Arsene Taxand - VAT & indirect taxes

Comments on the Opinion of Advocate General Paolo Mengozzi in Case C – 29/08 AB SKF

The delicate issue of the deduction of VAT on transaction costs of sale of shares still seems far from being settled. Taxpayers and lawyers await with interest the ECJ decision on the AB SKF case, on which Advocate General Paolo Mengozzi has just made known his position.

In this case, the ECJ has been asked to give a preliminary ruling on the deductibility of VAT on costs incurred by a mixed-activity holding company for the disposal of shares.

While the Advocate General’s Opinion, which was made public on 12 February last, proposed that the Court reject the right to deduct this VAT, it still warrants particular attention.

The facts are common and correspond to the situation of a lot of companies: SKF, the parent company of an industrial group, holds shares in two subsidiaries. It has been involved in the management of these companies and invoices them for various services, including administration, accounting and marketing. SKF is therefore liable for VAT on this basis.

The questions referred to the Court for a preliminary ruling by the Swedish Revenue Law Commission clearly define the subject, by distinguishing between the VAT treatment applied to the disposal transaction, on the one hand, and, on the other hand, to the costs (services in the area of valuation of the shares to be disposed of, assistance with the disposal negotiations and the drafting of the contracts) incurred within the scope of this transaction.

The Court is thus requested to make a complete, detailed analysis of these points.

We have the following observations on this Opinion.

1. Treatment of the share disposal transaction:

The Court will firstly have to rule on the VAT treatment that is applicable to the sale of shares itself.

This means determining whether the sale of shares performed by a mixed-activity holding company is an activity that falls outside the scope of application of VAT or whether it must be analysed as a transaction that falls within the scope of, but is exempted from, VAT.

For the Advocate General, the transaction falls within the scope of VAT, but is exempted from VAT.

This analysis appears to confirm the longstanding characterisation used, inasmuch as before the appearance of activities that fall “outside the scope” of VAT it was accepted by both the administration and the national courts that the sale of shares was covered by Article 13 B d) 5 of the Sixth Directive on exempt financial transactions.

The Advocate General firstly states that transactions related to financial holdings in other undertakings are not, in principle, an economic activity for the purposes of VAT (and therefore fall outside the scope of its application), but may under certain circumstances fall within the scope of application of VAT. This is the case when the transactions are part of a commercial activity that involves trading in securities, or when their purpose is direct or indirect involvement in the management of companies.

The concept of involvement was defined by the ECJ in several decisions (ECJ 20 June 1991, Polysar Investments Netherlands (C-60/90, Rec. p. I 3111, point 13 and 14), ECJ 14 November 2000, Floridienne and Berginvest (C-142/99, Rec. p. I-9567, point 18), ECJ 27 September 2001, Cibo Participations (C-16/00, Rec. p. I-6663, point 20)) pursuant to which:

- the mere acquisition of financial holdings in other undertakings does not amount to the exploitation of property for the purpose of obtaining income therefrom on a continuing basis because any dividend yielded by that holding is merely the result of ownership of the property;

- however direct or indirect involvement in the management of subsidiaries, in particular by supplying them with administrative, accounting and information technology services, is an economic activity for the purpose of VAT.

Accordingly, for the Advocate General, financial transactions performed by mixed-activity holding companies that concern shares of the companies in whose management they are involved, are economic activities that fall within the scope of application of VAT.

We will therefore wait to see if the Court will also use the criterion of management involvement in order to characterise the existence of an economic activity, inasmuch as this criterion of involvement is not used in the most recent decisions on this subject (EDM decision of 2004 Kretztechnik decision of 2005).

2. Deduction rules applicable to VAT on costs incurred for the performance of the sale of shares transaction:

There are two opposing analyses:

- analysis based on the direct, immediate effects of the transaction;

- and analysis based on the ultimate (more long-term) aim of the transaction.

Certain French courts adopted the solution that involves analysing the non-immediate consequences and the ultimate economic aim of the transaction, on the subject of disposal costs (Paris Administrative Court 13 April 2005 no. 98-8770 and 00-14423, Sofémi; Paris Administrative Court 8 July 2005 no. 98-17939, Parke-Davis SCA; Nantes Administrative Court of Appeal 30 December 2005 no. 03-76, SA Siva.).

