Arsene Taxand - TVA & indirects tax

Share transfer expenses and VAT recovery: the law and management of proof

On 23 December 2010, the Conseil d’État (French Supreme Administrative Court) handed down two decisions in the cases Pfizer Holding France (no. 307698) and SA Michel Thierry (no. 324181) on the deductibility of VAT on the transaction costs of share sales. These decisions conclude a cycle of case law decisions that started more than fifteen years ago, with the BLP Group decision (ECJ, 6 April 1995).

In order to have a better understanding of the exceptionally long debate on this issue, and the differences in approach between the ECJ and the national courts, we need to review the respective role of these courts before analysing the two Conseil d’État decisions mentioned above.

      1.  The Court of Justice of the European Union ("CJEU") in its role of interpreting Community legislation

Firstly, it is important to note that the CJEU, which clarifies points concerning the interpretation of EU law, acts within a framework that is very different from the national courts.

The CJEU does not rule in the last instance, as it only interprets Community law. It is always up to the national courts to draw conclusions from the CJEU's clarifications.

Given this state of affairs, the issue is not so much to analyse changes in the CJEU's position (which in reality correspond to changes in case law) but rather to understand the characteristics of the questions referred to the CJEU within the existing, restrictive framework.

This restrictive framework can be illustrated by the following points: (1) only the national courts are authorised to refer matters of interpretation to the CJEU; unfortunately, during the proceedings before the CJEU, and in support of their observations, the parties cannot change the material scope of the questions, as referred by the national courts; (2) the CJEU is moreover not permitted to answer questions that were not submitted by the national courts, even at the request of a party to the dispute; (3) lastly, in referrals for preliminary rulings on interpretation, the questions must be worded in such a way that they are confined to Community law alone and not concerned with national law.

In practice, and given that there have been a certain number of requests for preliminary rulings that have been poorly worded, it is reassuring to know that the CJEU has the right to expand or limit the questions compared to those originally asked, in the interests of the proper administration of Community justice.

The period of fifteen years can largely be explained, in our opinion, by the difficulty in applying the principles of interpretation given by the CJEU to practical cases: the concept of a direct and immediate connection between the expenses and the downstream operations originates in the aforementioned BLP Group decision; it is on this basis that, at the time, the administration had held in its Instruction of 10 January 2006 (3 A-1-06) that the sale costs were not eligible for deduction; it is on these same grounds that the AB SKF decision of 2009 (ECJ, C-29/08, 29 October 2009) reopened the possibility of exercising the right to deduction. This possibility was confirmed in a specific case by the Conseil d’État on 10 June 2010 in the SA Siva case, no. 292389).

In short, as our colleague Philippe Tournés so rightly stated in an article dated 21 January 2010 (La Semaine Juridique Entreprise et Affaires, no. 3), the CJEU landscape in this area has not fundamentally changed in fifteen years.

This landscape has only been detailed, refined and supported by the CJEU.

It is up to the national courts to draw the practical conclusions and to the administration to accept th e consequences.

      2.  The purport of the two Conseil d’État decisions of 23 December 2010

These decisions have the merit of clarifying a certain number of points, which are worth reviewing in detail.

a)    The sale of shares in a subsidiary is, in most cases, a transaction that is taxable for VAT purposes
This is the case, in particular, when a parent company sells shares after being directly or indirectly involved in the management of the sold entity, when the sale constitutes the direct, permanent, necessary extension of its taxable activity or, furthermore, when the sale is part of a commercial securities trading activity. As far as a certain number of European States and the ECJ are concerned (in particular, in decisions C-142/99 Floridienne and Berginvest or C-16/00 Cibo Participations), the concept of management involvement is held to exist when the parent company supplies services or sells goods to its subsidiary. For the sake of clear reasoning, it is unfortunate that this concept of management involvement, which had already been used in other areas (in order to determine whether or not an economic activity exists) and that is unclear to say the least, is still being used by the CJEU and the national courts.

