Share sales, holding companies and input VAT recovery

A parent company was not entitled to recover input VAT incurred in relation to the sale of shares in a subsidiary to raise funds to pay off a creditor.

The ECJ has held that costs associated with the sale of shares in a subsidiary to which the seller has provided management services will not be deductible for VAT purposes unless it can be shown, objectively, that the transaction was for the benefit of the group’s wider taxable activities: C&D Foods Acquisitions ApS v Skatteministeriet (ECJ, 08 November 2018). In circumstances where the sale of the shares was to raise funds to pay off the debt owed to a creditor, the ECJ held that the sale of shares lacked the necessary link to the group’s wider taxable activity and the input VAT was not deductible.

The decision appears to give significant importance to the overall purpose of the sale of shares in determining input VAT recovery, which may enable input VAT recovery in situation where the seller can more clearly show a link to the continuing taxable activities of the group.

Background

The case concerned a Danish group of companies which fell into arrears with its creditor, Kaupthing Bank. Kaupthing assumed ownership of the group and, on behalf of the parent of the group (C&D Foods) sought advice on the sale of a subsidiary, Arovit Petfood. C&D Foods provided management and IT services to Arovit Petfood. Ultimately, the group failed to find a buyer for the subsidiary and no sale took place. C&D Foods sought to deduct the input VAT it had incurred in relation to the failed disposal.

The Danish tax authorities denied C&D Foods a deduction for the input VAT, considering the input VAT had a direct and immediate connection with an exempt supply of the shares. The Danish rules did allow a right to deduct VAT on fees incurred in the context of a sale of shares in a subsidiary but only where the parent could show that those fees formed part of the general costs of the parent’s economic activity. By contrast, the Danish tax authorities considered that in this case, the costs could not be seen as a cost component of the parent’s wider economic activity.

Decision of the ECJ

The ECJ considered that the first question to determine was whether the share disposal in this case constituted an economic activity and referred specifically to the need for an economic activity to involve activities of “producers, traders or persons supplying services and, more particularly, the exploitation of tangible or intangible property for the purposes of obtaining income therefrom on a continuing basis”. In this context, the court recalled its decision in SKF in which it held that a disposal of shares which enabled the parent to restructure its group could be regarded as a “transaction which consisted in obtaining income on a continuing basis from activities which went beyond the compass of the simple sale of shares”. In that case, the sale had a direct link with the organisation of the activity of the group and constituted a “direct, permanent and necessary extension of the taxable person”.

The court noted that the reason for a transaction can be a factor to take into account when attributing VAT. “Where it is clear that a transaction has not been performed for the purposes of the taxable activities of a taxable person, that transaction cannot be regarded as having a direct and immediate link with those activities”. The reason is part of the “objective content” relevant for determining whether there is a direct and immediate link.

In the context of a sale of shares, the court suggested that “in order for a share disposal transaction to be able to come within the scope of VAT, the direct and exclusive reason for that transaction must, in principle, be the taxable economic activity of the parent company in question, or that transaction must constitute the direct, permanent and necessary extension of that activity. That is the case where that transaction is carried out with a view to allocating the proceeds of that sale directly to the taxable economic activity of the parent company in question or to the economic activity carried out by the group of which it is the parent company.”

In the current case, it was clear that the objective was to use the proceeds to settle the debts owed to Kaupthing Bank. Such a sale could not be regarded as either for the purposes of the taxable activities of the group or an extension of those activities. In these circumstances, the “sale does not constitute a transaction consisting in obtaining income on a continuing basis from activities which go beyond the compass of the simple sale of shares and, accordingly, it does not come within the scope of VAT”. (There is no reference in the judgment to the Danish treatment of the share sale as an exempt supply.)

As a result, the ECJ held that the input VAT incurred by C&D Foods was not deductible. It made no difference to the analysis that C&D Foods had carried on an economic activity in supplying management and IT services to its subsidiary. As the ECJ pointed out, Kaupthing Bank would have insisted on the sale irrespective of whether C&D Foods had provided management services or not. Therefore, “the direct and exclusive reason for any cessation of the supply of services at issue in the main proceedings cannot be found in the economic activity of C&D Foods”.

Finally, the court confirmed that it made no difference to the analysis that the share sale did not actually take place. Just as input VAT can be attributed to an aborted taxable activity, it can be attributed to an aborted activity which is not a taxable activity.

Comment

We appear to have come a long way since the relatively straightforward decision of the ECJ in BLP that input VAT incurred on costs associated with a share sale was irrecoverable as it was directly attributable to an exempt supply. Of course, in BLP it was simply assumed by the UK referring courts that the sale of the shares in the subsidiary was an exempt supply and that issue was not referred to the court. We now appear to have two important caveats to the BLP case: input VAT may in appropriate cases be attributed to the wider taxable activities of the parent group selling the subsidiary; and the sale of shares may in fact not be an exempt supply but rather not a taxable activity at all (even where management services have been supplied to the subsidiary).

The most interesting aspect of the decision is the question of how far is it possible to have regard to the underlying purpose of the seller in determining the correct attribution of input VAT (and it seems the question whether the associated transaction is a taxable activity). It is also, in some respects, the least satisfying. How to distinguish between circumstances where such costs must be directly attributed to the share sale as opposed to general overheads remains uncertain and will, not doubt, continue to give rise to marked differences of opinion. It does seem that the ECJ paid significant attention to the overall purpose of both the creditor and the parent company in this particular context, which may encourage arguments that the wider business purposes of the sale should override the immediate (exempt or non-economic activity) sale in appropriate cases. However, the ECJ’s analysis in this case is not helped by the way the decision seemingly swings between the analysis of the non-taxable nature of the output transaction (share sale) and the question of attribution of the input VAT and the relevance of what the court refers to as “objective content”.

Distinguishing between situations which may fall into the SKF analysis rather than the BLP analysis will remain a difficult task despite this latest decision of the ECJ.

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