These decisions are based on the Cibo judgment, which was handed down on the subject of acquisition costs, in which the Court holds that services purchased by a mixed holding company in connection with the acquisition of a shareholding in a subsidiary form part of its general costs and therefore have a direct and immediate link with its business as a whole.

This long-term vision is also defended by the Commission in the case at hand.

On the other hand, the Advocate General is against transposing this reasoning to the subject of shareholding disposals.

He considers, as did the Court in the BLP Group judgment (ECJ 6 April 1995, BLP Group, C-4/94), that such costs have a direct, immediate link with the disposal transaction, which is an economic operation that falls within the scope of application of VAT but is exempted from VAT. The Advocate General therefore considers that the link between these expenses and the taxable activities is only indirect.

It is worth pointing out that, according to case law, the direct and immediate link between expenditure and one or more output transactions is established when the expenditure forms part of the price of the output transaction (The concept of the direct and immediate link results, in particular, from the Midland Bank (point 30), Abbey National (point 28), Cibo Participations (point 31) and Kretztechnik (point 35) judgments).

For the Advocate General, the fact that an exempt transaction occurs between the expenditure and the taxable output transactions means it is not possible to consider that the expenditure is directly and immediately linked to the taxable transactions.

The Advocate General also rules out characterising the costs as overheads: in his opinion, this characterisation, which means recognising that the expenditure has a direct and immediate link with company’s activities as a whole, is only possible when there are no exempt transactions between the expenditure and the taxable output transactions.

To our knowledge, to date, only one case led the Court to apply this analysis while upholding the characterisation of overheads. This was the Kretztechnik case, which concerned the costs of issuing shares by a mixed-activity holding company. The Court had emphasised that, while the issue of shares did not fall within the scope of application of VAT, the link between the costs and the activities as a whole could be established (without “breaking the chain” as pointed out by the Advocate General in the AB SKF case).

If the Court confirms this analysis of the case at hand, the VAT on the input expenses may only be deducted as overheads if the transaction to which the input expenses immediately relates falls outside the scope of application of VAT.

This shows the importance of the first question referred to the Court.

In conclusion:

The analysis defended by the Advocate General (expenditure connected to exempt transactions) therefore leads to the input VAT not being deducted.

This seems consistent with existing provisions concerning the characterisation of a sale of shares.

On the other hand, we do not share the opinion of the Advocate General concerning the costs themselves: by stating that the exempt transaction prevents the recognition (“breaks the chain”) of the direct and immediate link between this expenditure and the taxable output transactions, this analysis ignores the economic reality whereby this transaction, in cases such as the one at hand, necessarily contributes to the whole of the company’s activities.

We even go as far as to consider that, if the Court should follow this opinion, the matter will not necessarily be settled.

Indeed, the nature of the costs in question in this case means that they have a particularly direct link to the disposal transaction, strictly speaking. Other types of cost could, in our opinion, make more of a case for taking into account the ultimate economic aim of the transaction: disposing of shares could mean assessing the value of and transferring the title to the shares, as occurred here, but also restructuring and refinancing.

We may therefore question whether the position put forward by the Advocate General is still relevant for costs that are not exclusively and directly related to the disposal transaction (invoice of costs related both to the disposal, strictly speaking, and to advisory services that cover wider aspects such as WCR, financing, etc.). From both a technical and economic standpoint, as such expenditure is not exclusively and directly linked to the disposal transaction, in our opinion it should be deemed to be mixed, thus authorising the pro rata deduction of VAT (standard taxation coefficient).

Lastly, in order to limit the consequences of the analysis put forward by the Advocate General, we emphasise the position of the British tax administration, according to which share disposal costs contribute to realising a taxable transaction that is exempted from VAT (the disposal of shares), however the VAT on these costs, when used to make an incidental financial supply outside the EU (invoice sent to a buyer outside the EU), is recoverable.

Indeed, we have to bear in mind, in the case where the ECJ follows the opinion of the Advovcate General, that the concept of VAT exemption in the field of banking and finance is not exactly synonymous with non-recoverability.