The sale of shares in a subsidiary may not taxable for VAT purposes in two cases: (i) a sale of shares that is assimilated, if the State concerned so elects, to the transfer of a totality of assets within the meaning of Article 19 of Directive 2006/112 (Article 5 § 8 of the Sixth Directive) and (ii) the acquisition and sale of shares, when they do not constitute economic activities (the case of an asset holding company, for example).

b)    A sale of shares is a VAT-exempt transaction
When share sales are taxable for VAT purposes, they are VAT-exempt transactions pursuant to Article 135 § 1 subparagraph f of Directive 2006/112 (Article 13 B subparagraph d) point 5 of the Sixth Directive). In this respect, the limitation of the exemption to cases of the commercial activity of transactions in securities, which the Commission wanted at the time of the AB SKF case and that was not accepted by CJEU, was also not applied by the Conseil d’État.

c)    The deduction of the expenses linked to a sale of shares, which is taxable for VAT purposes but a VAT-exempt transaction, raises a question that is in reality a classic tax problem: should the costs of the sale be attributed to the share sale transaction or to the general activity of the undertaking? According to the administration, there are apparently expenses that are "inherent" in the sale that should not be eligible for deduction (with the exception, in our opinion, of the sale of non-EU shares that grants the right to deduction) and, on the other hand, expenses that are "attributable" to the sale, which can be deductible as overheads. Behind this terminology of a direct and immediate connection and inherent expenses, we find, in reality, well-known concepts that existed before the French rules governing deduction rights were recast, namely the attribution rule or the proportion rule.

According to the attribution rule, no deduction of input VAT is apparently possible since the sale of shares is a VAT-exempt output transaction (with the exception of the sale of non-EU shares); according to the proportion rule (overheads), the input VAT is deductible on a proportional basis.

The Conseil d’État, which had to decide between the attribution and proportion rules, uses the same wording as the CJEU in its AB SKF decision: the existence of a direct and immediate link (the attribution rule) presupposes that the expenditure incurred in acquiring the input services is incorporated in the sale price of the shares. For sale transactions involving listed shares, there would therefore be no doubt that, in principle, there cannot be a direct and immediate link; for sale transactions involving non-listed shares, in contrast it would be harder to prove, post hoc, that the sale price does not incorporate these expenses; absent such proof, the Conseil d’État considers that the deduction cannot be permitted.

Accordingly, in the Pfizer Holding France case, which involved a sale of non-listed shares, the company found itself denied the right to deduction as it did not succeed in proving what does not exist (the sale price of non-listed securities is very often determined using objective criteria such as the discounted cash flow method, of the goodwill, for example, without taking into account the costs paid by the sellers).

In practice, however, Pfizer Holding France should have been entitled to deduct this VAT on the sole basis of Article 271 b) of V of the French Tax Code (non-EU sale); Pfizer Holding France was not even granted this deduction on this basis and at this stage we are not in a position to explain the reasoning used (the forthcoming publication of rapporteur Olléon's arguments will no doubt enlighten this point).

In the same decision, the Conseil d’État therefore succeeded in being consistent with the European AB SKF decision, which contradicted the administration's traditional positions, in upholding the administration's case by overturning the Court of Appeal's decision, and in not accepting the taxpayer's practice by not permitting the taxpayer to deduct the VAT, despite the non-EU nature of the transaction.

In a previous newsflash that commented the AB SKF decision, we already stated that behind the intellectual debate on ideas and principles, two situations made it possible to significantly attenuate the VAT recovery problem: sales outside the EU or, since 2009, election of the single, flat-rate tax coefficient, which has only been possible since 2009.
In our opinion, this is still true and all the more useful.
It is also advisable, in order to prove that "what does not exist" (inherent costs) does indeed not exist, to stipulate in the instrument of sale for non-listed shares that the expenses paid by the seller and that pertain to the sale transaction are not included in the sale price of the shares and will be paid by the seller.

Organising proof that the expenses incurred were not incorporated into the sale price should, in this respect, make it possible to avoid the pitfall of the non-deductibility of the tax. This is precisely what the taxpayer was able to prove in the second decision (SA Michel Thierry) handed down on the same day by the Conseil d’État.

Alain Recoules
Partner Arsene Taxand