This article was first published in ITR supplemental 8th Edition (Tax reference Library n°55).
Strategic holding companies are common features in global commercial and industrial organizations and are used tactically in M&A. Private equity houses also use holding companies extensively in the context of their transactions. In the absence of efficient service flows structuring, all these players are very likely to suffer significant VAT costs.
This article will review the developments of the VAT jurisprudence in this area and identify risks and opportunities deriving from the evolution of this jurisprudence. Indeed, the VAT concepts applicable to the holding companies have been evolving significantly in recent years and may seem quite complicated at the first sight. Attention must however be paid to the flows of services and their implications in the light of the VAT legislation. Indeed, inadequate structuring leads to VAT costs - VAT itself with rates ranging between 15% to 25% in the European Union - but also time-consuming administrative obligations.
A holding company is usually defined as being a company which owns shares in one or several companies in order to control them. It is not required to use a special legal form of company.
In a case relating to direct taxes, the European Court of Justice ("ECJ") confirmed this view and specified that "the holding company's business consists wholly or mainly in the holding of shares in subsidiaries1".
The purpose of holding companies is easy to define and understand. There are different types of holding companies, with different implications in the field of VAT:
- Pure holding companies which have for sole activity the mere holding of shares;
- Mixed holding companies which, in addition to holding of shares, perform additional activities such as financing activities or supply of services.
Considering the large scope of activities performed by holding companies and difficulties in interpreting traditional VAT concepts, there have been many cases brought to court for many years., This jurisprudence is in particular relating to the status of taxable person and the right to deduct input VAT.
1. The qualification of taxable person
In accordance with article 9 of Directive 2006/112/CE, "is considered as a taxable person, any person who independently carries out in any place any economic activity, whatever the purpose or results of that activity".
Economic activities are defined in the VAT legislation as encompassing all activities of producers, traders and persons supplying services, including"the exploitation of tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis".
The interpretation of this definition does not raise issues in a majority of sectors where companies perform commercial and industrial activities. The determination of the VAT status of holding companies is however more difficult. In effect, the activities performed by a holding company need to be analysed to determine if they qualify as economic activities falling within the scope of VAT.
Are holding companies taxable persons for VAT purposes?
As stated above, holding companies can be divided into two main types (i.e. pure holding companies or mixed holding companies). The ECJ had the chance to give its interpretation several times on the qualification as taxable person of both types of holding companies.
- a. Pure holding companies
The ECJ gave in first instance its opinion regarding the status of pure holding companies. The Court analyzed whether the income arising from the mere holding of shares could be qualified as a consideration for an economic activity falling within the scope of VAT.
The ECJ2 stated that "a holding company whose sole purpose is to acquire holdings in other undertakings, without involving itself directly or indirectly in the management of those undertakings, without prejudice to its right as shareholder, does not have the status of taxable person for the purposes of VAT."
The ECJ considered that to be characterized as economic, the income should exist on a permanent basis. However, as dividends are paid on basis of the holding of a share and, as dividends depend on the performance of a subsidiary, the remuneration resulting from the holding of shares is uncertain. Therefore, the ECJ considered that the mere acquisition and holding of shares in a company is not to be regarded as an economic activity conferring on the holder the status of a taxable person for VAT purposes. The mere acquisition of financial holdings in other undertakings does not amount to the exploitation of property for the purpose of obtaining income therefrom on a continuing basis because any dividend yielded by that holding company is merely the result of ownership of the property3.
This interpretation has been confirmed several times and it has become constant jurisprudence that the mere holding of shares does not qualify as an economic activity for VAT purposes.
As a consequence, a pure holding company cannot be regarded as a taxable person for VAT purposes.
- b. Mixed holding companies
If the VAT status of pure holding companies is clear, the ECJ has been asked on several cases to determine if holding companies having additional activities were to be qualified as taxable persons for VAT purposes.
The ECJ addressed this issue many times and the results of its findings sometimes appeared unclear. However, step by step, criteria for the qualification of taxable person for holding companies were elaborated.
As the VAT deduction right of a company is necessarily linked to the status of taxable person of the company, most of the cases which have been treated by the ECJ concerned both subjects.
