Costs incurred for business purposes and benefit of third party - VAT deductible?
In the Netherlands, an interesting case (case: 18/01184, NL:HR:2020:481) was published about the deductibility of VAT. In this case, a private limited company paid lawyer’s fees for the director and major shareholder and deducted the VAT. The dispute is whether the VAT on the lawyer’s fees is deductible. The Dutch Supreme Court ruled on this subject.
The judgment of the Dutch Supreme Court
The facts in this proceeding were as follows. B was, together with his partner C, direct and major shareholder of two private limited companies: Company D and Company E. The activities of the companies consist of providing financial advice and consultancy and management services. B and Company D were suspected of bankruptcy fraud. In 2005, a criminal investigation started against B because of the supposed bankruptcy fraud. Eventually, in 2012, B was cleared of any charge. During the trial, a law firm represented B. The invoices sent by this law firm were paid by Company E, which was not involved in the supposed bankruptcy fraud. Subsequently, Company E deducted the VAT on the lawyer’s fees. The dispute was whether this VAT is deductible.
The Court of Appeal ruled that Company E was not the actual consumer of the legal services and the VAT is therefore not deductible. Besides, in the opinion of the Court of Appeal, it does not become apparent from the facts that Company E was involved in the trail. The Court of Appeal did not address the argument of Company E that the legal services were necessary for the business continuation of Company E. Because of the reputational damage of B, Company E did not receive any new assignments. Only after B was cleared of any charge, could Company E could continue its business activities.
The Dutch Supreme Court ruled that the Court of Appeal wrongfully did not address this argument. The Supreme Court referred the case back to the Court of Appeal to inquire into the necessity of the legal services to secure the business continuity. According to the Dutch Supreme Court, Company E can be regarded as the consumer of the legal services and the deduction of VAT is not excluded if the legal services were indeed necessary to secure Company E’s business activities. In addition, the authors note that VAT can only be deducted if the invoices are also in the name of the private limited company.
Prudence is in order
When your private limited company incurs costs from which third parties also (indirectly) benefit, such as costs for the benefit of the director and major shareholder, an employee or another group company, the right to the VAT deduction may be called into question. The judgment of the Dutch Supreme Court shows that caution is required and deduction of VAT is not excluded in advance. It is therefore important in such a case to carefully examine whether, and to what extent, the right to deduct VAT exists.