The European Court of Justice (ECJ) (First Chamber) ruled that, under art. 13(C) and 17(6) of Directive 77/388 (the sixth directive), a member state which gave its taxpayers the right to opt for taxation of the letting of a property was not permitted to exclude deduction of VAT on immovable property investments made before that right of option was exercised, where the application to exercise that option was not made within six months of the property being brought into use.

Facts

The taxpayer had restored a building which it owned and let space in it to the Finnish state, one part from 1 June 1995 and the other part from 1 September 1995. From 31 August 1995, the taxpayer also let an industrial building which it had built to an undertaking liable to VAT. The costs for both projects included VAT.

On 4 April 1996 the taxpayer applied to the Tax Office to become liable to VAT with respect to the letting of those two properties. The tax authority approved that application with effect from the date on which it was made, since the application had not been made within six months of bringing the property into use, as laid down in the national legislation.

The taxpayer subsequently applied to the national court under art. 20 of the sixth directive, for adjustment of the tax deductions and a refund of part of the VAT paid in connection with building and restoration works. Those applications were rejected on the grounds that deduction of the VAT in question was possible under national law only if the option to become liable to that tax had been exercised within six months of the properties being brought into use.

The taxpayer appealed unsuccessfully for those decisions to be set aside. It then appealed to the Supreme Administrative Court which stayed the proceedings and referred to the European Court of Justice for a preliminary ruling on the interpretation of art. 13(C), 17(6) and 20 of the sixth directive.

Issue

Whether the conditions to which the deduction of VAT was subject were contrary to the sixth directive in so far as the national law restricted the adjustment of deductions of VAT in connection with the letting of property initially brought into use in non-taxable activity before being used in taxable activity unless the application for the letting to become taxable was submitted within six months of the property being brought into use

Decision

The ECJ (First Chamber) (ruling accordingly) said that input taxes on goods or services used by a taxable person for his taxable transactions might be deducted.Where goods or services acquired by a taxable person were used for purposes of transactions that were exempt or did not fall within the scope of VAT, no output tax could be collected or input tax deducted. However, where goods or services were used for the purposes of transactions that were taxable as outputs, deduction of the input tax on them was required in order to avoid double taxation.

The time-limit laid down in art. 20 of the sixth directive for adjustment of deductions made it possible to avoid inaccuracies in the calculation of deductions and unjustified advantages or disadvantages for a taxable person where, in particular, changes occurred in the factors initially taken into consideration in order to determine the amount of deductions after the declaration had been made. The likelihood of such changes was particularly significant in the case of capital goods, which were often used over a number of years, during which the purposes to which they were put might alter. The sixth directive therefore provided for an adjustment period of five years, extendable to 20 years in the case of immovable property, with varying deductions staggered over the whole period. Under art. 20(2), adjustment of the deduction of VAT on the purchase price from the second year onwards resulted in keeping the deductible tax at one fifth of the purchase price, a fraction which corresponded to the property's first year of use. Application of art. 5(6) and 6(2) of the sixth directive, by contrast, resulted in taxation of the full value of the property at the time of the change in its use. Those provisions applied only where the goods concerned were put to private use, not where the goods were put to another use in nontaxable activity.

The applicability of each of the provisions in question depended on whether the taxable person had decided to use the property permanently for his private use or rather envisaged the possibility of using it in future for the purposes of his business and therefore decided to keep it as one of the assets of that business. In the first case, art. 5(6) and 6(2) would apply, and in the second case, art. 20 would apply. Thus, subject to the provisions of subsection (5), s. 20 required member states to make provision for adjustment of VAT deductions on capital goods.

Pursuant to art. 17(1) of the sixth directive, the right to deduct VAT arose when the deductible tax became chargeable. Consequently, only the capacity in which a person was acting at that time could determine the existence of the right to deduct. Moreover, the use to which capital goods were put merely determined the extent of the initial deduction to which the taxable person was entitled under art. 17 and the extent of any adjustments in the course of the following periods, but did not affect the origin of any right to deduct. It followed that the immediate use of the goods for taxable supplies did not in itself constitute a condition for the application of the system of adjustment of deductions. Adjustment of the deduction under art. 20 also applied necessarily where alteration of the right to deduct depended on a deliberate choice on the part of the taxpayer, such as exercise of the option provided for in art. 13(C).

Exercise of that option had no effect on the origin of the right to deduct, which was governed by art. 17(1). Since the letting of a property was taxable after the option to become liable to tax had been exercised, an adjustment of the deductions became necessary in order to avoid double taxation of the input costs, irrespective of the fact that that taxation was the consequence of a deliberate choice by the taxpayer. Accordingly, pursuant to art. 20, the adjustment was also applicable where the capital goods were first used in non-taxable activity that was not eligible for deduction and were then used in activity, subject to VAT during the adjustment period.

Member states were free to lay down the procedural requirements under which a right of option might be exercised, which included the possibility of providing that taxation would be effective only after the application had been made and only after that date would deduction of input taxes be possible. However, such rules should not result in restricting the right to deduct in connection with taxable transactions where the right of option had been properly exercised in accordance with those rules. Restricting deductions in connection with taxable transactions after the right of option had been exercised would affect, not the ‘scope’ of the right of option, but the consequences of exercising that right. Thus member states were not to restrict the right to deduct provided for in art. 17 or the need to adjust such deductions under art. 20.

An analysis of the origin of art. 17(6) showed that the option given to member states by the second subparagraph applied only to maintaining exclusions from deduction with regard to categories of expenditure defined by reference to the nature of the goods or services acquired rather than by reference to the use to which they were put or the way in which they were used. In certain circumstances it was possible to deduct VAT on immovable property investments, such as building costs and purchases related to such property. The exclusion in question relating to costs incurred before the option to become liable to VAT was exercised did not therefore fall within thederogation provided for in the second subparagraph of art. 17(6).

European Court of Justice (First Chamber). Judgment delivered 30 March 2006.