"Involvement" in the management of subsidiaries
One criterion developed by the ECJ refers to the involvement in the management of subsidiaries. This criterion was used by the ECJ for the first time in the famous Polysar case4. Nevertheless, the Court initially did not develop a definition of what could be qualified as involvement in the management of a subsidiary. It was however clear that, without involvement in the management of their subsidiaries, holding companies should not be qualified as taxable persons. In addition, this involvement should in any case involve more than the sole holding of shares and the exercise of the rights as a shareholder.
The ECJ specified later the notion of "involvement"5. In order to be considered as being involved in the management of its subsidiaries, a holding company has to supply services subject to VAT, such as the provision of administrative, accounting and information technology services.
Not all holding companies supply taxable services to their subsidiaries. It is however common practice that holding companies grant interest-bearing loans to their subsidiaries. The ECJ had to give its interpretation on whether such financing activities were to be considered as economic activities entering the scope of VAT.
The ECJ6 first stated that unlike the receipt of dividends by a holding company, interest received on investments made for its own account cannot be excluded from the scope of VAT, since the interest does not arise simply from ownership of the asset, but is the consideration for placing capital at the disposition of a third party. The receipt of interest resulting from the investments constitutes the direct, permanent and necessary extension of the taxable activity.
The ECJ7 added later that such activity may of itself be considered as an economic activity, provided that:
- it is not carried out merely on an occasional basis and is not confined to managing an investment portfolio in the same way as a private investor and;
- it is carried out with a business or commercial purpose characterised by, in particular, a concern to maximise returns on capital investment.
This introduces the concept of "commercial view" as a criterion to determine the performance of economic activities entering the scope of VAT. This concept was later confirmed by the ECJ8. In particular, it was made clear that an entity performs an economic activity if it uses funds forming part of its assets to supply services such as the granting of interest-bearing loans to companies in which it has shareholdings, whether those loans are granted as economic support to those companies or as placements of treasury surpluses or for other reasons. Therefore, it must be held that the annual granting by a holding company of interest-bearing loans to companies in which it has a shareholding and placements by that holding company in bank deposits or in securities, such as Treasury notes or certificates of deposit, constitute economic activities carried out by a taxable person.
"Partial" holding companies
For many years, the question of whether mixed holding companies should be regarded as taxable persons for their activities as a whole or only for their activities entering the scope of VAT had been under discussions.
This grey area raised issues. As an example, what was the VAT treatment applicable to a supply of "intangible" services (e.g. tax, legal, advisory services) rendered to a mixed holding company within the context of a disposal of shares? Was it to be considered as rendered to a nontaxable person as linked to holding activities? In this case, such services were subject to VAT in the country of the supplier9. Or, could it be argued that the status of taxable person (and in most cases the VAT registration) of the holding company for its commercial activities attracted the place of supply where the recipient was established10. In this case, the services were subject to VAT in the country of the mixed holding company under the so-called reverse charge mechanism.
This was differently interpreted in the various Member States, leading to situations of either double-taxation or non-taxation.
This issue was resolved with the TRR11 case and the entry into force of the "VAT Package". Clarifications were made and the following was made clear for the purpose of applying the rules concerning the place of supply of services12:
- A taxable person who also carries out activities or transactions that are not considered to be taxable supplies of goods or services shall be regarded as a taxable person in respect of all services rendered to him;
- A non-taxable legal person who is registered for VAT purposes shall be regarded as a taxable person.
Based on these provisions and the new rules governing the place of supply of services (see text box), services rendered to mixed holding companies should be taxable where mixed holding companies are established.
The main conceptual changes brought by the VAT package regard the rules for determining the place of supply of services ("place of taxation"). As from January 1, 2010, the general rules are as follows:
- B2B services are taxable in the country where the recipient is established, and no longer where the supplier is located. In other words, the reverse charge mechanism is applied more extensively.
- B2C services remain in principle taxable where the supplier is established.
Exceptions are made for certain services, most notably for services connected with immovable property, transport services, cultural, sporting, scientific and educational services, work on movable property, restaurant and catering services as well as the hiring of means of transport.
