The European Court of Justice ruled that under art. 4(5) of the sixth directive and point 2 of annex D and art. 12(3)(a) and category 2 of annex H thereto, the laying of a mains connection of water which consisted in the installation of piping permitting the connection of a building's water system to the fixed water supply network formed part of the ‘supply of water’ and ‘water supplies’, as defined therein, so that a body governed by public law acting as a public authority was a taxable person in respect of that transaction for VAT purposes. Furthermore, member states might apply a reduced rate of VAT to concrete and specific aspects of water supplies, such as the laying of mains connections, provided that they complied with the principle of fiscal neutrality inherent in the common system of VAT.

Facts

The German Zweckverband ensured the supply of drinking water and disposal of sewage on behalf of a number of towns and municipalities. Its activities included, inter alia, the collection, piping, treatment and supply of drinking water to the owners of buildings connected to the water supply network. It laid mains connections at the request of its customers, for which it received a single fee corresponding to the cost of the work. The connection remained the property of the Zweckverband.

Taking the view that the laying of a connection was distinct from the supply of water, the Finanzamt applied to it the standard rate of VAT laid down by national legislation. After an unsuccessful objection to the Finanzamt, the Zweckverband brought proceedings before the Finanzgericht Sachsen (Finance Court, Saxony), claiming that a mains connection should be subject to the same reduced rate of VAT as applied to the supply of water.

The Finanzgericht Sachsen upheld the Zweckverband's action, considering that the supply of water and the laying of the mains connection constituted a single service of ‘water supply’, within the meaning of the national legislation which transposed the sixth directive. The Finanzamt appealed against that decision to the Bundesfinanzhof (Federal Finance Court) on a point of law.

The Bundesfinanzh of proceeded on the basis that, in laying a mains connection, the Zweckverband acted as a trader in accordance with the national legislation. However, the Zweckverband acted pursuant to its public law statutes and under public law, which argued against its being subject to VAT, in the light of art. 4(5) of the sixth directive. As regards the rate of VAT applicable, the Bundesfinanzhof was inclined to the view that laying mains connections formed part of water supplies. However, it considered that that question depended on the interpretation of art. 12(3)(a) of the sixth directive and of category 2 of annex H thereto. Accordingly it decided to stay the proceedings and to refer to the European Court of Justice for a preliminary ruling.

Issue

Whether a reduced rate of VAT should apply to the connection of a building's water system to the water supply network (‘the mains connection’); whether connection of the water distribution network to a property owner's installation by a water supply undertaking for a separately calculated fee came under the heading of ‘the supply of water’/‘water supplies’ within the meaning of the sixth directive (art. 4(5), annex D, point 2, and art. 12(3)(a), annex H, category 2).

Decision

The European Court of Justice (Second Chamber) (ruling accordingly) said that the court might refuse to rule on a question referred for a preliminary ruling by a national court only where it was obvious that the interpretation of Community law sought bore no relation to the facts of the main action or its purpose, where the problem was hypothetical, or where the court did not have before it the factual or legal material necessary to give a useful answer to the questions submitted to it. However, none of those conditions was fulfilled in the present case, where the interpretation of Community law sought had a bearing on the facts and purpose of the main action and was not hypothetical. Thus the question referred for a preliminary ruling was admissible. In the absence of a definition in the sixth directive, in interpreting a provision of Community law, such as point 2 of annex D, it was necessary to consider not only its wording, but also the context in which it occurred and the objective pursued by the rules of which it was part.

It was clear from the third subparagraph of art. 4(5) that, by providing that bodies governed by public law were in any case to be regarded as taxable persons in respect of the activities listed in annex D so long as they were not on such a small scale as to be negligible, that provision made the rule that such bodies were not to be regarded as taxable persons subject to a limitation which had to be added to those resulting from the condition laid down in the first subparagraph, namely, that they must engage in activities as public authorities, and from the derogation laid down in the second subparagraph in cases where treatment as non-taxable persons would lead to significant distortions of competition.

The third subparagraph of art. 4(5) sought to ensure that certain categories of economic activity the importance of which derived from their subject-matter were not exempted from VAT on the ground that they were carried out by bodies governed by public law as public authorities. In the present case, the supply of water was characterised by making water available to the public and that supply was carried out by means of fixed networks intended to provide a service to the public. Moreover, laying a mains connection consisted in the installation of piping permitting the connection of a building's water system to the fixed water supply network. It was common ground that, if that connection was not made, it was impossible to make water available to the owner or occupier of the building. Accordingly, that connection was essential for making the water available and, in all the circumstances, the connection formed part of the supply of water referred to in point 2 of annex D. It followed that, even if the Zweckverband were to lay the mains connection as a public body within the meaning of the first subparagraph of art. 4(5), pursuant to the third subparagraph it would be considered a taxable person in respect of that connection.

It followed from art. 12(3)(a) that the application of either one or two reduced rates of VAT was an option accorded to the member states as an exception to the principle that the standard rate applied. Moreover, the reduced rates of VAT might be applied only to supplies of the goods and services specified in annex H. While the sixth directive did not define the concept of water supply, it was also not apparent from its provisions that that term should be interpreted differently according to the annex in which it was mentioned. Since a mains connection was essential in order to make water available to the public, it also formed part of the water supplies referred to in category 2 of annex H.

However, there was nothing in the text of art. 12(3)(a) which required that provision to be interpreted as meaning that the reduced rate could be charged only if it was applied to all aspects of the water supplies covered by annex H, so that a selective application of the reduced rate could not be excluded provided that no risk of distortion of competition resulted. However, the introduction and maintenance of reduced rates of VAT lower than the standard rate fixed in art. 12(3)(a) were permissible only if they did not infringe the principle of fiscal neutrality, inherent in the common system of VAT, which precluded treating similar goods and supplies of services, which were thus in competition with each other, differently for VAT purposes. Accordingly, subject to compliance with the principle of fiscal neutrality inherent in the common system of VAT, member states might apply a reduced rate of VAT to concrete and specific aspects of water supplies covered by category 2 of annex H, such as mains connections.

European Court of Justice (Second Chamber).
Judgment delivered 3 April 2008.