A transaction which was exempted from VAT within the territory of a member state under art. 13(A)(1)(e) of Council Directive 77/388 (‘the sixth directive’) did not give rise to the right to deduct input tax pursuant to art. 17(3)(b) of that directive, even when it was an intra-Community transaction, and regardless of the system of VAT applicable in the member state of destination.

Facts

The taxpayer was a company established in Luxembourg and engaged in making and repairing dental prostheses for customers based in Germany. For the accounting periods 1992 and 1993, the tax authority refused to permit the taxpayer to deduct the input VAT charged on goods used to supply goods and services to customers based in Germany on the ground that the national law on VAT, which permitted deduction of input VAT, did not apply. The Luxembourg District Court, before which the taxpayer brought an action for annulment and variation of that decision, held the deduction had been incorrectly refused but the tax authority appealed. The appeal court referred to the European Court of Justice for a preliminary ruling whether art. 13 of the sixth directive took precedence over art. 28C thereof. Article 13(A) of the sixth directive provided for the exemption from VAT of certain activities in the public interest, including, under art. 13(A)(1)(e), services supplied by dental technicians in their professional capacity and dental prostheses supplied by them. Under art. 17(2)(a), where a taxable person supplied goods or services to another taxable person who used them for an exempt transaction pursuant to art. 13(A), the latter person was not, as a rule, entitled to deduct the input VAT paid. In such a case, the goods and services concerned were not used for taxable transactions.

In the present case, it was not disputed that the transactions carried out by the taxpayer were covered by those provisions when they took place within the territory of the member state in which that company was established. The national court sought solely to establish whether the transactions were still covered by those provisions where they were effected for customers based in another member state, in this case Germany.

As regards transactions of an intra-Community nature, art. 15(1)–(3) of the sixth directive, before 1 January 1993, provided for the exemption of supplies of goods and supplies of services relating to goods which were dispatched or transported to a destination outside the territory of the member state. As from that date, the exemption of those supplies to another member state was provided for in the first subparagraph of art. 28C(A)(a). Under art. 17(3)(b), as amended by art. 28F(1), the deduction of input VAT on such transactions was permitted in the member state of the departure of the dispatch or intra-Community transport of the goods.

The tax authority submitted that the intra-Community transactions in question did not give rise to a right to deduct because art. 13(A)(1)(e), which provided for a special exemption, took precedence over the more general provisions laid down in art. 15 and 28C(A)(a). The taxpayer argued that, as art. 13, on the one hand, and art. 15 and 28C, on the other hand, had different fields of application, art. 13 could not take precedence over art. 15 and 28; art. 13 was only applicable to transactions carried out within the territory of member states whilst transactions between member states were covered by art. 15 and 28C.

Issue

Whether transactions like the making and repair of dental prostheses which, when they took place within the territory of a member state, were exempt from VAT as activities in the public interest, might give rise to a deduction of input VAT when they were intra-Community transactions.

Decision

The European Court of Justice (Third Chamber) (ruling accordingly) said that it was only by way of exception that the sixth directive provided, in particular in art. 17(3)(b), for the right to deduct VAT on goods or services used for exempt transactions. Therefore, the terms used by the directive in that regard had to be interpreted strictly.

Although art. 17(3)(b) referred generally to the provisions of the sixth directive which provided for the exemption of intra-Community transactions, namely, art. 15, for the period before 1 January 1993, and art. 28C, for the period after that date, clearly that provision did not refer at all to the exemptions provided for in art. 13. Furthermore, art. 17(3)(c) specifically granted the right to deduct VAT as regards certain transactions exempted under art. 13(B). That provision would have no purpose if the exemptions provided for in art. 13 were already covered by art. 17(3)(b).

If intra-Community transactions were to give rise to the right to deduct input VAT in the member state of departure, they could be supplied in the Community totally exempt from VAT. It was apparent from the objective of the common system of VAT and of the transitional arrangements introduced by Council Directive 91/680, for the taxation of trade between the member states, that a taxable person who benefited from exemption and was consequently not entitled to deduct input tax within the territory of a member state was not entitled to do so either where the transaction concerned was of an intra-Community nature. That principle was enshrined in art. 17(3)(a) as, under that provision, the right to deduct the VAT relating to a transaction carried out in another country was precluded if that transaction was not eligible for deduction of tax within the territory of the member state.

As regards the scheme of the sixth directive, the exemptions provided for in art. 13(A), as they benefited only certain activities in the public interest which were listed and described in detail in that provision, were of a specific nature. On the other hand, the exemption for intra-Community transactions was of a general nature, as it referred in an unspecified manner to economic transactions between the member states. Thus, it was consistent with the scheme of the sixth directive that the rules applicable to the specific exemptions provided for in art. 13(A) were accorded precedence over the rules applicable to the general exemptions provided for by the directive as regards transactions of an intra-Community nature.

Furthermore, the principle of fiscal neutrality precluded treating similar supplies of services, which were thus in competition with each other, differently for VAT purposes. If the present disputed transactions gave rise to the right to deduct tax where they were of an intra-Community nature, that principle would not be observed as the same transactions did not give rise to a deduction where they were carried out within the territory of a member state. Consequently, taxable persons carrying out intra-Community transactions would be treated more favourably than taxable persons effecting domestic transactions.

The harmonisation of national VAT legislation had not yet been achieved in so far as art. 28(3)(a) of the sixth directive authorised member states to retain certain provisions of their national legislation predating that directive which would, without that authorisation, be incompatible with the directive. However, the exceptions provided for in art. 28(3)(a) had to be strictly interpreted and their scope could not therefore be extended to member states which had complied with the principle enshrined in the sixth directive in exempting certain activities in the public interest listed in art. 13. The obligation of those member states not to allow the deduction, under art. 17(2)(a), of input tax on those exempt activities could not be affected by the decision of another member state to opt for derogating and transitional arrangements.

Such an extension would be contrary to art. 28(3)(a) which did not permit a member state, like Luxembourg, which exempted the disputed transaction in accordance with the harmonised system, as provided for in art. 13, to introduce or reintroduce a tax scheme in respect of that transaction. There was no right to deduct input tax, even for the purpose of remedying a possible distortion of competition undermining the Community principle of equal treatment, reflected in the area of VAT by the principle of fiscal neutrality. On the other hand, in view of the transitional nature of the derogating taxation arrangements chosen by Germany, there was nothing to prevent it, in accordance with the objective of art. 28(4), from also deciding to exempt, as generally required by that directive, the transaction in question in order to remove such a distortion of competition.

European Court of Justice (Third Chamber).
Judgment delivered 7 December 2006.