On 16 September 2020 the Court of Justice of the European Union (CJEU) handed down a judgment (C-528/19) strengthening the right of entrepreneurs to deduct input VAT and, thus, strengthening the neutrality of VAT. The CJEU held that companies that carry out development measures (for example, construction of a road or extension of an existing road) and later leave this investment to the municipality free of charge are entitled to deduct input VAT. The CJEU also rejected the notion that leaving the facilities to the municipality is a gratuitous transfer of value that is taxable. The plaintiff, Mitteldeutsche Hartstein-Industrie (MHI), intended to operate a limestone quarry and to do so it needed permission from the district government. As a condition for the permit, the district government obligated MHI to develop, upgrade, and expand a public road (especially for heavy goods traffic) belonging to the municipality where the quarry was located.
In the case heard by the CJEU, the German tax office initially granted the plaintiff the input VAT deduction for construction expenses for the development of the public road the district government required. Additionally, the tax office also assessed VAT on the value of the road, treating it as a gratuitous transfer of value. The taxpayer objected to the gratuitous transfer treatment and brought the matter to the tax court. The tax court refused to recognize such a gratuitous transfer of value but it also denied the input VAT deduction.
Given conflicting outcomes in similar cases decided by the German Federal Court of Finance (BFH), the BFH referred the case to the CJEU to clarify whether previous BFH decisions are still compatible with European Union law. For example, in 2011 the BFH denied such an input VAT deduction in a situation involving a ‘free value’ delivery to a municipality (V R 12/08). In more recent CJEU cases, such as the Sveda and Iberdrola cases, however, the CJEU decided in favor of an input VAT deduction.
In its decision, the CJEU noted that without the work on the expansion of the municipal road in question, the operation of the quarry would have been both practically and legally impossible and so the CJEU saw the expenses as indispensable for the plaintiff to carry out its economic activities. But, only expenses that are essential for the operation of the quarry could be considered for input VAT deduction. It is the task of the referring court to decide which cost items were essential to upgrade and expand the public road. The fact that the public can use the road free of charge is not relevant according to the CJEU.
The CJEU rejected the notion that constructing the road was part of an exchange-like transaction (granting of the permit to operate the quarry in exchange for building the road). As the CJEU saw it, the permission issued by the district government for the operation of the quarry was a unilateral sovereign act and thus, in principle, the granting of permission cannot establish a legal relationship leading to an exchange of services with the municipality as a third party and owner of the road.
And finally, the CJEU examined the taxation of a gratuitous transfer of value argument and found that neither consumption for private use nor consumption for the plaintiff’s personnel were applicable in this case. Also, the plaintiff did not pursue any purposes other than those of its business. The CJEU did not see any danger that construction of the road would result in untaxed final consumption, nor was there a violation of the principle of equal treatment. The extension of the road benefited the plaintiff and had a direct and immediate connection to its entire economic activity. Furthermore, the road construction costs the plaintiff incurred form part of the factors in the cost of the output transactions carried out by the plaintiff. Thus, with the same arguments with which the deduction of input VAT was previously justified, the CJEU denied the tax authorities’ claim there had been a taxable gratuitous transfer of value.
The judgement provides welcome relief for entrepreneurs who are obliged to carry out development measures to even start their economic activities but who then must leave these to a public body free of charge. The BHF, as well as the German tax authorities, will have to reconsider their current position regarding such transactions, taking this CJEU decision into account. Entrepreneurs are well advised to review comparable situations carefully to assess if an input VAT deduction is possible.