Summary of the status of taxable person for VAT purposes
Despite the various VAT concepts, decisions and clarifications brought by the ECJ, it seems that the determination of the VAT status of holding companies is not always obvious and must be analyzed in the light of the activities performed by a given entity. Certain trends however result from the different opinions remitted by the ECJ. In particular, where a company performs activities exceeding the mere passive holding of shares, the chances are that it should be considered as a taxable person for VAT purposes. The immediate consequence is that services supplied to this kind of mixed holding company are deemed to be taxable where this mixed holding company is established. The potential VAT obligations are then transferred to that company (VAT registration, filing of VAT returns, payment of VAT...).
2. VAT deduction right of holding companies
The status of taxable person for VAT purposes is of primary importance to define where services should be taxed. Even more important is, of course, whether the VAT due can be recovered.
The basic principle13 regarding the deduction of input VAT is that "in so far as the goods and services are used for the purposes of the taxable transactions of a taxable person, the taxable person shall be entitled, in the Member State in which he carries out these transactions, to deduct the input VAT from the VAT which he is liable to pay".
Initially, the ECJ stated14 that companies whose activities were limited to the mere holding of shares did not have the right to deduct input VAT as such companies were not considered as taxable persons for VAT purposes. As detailed previously, the concept of taxable person evolved over the years and holding companies performing additional activities were soon considered as taxable persons, leading to complex questions about the deduction of input VAT.
The "direct and immediate" link
In the early nineties, the ECJ decided that in order to be entitled to deduct the input VAT incurred, the activities carried out by a taxable person should have a direct and immediate link with its taxable activities. The requirement of a direct and immediate link implies that, to be deductible, input VAT incurred is in direct relation with the performance of taxable supplies. Input VAT incurred within the framework of VAT exempt transactions or transactions out of the scope of VAT should not be deductible, even if these transactions are necessary for the performance of taxable transactions.
The reasoning of the Court could be understandable. If an indirect link could be sufficient to allow the deduction of input VAT incurred, it would be in practice very difficult to check the intention of the taxable person at the moment it incurs VAT.
This rather restrictive approach was however tempered by stating that these principles were not applicable if the activity of holding of shares is combined with direct or indirect involvement in the management of subsidiaries. As already mentioned, the concept of direct or indirect involvement in the management of subsidiaries was defined15 as carrying out transactions which are subject to VAT, such as the supply of administrative, accounting and information technology services to their subsidiaries.
The "Cibo" case
In the Cibo case16, the question was referred to the ECJ whether a holding company may deduct VAT charged on expenditures incurred in relation to services within the framework of the acquisition of shares in its subsidiaries. The holding company was involved in the management of its subsidiaries and derived income subject to VAT resulting from the supply of services rendered to these subsidiaries.
Although it took into account concepts laid out previously, such as the direct and immediate link between the supplies made and the input VAT incurred, the decision of the ECJ in the Cibo case appeared rather superficial regarding the limitation of the right to deduct input VAT. In particular, the ECJ stated that expenditure incurred by a holding company in respect of the various services purchased in connection with the acquisition of a shareholding in a subsidiary forms part of its general costs and therefore has, in principle, a direct and immediate link with its business as a whole. If a holding company carries out both transactions in respect of which VAT is deductible and transactions in respect of which VAT is not deductible, it may deduct only the proportion of VAT which is attributable to transactions in respect of which VAT is deductible.
This decision disrupted the common concepts applicable to the deduction of input VAT for holding companies and some abuses resulted from a broad interpretation of this decision. Some dubious VAT planning involved unsignificant amounts of services subject to VAT to subsidiaries and claiming the deduction of hundred thousands of Euros of input VAT incurred within the framework of acquisition/disposal of shares. Such practice certainly was not the objective of the ECJ when releasing its decision in the Cibo case.
