this problem, since the minimum assessment base under Art. 80 of the EU VAT Directive is generally not applicable to activities of a public body. However, any attempts to implement a general requirement of “market participation” in the form of a comparison test with other market players may not be in line with the systemic of the EU VAT system and cannot be securely based on CJEU case law since the CJEU applies a comparison test between the actual activity performed and the activity performed by other market players in order to decide whether a person is carrying on an economic activity only in certain circumstances. However, the CJEU does not always apply this test where a public body carries on a loss-making activity.

Accordingly, such a comparison test does not introduce a general threshold for any economic activity nor does the Boresele case change this picture. The ruling of the CJEU is not clear with respect to the comparison test and thus is open to different interpretation. What is more, the subsequent case law indicates that a comparison test should not be applied to determine whether a public body is carrying on an economic activity.