Pursuant to the rulings of the Court of Justice of the European Communities with respect to the scope of the VAT, the authorities have defined the concept of "direct connection".
Drawing the consequences of this definition, the authorities have repealed the 1983 instruction relating to the liability to taxation of commercial waivers of receivables. Henceforth, only subsidies and grants between companies which constitute consideration for customized services, or the price supplement for a taxable service, will be subject to VAT. Likewise, indemnities are exempt from VAT, if they correspond solely to the reparation of a loss, but are subject to VAT if they constitute compensation for a service or delivery of goods, or a price supplement (and in particular, according to the authorities, if they constitute indemnification for "common commercial damage").
In addition, the authorities have expressly excluded certain receipts from the scope of VAT: dividends (applying the SATAM ruling) and profits distributed by partnerships and similar undertakings.
2. Rules governing entitlement to deduction of VAT
2.1 Parties subject to partial liability
In practice, the recoupment of VAT charged on the expenditure of parties performing both exempt transactions and transactions subject to VAT varies according as the expenditure is related to a transaction in the former class: no deduction for "exempt" transactions, or one in the latter class: right to recoupment contingent, as in the past, upon the status of the transaction to which the expenditure relates: transaction giving rise to a deduction or not, and proration.
For instance, the authorities have stated that the VAT on expenses incurred by a holding company for the acquisition of shares or the collection of dividends may not be recouped.
In the case of dual-purpose expenses (goods and services used in combination for the performance of exempt transactions and transactions subject to VAT), however, the VAT is not deductible in proportion of the physical use of such goods and services in the performance of transactions excluded from VAT.
2.2 Parties liable for partial VAT
This concerns parties performing transactions subject to VAT, but some of which are exempt and not eligible for deduction (such as financial income from French sources). For the determination of the percentage of deduction applicable to fixed assets ("proration"), the authorities have confirmed that receipts outside the scope of VAT are excluded from computation of the proration.
Financial earnings other than dividends, and exempt earnings from realty, must be included in the proration's denominator, with the undertaking's realt receipts, unless they account in the aggregate for less than 5% of the total sales including VAT, and are sevrable from the remainder of the business. It remains possible, however, to set up a separate sector of operation, if the exempt transactions are accessory to the principal business not exceed the 5% threshold.
As for grants, subsidies and waivers of receivables obtained, they are now subject to complex treatment. In practice, only waivers of receivables on an exceptional basis (no repeated and in an accessory amount) and non-taxable subsidies financing exempt transactions are excluded from computation of the proration. Accordingly, repeated subsidies no subject to VAT may, in some cases, affect the entitlement to deduction of upstream VAT for the party receiving them.
For further information contact Thierry Pons (Paris) (33) (1) 46 93 60 72.
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.
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