OUR INSIGHTS AT A GLANCE

  • The Luxembourg Court of Cassation (hereafter the "Court") ruled that the VAT deduction right of a holding company does not have to be limited by the 1:1 ratio when it can be demonstrated that the input VAT incurred is related to the part of its turnover granting a VAT deduction right.
  • The Court ruled that a discrepancy between the volume of costs borne and the income granting a VAT deduction right earned shall not lead automatically to a limitation of the VAT deduction right.
  • In line with EU VAT principles, this judgment is very welcome for Luxembourg holding companies performing VAT taxable activities (e.g. holding providing management services to group companies, etc.).

On 17 March 20221 , the Luxembourg Court of Cassation (hereafter the "Court") ruled that the VAT deduction right of a holding company does not have to be limited by the 1:1 ratio when it can be demonstrated that the input VAT incurred is related to the part of its turnover granting a VAT deduction right. The Court ruled that a discrepancy between the volume of costs borne and the income granting a VAT deduction right earned shall not lead automatically to a limitation of the VAT deduction right.

Background

In the case at hand, a Luxembourg company X, member of a real estate group, provided management services to subsidiaries and to related parties. Furthermore, X held shares in subsidiaries to which it also granted loans. From a VAT perspective, X performed both activities granting a VAT deduction right (i.e. management services) and activities not granting such a VAT deduction right (i.e. the holding of shares and the granting of EU financing). To limit its VAT deduction right, X used a pro-rata amounting to 94% for 2004 and of 91% for 2005.

The VAT authorities challenged the VAT recovery right of X on the ground that the costs incurred by the company were higher than the turnover granting a VAT deduction right earned. According to the VAT authorities and in order to benefit from the deduction right, X had to demonstrate that the costs incurred were:

  • directly and immediately linked to its economic activity granting a VAT deduction right, and
  • incorporated in the price of the services provided granting a VAT deduction right.

Noticing that the costs incurred by X were higher than its turnover, the VAT authorities considered that the costs were not incorporated in the price of the services rendered and, therefore, the VAT deduction right of X should be limited in due proportion to its turnover granting a VAT recovery right (the so-called "1:1 ratio").

The decision of the Director of the VAT authorities was brought to the Luxembourg District Court and to the Court of Appeal. In the frame of the litigation and to assess the "direct and immediate link", an expert was mandated by the District Court to determine whether the costs borne by X were effectively related to its activity granting a VAT deduction right. The conclusion of the expert report was that the costs borne by X were related to its management activity (i.e. to its activity granting a VAT recovery right).

Position of the Court

The Court confirmed the position of the Court of Appel based on which X was entitled to deduct the input VAT incurred:

  • considering the demonstrated "direct and immediate link" of the input VAT incurred by X in relation to its economic activity granting a VAT recovery right,
  • irrespectively of the huge difference between the volume of costs incurred and the limited income granting a VAT deduction right earned.

The Court also confirmed that the decision of the Court of Appeal was not challengeable on the ground that the incorporation of the costs borne by X in its turnover granting a VAT deduction right was not verified. In other words, the Court confirmed that the demonstration of the incorporation of the price of the costs borne in the turnover granting a VAT deduction right is not a condition to benefit from the right to deduct.

Actions to be taken

This case has a positive impact on the VAT deduction right of active holding companies, i.e. companies whose activities go beyond the mere passive holding of shares and which provide services, such as management or administrative services to their subsidiaries. To the extent that the "direct and immediate link" is demonstrated by factual elements (agreements, invoices, etc., making a clear link between the costs and the turnover), Luxembourg holding companies should no longer see their VAT deduction right challenged by the VAT authorities using the 1:1 ratio.

We recommend active holding companies to review their VAT deduction methodology and the documentation available to demonstrate the "direct and immediate link".

Footnote

1 n°43/2022 from 17 March 2022

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.