The European Court of Justice declared that, by providing for a deductible proportion of VAT for taxable persons who carried out only taxable transactions, and by laying down a special rule which limited the right to deduct VAT on the purchase of goods and services which were subsidised, Spain had failed to fulfil its obligations under art. 17(2) and (5) and 19 of Directive 77/388 ('the sixth directive').

Facts

The Commission initiated the infringement procedure under art. 226 EC by a letter of formal notice sent to the Spanish Government on 20 April 2001, in which it maintained that the national law restricted the right to deduct VAT, contrary to art. 17(2) and (5) and 19 of the sixth directive. Under a general rule of the national law, subsidies to finance the trade or business of a taxable person, which did not form part of the basis of VAT assessment, were taken into account in the calculation of the deductible proportion in so far as they were part of the denominator of the portion which that proportion resulted from. Those subsidies thus generally diminished the right to deduct enjoyed by taxable persons. The latter consisted not only of taxable persons who used the goods and services obtained as inputs to carry out, at the same time, transactions in respect of which VAT was deductible and other transactions of a similar nature in respect of which it was not, but also taxable persons who used goods and services exclusively to carry out transactions in respect of which VAT was deductible. Under a special rule, subsidies granted specifically to fund the purchase of certain goods or services acquired in connection with transactions that were taxable and not exempted from VAT reduced exclusively the amount of the deduction of VAT borne or paid in respect of those transactions, to the precise extent to which they had contributed to their funding. Consequently, in the case of a subsidy amounting, for example, to 20 per cent of the purchase price of a good or service, the right to deduct the VAT specifically imposed on that good or service was reduced by 20 per cent. The Commission argued that the general rule unlawfully extended the restriction of the right to deduct laid down in art. 17(5), read in conjunction with art. 19, by applying that restriction not only to mixed taxable persons but also to fully taxable persons. In addition, the special rule introduced a mechanism of deduction which was not provided for in the sixth directive and was thus contrary to it.

Issue

Whether the kingdom of Spain had failed to fulfil its obligations under art. 17(2) and (5) and 19 the sixth directive.

Decision

The European Court of Justice (Third Chamber) said that art. 17(2) set out the principle of the right to deduct VAT. The latter concerned input tax on the goods and services used by taxable persons for the needs of their taxed transactions. Where the taxable person carried out, at the same time, transactions in respect of which VAT was deductible and exempted transactions in respect of which it was not, art. 17(5) stated that only such proportion of the VAT should be deductible as was attributable to the taxed transactions. That proportion was calculated according to the method laid down in art. 19.

The provisions of the second indent of art. 19(1) on subsidies which were not included in the price of the good or service provided and which did not form part of the taxable amount, must be read in the light of art. 17(5). However, as was clear from its wording, art. 17(5) only applied to mixed taxable persons. It followed that, given that it was not an exception applicable to both mixed and fully taxable persons, the second indent of art. 19(1) permitted limitations of the right to deduct, taking account of the subsidies thus defined, only in the case of mixed taxable persons. Consequently, by extending the restriction of the right to deduct to fully taxable persons, the general rule introduced a restriction which went beyond the one expressly provided for in art. 17(5) and 19 and infringed the provisions of the directive. Further, the special rule introduced a mechanism for limiting the right to deduct which was not provided for in art. 17(5) and 19 or in any other provision of the sixth directive. Consequently, such a mechanism was not authorised by the directive. The member states were required to apply the sixth directive even if they considered it to be less than perfect. Even if the interpretation put forward by certain member states better served certain aims of the sixth directive, such as fiscal neutrality, the member states might not disregard the provisions expressly laid down in that directive by introducing, in this case, limitations of the right to deduct other than those laid down in art. 17 and 19. It had to be established that the state authorities were prompted to adopt legislation or conduct contrary to Community law because of objective and significant uncertainty regarding the implications of the Community provisions concerned. However, there was no such uncertainty in this instance and it was thus not necessary to restrict the effects in time of the present judgment.

European Court of Justice (Third Chamber). Judgment delivered 6 October 2005.