Securenta and SKF cases
The Cibo case left opportunities for a broad interpretation of the rules applicable to input VAT deduction. The Securenta case17 is somehow bringing us back to VAT basics. The ECJ ruled that where a taxable person simultaneously carries out economic activities, taxed or exempt, and activities outside the scope of VAT, the deduction of the VAT relating to expenditure connected with the issue of shares and atypical silent partnerships is allowed only to the extent that expenditure is attributable to the taxpayer's economic activity. Input VAT borne in relation to VAT exempt or out of scope activities should not be permitted. The methods of calculation of input VAT deduction were left open to Member States but must objectively reflect the part of the input expenditure actually to be attributed, respectively, to those types of activities.
The last major decision of the ECJ regarding holding companies is known as the SKF18 case. Its main findings are that input VAT on costs incurred for the purposes of disposal of shares can be (partially) deducted to the extent that there is a direct and immediate link between these costs and the overall activities of the active holding company.
In order to establish whether there is such a direct and immediate link, it is necessary to ascertain whether the costs incurred are likely to be incorporated in the price of the shares or whether they are only among the cost components of the holding's products.
Under some circumstances, a disposal of shares in subsidiaries in which a holding company plays an active management role can be qualified as a transfer of going concern outside the scope of VAT. Under this approach, input VAT on costs incurred for the purposes of such disposal can be (partially) deducted.
This ECJ case law is very important as it creates opportunities to deduct, at least partially, input VAT incurred within the framework of share disposals. The deduction of input VAT is however not straightforward as it must be considered in the light of all the circumstances surrounding the transactions.
For nearly twenty years, the ECJ was referred different cases relating to the holding companies. The various decisions given by the ECJ have been going from very restrictive to sometimes very broad. The latest judgments however tend towards achieving the complete neutrality of taxation of economic activities. This means relieving taxable persons entirely of the burden of the VAT payable or paid in the course of economic activities and the non-deduction of input VAT borne in relation to VAT exempt or out of scope activities.
Considering the prolific and complex ECJ jurisprudence detailed above, the impact of VAT on acquisitions/disposals of shares, or more generally on transactions involving holding companies must be considered with attention and must be carefully planned.
Furthermore, one should always keep in mind that the judgments rendered by the ECJ are based on specific cases and that facts have a primary importance in leading the reasoning of the Court. Therefore, in interpreting the concepts, one has to ensure that the case at hand matches with the factual case exposed to the ECJ.
Without the appropriate level of focus, holding companies are very likely to suffer from an unavoidable VAT cost which can amount to millions of euros.
1. ECJ Imperial Chemicals Industries plc. (ICI), C-264/96, dated July 16, 1998, pt. 30.
2. ECJ Polysar Investments Netherlands BV, C-60/90, dated June 20, 1991.
3. Notably ECJ Cibo Participations S.A. vs Directeur regional des impôts du Nord-Pas-De-Calais, C-16/00, dated September 27, 2001; ECJ Sofitam, C-333/91, dated June 22, 1993; ECJ Harnas & Helm, C-80/95, dated February 6, 1997.
4. ECJ Polysar Investments Netherlands BV, C-60/90, dated June 20, 1991.
5. ECJ Floridienne-Berginvest, C-142/99, dated November 14, 2000.
6. ECJ Régie Dauphinoise – Cabinet A. Forest S.à r.l., C-306/94, dated July 11, 1996.
7. ECJ Floridienne-Berginvest, C-142/99, dated November 14, 2000.
8. ECJ EDM, C-77/01, dated April 29, 2004.
9. Based on the general rule for defining the place of supply of services until December 31, 2009.
10. Derogation applicable to "intangible" services until December 31, 2009.
11. ECJ TRR Trygghetsradet, C-291/07, dated November 6, 2008.
12. Article 43 of Council Directive 2006/112/EC dated November 28, 2006 (as amended by the Council Directive 2008/08/EC dated February 12, 2008).
13. Article 168 of Council Directive 2006/112/EC dated November 28, 2006.
14. ECJ Polysar Investments Netherlands BV, C-60/90, dated June 20, 1991.
15. ECJ Floridienne-Berginvest, C-142/99, dated November 14, 2000.
16. ECJ Cibo, C-16/00, dated September 27, 2001.
17. ECJ AB Securenta, C-437/06, dated March 13, 2008.
18. ECJ AB SKF, C-29/08, dated October 29, 2009.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.