Summary and implications

As is often the case with buses, a second important case on input tax recovery has come along shortly after another.

  • The CJEU has ruled in AES-3C Maritza East 1 EOOD (C-124/12) (AES) that the company has the right to deduct VAT incurred on various goods and services provided for workers who were not its employees.
  • The link between input and output activities, which must exist in order to be able to deduct VAT, need only be "purely economic". This is a far broader test than previously applied.
  • This ruling was issued on the same day as another, PPG Holdings BV (C-266/12), which similarly considered the nature of the link required between input tax and the general costs of the business. In both cases the CJEU has gone much further than HMRC would have liked and together they open up the possibility of far greater input tax recovery.

Background

AES operates a power station. It has no employees but hires staff under contract with another company. AES provided work clothing, protective gear and transport to the staff. The provision of protection gear was a requirement of Bulgarian law.

Bulgarian domestic law restricts the right to deduct VAT on certain goods and services provided free of charge, except where they are provided by an employer to an employee. The Bulgarian tax authority therefore rejected the deduction of VAT on those goods and services on the grounds that AES was not an employer. The national court asked the CJEU for a preliminary ruling as to whether Bulgarian law was compatible with EU law. There is no similar restriction in EU or UK law to that in Bulgarian law; however, the CJEU's discussion about the right of deduction of VAT is of significance to all EU member states.

Decision

The court discussed the fundamental principles of the VAT system. The right of deduction, intended to relieve the trader of the burden of VAT paid in the course of its business activities, is integral to the scheme of VAT and in principle should not be restricted. For a right to deduct, there must be a direct and immediate link between particular input and output transactions or, where it is a general cost, a direct and immediate link with the economic activities of the business as a whole.

The court noted that the direct and immediate link did not depend on the status of workers. It was not relevant that the workers were employees of another entity. Moreover, they stated that the link that must exist is "purely economic". The crucial question in judging whether costs incurred by a business are deductible is whether there is an "economic link" between the costs incurred and the activities of the business.

Comment

The statement that the link which must exist for the right to deduct is "purely economic" is a powerful one and much wider than that used by the CJEU in the past.

However, the focus on establishing a link between taxpayer's expenditure and the taxpayer's business, rather than strictly to whom the supply of goods or services is made, is not something new. The well known House of Lords case, Redrow (Comms of Customs & Exercise v Redrow Group plc [1999] UKHL 4), was decided nearly 15 years ago on similar principles to AES.

The common feature in Redrow, AES and PPG is the existence of a tripartite arrangement: A paying the VAT on supplies provided by B to C. Redrow paid for the estate agent services provided to prospective house-buyers; AES paid for clothing and transport for the employees of another entity; and PPG paid for the management and investment services provided to a legally separate pension fund. All were able to recover the input tax charged.

From these cases, it is clear from both a UK and EU perspective that the question to ask when considering the deductibility of input tax is whether the cost incurred by the taxpayer has a direct and immediate link with the economic activity of the taxpayer's business, i.e. has the taxpayer received any benefit for his business? This potentially allows for a simplification of the application of the VAT legislation and for a spate of refund claims. It will further increase the pressure on HMRC to reconsider their stance in relation to input tax recovery generally.

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