CJEU to rule on VAT treatment of director fees
The District Court of Luxembourg has requested a preliminary ruling from the Court of Justice of the European Union (CJEU) on the VAT status of a member of the board of directors of a public limited company incorporated under Luxembourg law and the VAT treatment of the remuneration the director receives in the form of “percentage fees.” Under Luxembourg law, company directors are considered taxable persons for VAT purposes and supplies of their services are subject to the 17% Luxembourg VAT if the directors are deemed to be located in the country. As further explained below, the CJEU decision in this case could significantly impact current Luxembourg VAT practice.
The EU VAT directive is silent on the VAT treatment applicable to company management, although various EU member states have tried to address this gap using the general VAT rules in articles 9 and 10 of the directive. For example, article 9 broadly defines the term “taxable person” to encompass any legal person or individual carrying out an “economic activity,” regardless of its purposes and results, provided the activity is carried out “independently.” With respect to the independence criterion, article 10 excludes “employed and other persons from VAT in so far as they are bound to an employer by a contract of employment or by any other legal ties creating the relationship of employer and employee as regards working conditions, remuneration and the employer's liability.” The differing VAT treatment of company board members’ activities by the member states has created a patchwork of sometimes inconsistent rules for both the directors and the companies themselves.
The CJEU has not yet had an opportunity to address the issue of the VAT treatment of company directors. To date, the court has only ruled on the activity of a member of a supervisory board of a foundation established under Dutch law (C420/18, IO case).
Facts of the case
The case referred to the CJEU involves TP, a member of the board of directors of public limited companies incorporated under Luxembourg law, namely, a Luxembourg bank and three holding companies belonging to German and French groups. TP participates in decisions concerning the accounts, risk management policy and strategy to be followed by the groups and in developing proposals to be put forward at shareholder meetings. In his role as director, TP received fees in the form of a percentage of company profits, with the amount of the payment based on a decision of the company’s shareholders.
The Luxembourg VAT authorities took the position that VAT was due on the percentage fees because a company director independently carries out an economic activity and thus qualifies as a taxable person for VAT purposes. TP disagreed and appealed the final decision of the VAT authorities to the referring court. The court has asked the CJEU to rule on whether:
- Percentage fees received by a board member of a Luxembourg public limited company should be regarded as remuneration paid for services supplied to the company; and
- An individual who is a board member of the company carries out his activity independently within the meaning of articles 9 and 10 of the VAT directive.
Arguments of the parties
TP argues that a board member of a Luxembourg company does not carry out their core duties as a board member independently but rather as a member of a collective body representing the company. Members of a board of directors are not independent of the company and the management services the board collectively provides are deemed to be provided by the company itself. As a result, TP cannot be said to be engaged in an economic activity when carrying out their core duties as a board member and remuneration for board services is outside the scope of VAT. In support of their arguments, TP claims that the independence criterion, as interpreted by the CJEU in the IO case, is not met for the following reasons:
- The company bears the economic risk associated with the board members. Directors can be held personally liable only where they manifestly exceed the limits of acceptable conduct and/or breach their fiduciary duties;
- As the board’s decisions are taken collectively, any contribution to the management of the company should be regarded as a service provided by the collective body itself and not by its individual members; and
- The percentage fees should not be considered remuneration for services agreed between a service provider and its client (i.e., which would be subject to VAT), but rather as compensation granted by the general meeting of shareholders (i.e., which is outside the scope of VAT).
The Luxembourg VAT authorities, however, argue that TP provides management services to the company, which are subject to Luxembourg VAT based on the following:
- There is a direct link between the percentage fees TP received and the services provided in their capacity as a director. This is because: (i) the resolution of the general meeting of shareholders to pay higher or lower fees is closely connected to the director’s expertise and the importance of the specific functions performed in the previous financial year; and (ii) the payment of the fees does not depend on the availability of distributable profits of the company; and
- There is no employment relationship between Luxembourg directors and the companies, so TP acts independently. In fact, (i) a director independently procures and organises the staff/equipment required for their activity; (ii) remuneration depends, at least in part, on the success of the business, and thus on the economic risk attached to the company; and (iii) a director has civil liability vis-à-vis the company and third parties in exercising their activity, as well as joint liability in tax/VAT matters.
This request for a preliminary ruling gives the CJEU an opportunity to articulate its position on the VAT status of company directors, as well the VAT treatment applicable to their remuneration (notably, percentage fees where the direct and immediate link with the activity carried out by the directors appears more dubious, given that these fees could be seen as solely dependent on the arbitrary decision of the company’s shareholders).
Based on guidance issued by the Luxembourg VAT authorities in 2016 (and applicable as from 1 January 2017), the current Luxembourg VAT practice can be summarised as follows:
- Director mandates exercised independently by Luxembourg individuals or legal persons constitute an economic activity that falls within the scope of VAT. Thus, in principle, directors' fees are subject to Luxembourg VAT at the standard rate of 17%.
- Luxembourg directors have the status of VAT taxable persons and must register for VAT purposes in Luxembourg, charge VAT to the company paying the directors’ fees, issue VAT-compliant invoices and file Luxembourg VAT returns.
- Luxembourg companies that qualify as taxable persons for VAT purposes must self-assess Luxembourg VAT under the reverse charge mechanism on directors’ fees paid to foreign directors (a B2B supply).
- Certain directors’ fees paid to Luxembourg VAT directors are exempt from VAT, specifically where (i) the director falls under the small enterprise scheme (i.e., their annual turnover does not exceed the EUR 35,000 threshold); (ii) the director is an “honorary" director; and (iii) director provides services to a qualifying regulated investment fund.
A conclusion by the CJEU either that the independence criterion of company directors is missing for VAT purposes and/or that there is no direct and immediate link between the activity performed by the directors and their remuneration would dramatically alter the Luxembourg VAT landscape. Such a ruling would mean that Luxembourg entities with zero or limited input VAT deduction rights would no longer have the additional 17% VAT cost on directors’ fees paid to individuals/legal persons and company directors would no longer have Luxembourg VAT compliance obligations. Being of an interpretative nature, the CJEU determinations could apply retroactively, thus entailing a potential reconsideration of the VAT status of Luxembourg company directors, who have had to comply with the Luxembourg guidance since 2017. It remains to be seen how the CJEU’s decision will affect Luxembourg VAT practice and whether the court will offer useful guidelines that could pave the way for a unified approach throughout the EU.