The European Court of Justice ruled that underart. 17(2) of Council Directive 77/388 (‘the sixth directive’) the cost of advisory services, which a taxpayer company obtained in order to establish the amount of a claim forming part of its assets and relating to a sale of shares prior to its becoming liable to VAT, did not have a direct and immediate link with that activity so that it had no right to deduct the VAT charged on them, in the absence of evidence that the exclusive reason for those services was to be found in the economic activity carried out by the taxpayer. The steps taken by a taxable person, on his own behalf, to recover a claim or establish the value thereof did not constitute the exploitation of property to produce income on a continuing basis, because any resultant gain derived merely from his status as holder of the claim in question, and was not the product of any economic activity within the meaning of the sixth directive.

Facts

The taxpayer owned shares in a clothing business (C) which it sold to H. At the time of that sale, it was agreed that it would receive, in addition to a fixed sum, a further sum the amount of which would depend on the profits made by C over a three-year period. Until 1 January 1993, the taxpayer's activity was that of a passive holding company, holding shares in other companies, but with no involvement in their management. Prior to 1 January 1993, the taxpayer did not perform any services for consideration. As from that date, under an agreement made with C, it carried out, for consideration, management activities for C.

A dispute arose between the taxpayer and H over the calculation of the sum payable to the taxpayer on the basis of C's profits. That dispute gave rise to arbitration proceedings in the course of which the costs related to legal advisory services were invoiced to the taxpayer.

The taxpayer deducted the VAT paid on those costs in respect of the 1996 financial year. As they took the view that the taxpayer was not entitled to make that deduction, the Netherlands tax authorities issued an additional assessment. The taxpayer appealed against that decision. The appeal court held that the taxpayer was not entitled to deduct the VAT paid on the costs in question, on the ground that the advisory services had been provided in connection with an activity which it did not at that time perform as a trader and that they did not have a direct and immediate link with an activity carried out in that capacity. The taxpayer appealed.

The national court took the view that the fact that the costs incurred related to a transaction carried out in a period in which the taxpayer did not have the status of a taxable person within the meaning of the sixth directive precluded there being a direct and immediate link with its business activity, and therefore, militated in favour of refusing the right to deduct. On the other hand, the fact that the claim corresponding to the sum payable to the taxpayer formed part of the assets of that company and that, in order to secure those assets, it incurred costs payable out of them could lead to those costs being regarded as forming part of the applicant's general costs and having a direct and immediate link with the activity carried out so giving a right to deduct.

In those circumstances, the court referred to the ECJ for a preliminary ruling on the correct interpretation of art. 17(2).

Issue

Whether, in the context of the deduction granted in art. 17(2), there was a direct and immediate link between the cost of advisory services in connection with arbitration proceedings and future taxable transactions where the proceedings concerned assets which arose in a period preceding that in which the taxpayer became a taxable person for VAT purposes.

Decision

The ECJ (Fourth Chamber) (ruling accordingly) said that it was settled law that the existence of a direct and immediate link between a particular input transaction and a particular output transaction giving rise to entitlement to deduct was, in principle, necessary before the taxable person was entitled to deduct input VAT and in order to determine the extent of such entitlement. The right to deduct VAT charged on the acquisition of input goods or services presupposed that the expenditure incurred in acquiring them was a component of the cost of the output transactions giving rise to the right to deduct (C & E Commrs v Midland Bank plc (Case C-98/98) [2000] BTC 5,199; [2000] ECR I-4177).

It was however also accepted that a taxable person had a right to deduct even where there was no direct and immediate link between a particular input transaction and an output transaction or transactions giving rise to the right to deduct, where the costs of the services in question were part of a taxable person's general costs and were, as such, components of the price of the goods or services which he supplied. Such costs did have a direct and immediate link with the taxable person's economic activity as a whole.

In the present case, the sale of shares did not in itself constitute an economic activity within the meaning of the sixth directive and did not therefore fall within its scope. Contrary to what the taxpayer claimed, the steps taken by a taxable person, on his own behalf, to recover a claim or establish the value thereof could not be treated as such an activity either. Such steps did not constitute the exploitation of property to produce income on a continuing basis because any resultant gain derived merely from his status as holder of the claim in question and was not the product of any economic activity within the meaning of the sixth directive.

As neither the sale of shares nor the steps taken by the taxpayer in connection with the claim which it had against H were transactions falling within the scope of the sixth directive, the costs related to the advisory services could not be regarded as having a direct and immediate link with a particular transaction or transactions giving rise to a right to deduct (Finanzamt Gross-Gerau v MKG Kraftfahrzeuge-Factoring GmbH (Case C-305/01) [2003] BTC 5,561; [2003] ECR I-6729 distinguished).

Therefore, it had to be ascertained whether the costs at issue in the main proceedings constituted general costs with a direct and immediate link with the taxable person's economic activity as a whole, on the ground that the claim to which they related formed part of the assets of the business which it operated.

There was no evidence to support an assertion that, had it not carried out economic activities which were subject to VAT as from 1 January 1993, the taxpayer would not have obtained the disputed advisory services. It thus appeared that, whether or not it carried out such activities as from that date, the taxpayer would have obtained those services with a view to safeguarding the financial consideration for the sale of shares to H which took place in 1989.

In those circumstances, it could not be considered that the costs relating to those services were incurred for the purposes of and with a view to the taxpayer's taxable activities. As the exclusive reason for those costs was not to be found in those activities, the costs had no direct and immediate link to them.

The taxpayer's position in this case was no different from that of a private shareholder who, having sold his shares, had sought legal advice and incurred expenditure relating to that advice in the course of a dispute with the purchaser concerning the claim corresponding to the price of that sale. Those circumstances did not fall within the scope of the sixth directive (Kretztechnik AG v Finanzamt Linz (Case C-465/03) [2005] BTC 5,823; [2005] ECR I-4357 distinguished).

European Court of Justice (Fourth Chamber)
Judgment delivered 8 February 2007.