The European Court of Justice (ECJ) ruled that, where a taxpayer simultaneously carried out economic activities, taxed or exempt, and non-economic activities outside the scope of Council Directive 77/388 (the sixth directive), deduction of the VAT relating to expenditure connected with the issue of shares and atypical silent partnerships was allowed only to the extent that that expenditure was attributable to the taxpayer's economic activity within the meaning of art. 2(1). Furthermore, the determination of the methods and criteria for apportioning input VAT between economic and non-economic activities within the meaning of the sixth directive was in the discretion of the member states who, when exercising that discretion, had to have regard to the aims and broad logic of that directive and, on that basis, provide for a method of calculation which objectively reflected the part of the input expenditure actually to be attributed, respectively, to those two types of activity.

Facts

The taxpayer's activities in the financial year 1994 involved acquiring, managing and selling real estate, securities, financial holdings and investments of all types. The taxpayer acquired the capital necessary for that by means of the issue of shares and atypical silent partnerships. While offering shares for public subscription, it admitted a multitude of silent partners. The persons thus associated provided capital which the company reinvested. During 1994, the taxpayer carried out taxable transactions which included dividend earnings and earnings from the sale of securities. The greater part of the taxpayer's output tax for that period was not attributable to specific output transactions.

In proceedings to determine the taxpayer's fiscal obligations, the taxpayer stated that, as all the input VAT paid related to expenditure connected with the acquisition of new capital, it was deductible on the ground that the issue of shares was linked to the reinforcement of the company's capital and that transaction had benefited the company's economic activity in general.

The Finanzamt refused deduction of the input tax relating to expenditure connected with the issue of atypical silent partnerships as well as the input tax relating to expenditure connected with the taxpayer's leasing transactions. As regards input tax not attributable to specific output transactions, the Finanzamt allowed a right of deduction in respect of the proportion calculated in accordance with a formula of approximately 45 per cent based on the application of a criterion linked to the size of the investments with a refund for the 1994 financial year.

The taxpayer's appeal against that decision was dismissed by the Finance Court but the Federal Court set aside that judgment. The Finance Court, hearing the case afresh, decided to stay the proceedings and to refer to the ECJ for a preliminary ruling on the correct interpretation of art. 2 and 17(5) of the sixth directive.

Issues

How the entitlement to deduct input tax was to be determined in the case of a taxable person who simultaneously engaged in an economic activity and a non-economic activity; and if deduction of tax was allowed only to the extent that that person's expenditure was correctly to be attributed to the economic activity, whether an investment formula or a transaction formula was appropriate for the purposes of apportioning the input tax between the economic activity and the non-economic activity.

Decision

The ECJ (Fourth Chamber) (ruling accordingly) said that the right to deduct was an integral part of the VAT scheme which in principle might not be limited and which had to be exercised immediately in respect of all the taxes charged on transactions relating to inputs. The rules governing deduction introduced by the sixth directive were meant to relieve the trader entirely of the burden of the VAT payable or paid in the course of all his economic activities. The common system of VAT consequently ensured complete neutrality of taxation of all economic activities, whatever their purpose or results.

It was apparent from the information supplied by the national court that the taxpayer carried out three types of activity: non-economic activities, which did not fall within the scope of the sixth directive; economic activities, which as such fell within the scope of that directive but were exempt from VAT; and taxed economic activities. The question therefore arose whether and, if so, to what extent such a taxable person had the right to deduct input VAT relating to expenditure which was not attributable to specific output transactions.

With regard to expenditure connected with the issue of shares or atypical silent partnerships, in order for the input VAT paid in respect of such a transaction to give rise to a right to deduct, the expenditure incurred in that regard had to be a component of the cost of the output transactions that gave rise to the right to deduct. In those circumstances, the input VAT paid in relation to the expenditure connected with the issue of shares or atypical silent partnerships could give rise to the right to deduct only if the capital thus acquired was used in connection with the economic activities of the person concerned. The deductions scheme laid down by the sixth directive related to all economic activities, whatever their purpose or results, provided that they were themselves subject in principle to VAT. To the extent that input VAT relating to expenditure incurred by a taxpayer was connected with activities which, in view of their non-economic nature, did not fall within the scope of the sixth directive, it could not give rise to a right to deduct.

The provisions of the sixth directive did not include rules relating to the methods or criteria which the member states were required to apply when adopting provisions permitting the apportionment of input VAT paid according to whether the relevant expenditure related to economic activities or to non-economic activities. The rules set out in art. 17(5) and 19 of the sixth directive related to input VAT on expenditure connected exclusively with economic activities, and distinguished between economic activities which were taxed and gave rise to the right to deduct and those which were exempt and did not give rise to such a right.

In those circumstances, and so that taxpayers could make the necessary calculations, it was for the member states to establish methods and criteria appropriate to that aim and consistent with the principles underlying the common system of VAT. In that regard, where the sixth directive did not contain the guidance necessary for such precise calculations, the member states were required to exercise that power, having regard to the aims and broad logic of the directive.

In particular, the measures which the member states were required to adopt in that regard had to comply with the principle of fiscal neutrality on which the common system of VAT was based. Accordingly, the member states had to exercise their discretion in such a way as to ensure that deduction was made only for that part of the VAT proportional to the amount relating to transactions giving rise to the right to deduct. They had therefore to ensure that the calculation of the proportion of economic activities to non-economic activities objectively reflected the part of the input expenditure actually to be attributed, respectively, to those two types of activity. Further, when exercising that discretion, the member states had the right to apply, as necessary, an investment formula or a transaction formula or any other appropriate formula, without being required to restrict themselves to only one of those methods.

European Court of Justice (Fourth Chamber).
Judgment delivered 13 March 2008.