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Input VAT deduction for holding companies: the "direct and immediate link" conundrum is back. Recent case-law by the CJEU and the Luxembourg Supreme Court


On 8 September 2022, the Court of Justice of the European Union ("CJEU" or "the Court") released its judgment in Finanzamt R v W GmbH (Case C-98/21), on the right for an active holding company to deduct input VAT on services that it purchased and then contributed to its subsidiaries, for the needs of their own, mostly VAT-exempt activity. The Court denied the holding company the right to deduct input VAT. This judgment comes on the heels of a Luxembourg Supreme Court’s decision that was favourable to the taxpayer also in relation to a holding company’s input VAT recovery position. It is therefore interesting to consider both cases together.

The CJEU judgment in brief

The case involved a holding company (“W”) which was supplying accounting and management services to two of its subsidiaries (“X and Y”) in exchange for payment, turning into a so-called “active” holding company (or “management” holding company), generally entitled to recover input VAT on its purchases. On the other hand, W also purchased services in connection with real estate projects of the same two subsidiaries. W contributed those services to X and Y, without consideration, but in exchange for a share in X and Y’s profits.

The German tax jurisdictions were uncertain whether W was entitled to deduct input VAT incurred on the services W purchased and contributed to X and Y. While there was no doubt W qualified as a taxable person in respect of a distinct flow of services (the provision of accounting and management services), questions were raised on the direct and immediate link between the services contributed and W’s taxable activity.

The CJEU ruled that input VAT on services contributed was not deductible at the level of W, as the Court did not find a direct and immediate link between the items contributed and any specific VAT-taxable supplies of W or as being part of W’s overheads, being cost components of the VAT-taxable activity of W. The Court rather applied a “look-through” to the destination of services transiting through W before they were used by X and Y, concluding that the contributed services were linked to the VAT-exempt activity of X and Y.

In details

Questions referred to the Court and decision by the CJEU

The Court was asked to rule whether W, an active holding company (with respect to the supply of accounting and management services), was entitled to deduct input VAT on services purchased and contributed to its subsidiaries in exchange for a proportional profit distribution.

As usual when it comes to the right to deduct input VAT, the Court recalled general principles, including the fact that the objective of the input VAT deduction system is to relieve entrepreneurs from the burden of VAT due or paid in the context of all their economic activities. However, this right to deduct is subject to the conditions laid down by the VAT Directive requiring the person claiming a right to deduct to be a taxable person, and the goods or services on which a deduction is claimed to be used for the purpose of transactions allowing input VAT deduction. In a nutshell, input VAT may be deducted on a purchase if VAT applies on a subsequent output transaction with which there exists a link.

The Court recalled settled case-law on the fact that pure holding companies do not carry out any economic activity and as such cannot benefit from the right to deduct. However, holding companies directly or indirectly involved in the management of subsidiaries (e.g. through the provision of management services) do qualify as taxable persons, which is the case of W.

The right to deduct is dependent on the existence of a direct and immediate link between a particular input transaction and one or more output transactions giving rise to a right to deduct. A right to deduct may also exist where there is no direct and immediate link between a particular input transaction and one or more output transactions giving rise to a right of deduction, but where the costs of the purchases qualify as overheads. For overheads, the direct and immediate link materialises if and when such overheads are cost components of the goods or services supplied (when they are “incorporated” therein) by the taxable person, since such costs have a direct and immediate link with the taxable person’s economic activity as a whole.

The Court pointed out that the purchases contributed to subsidiaries were lacking such a link with output supplies allowing input VAT deduction. The Court recalled that assessing the existence of the link should be made based on the objective content of the operations at stake and considering the effective use and the exclusive cause of the operation.

The Court failed to find a link with the supply, by W, of taxable accounting and management services but rather saw the reasons for W to contribute the services to X and Y, being X and Y’s VAT-exempt activity of building and selling properties. The conclusion is that input VAT is not deductible at the level of W.

The purchases are neither part of W’s overheads, which would have allowed a link with W’s taxable activity as part of its overall active holding activity, but they relate to the shareholding activity of W (its investments in X and Y), which is not in itself an economic activity for VAT purposes. The exclusive cause of the operation involving the costs on which input VAT deduction is claimed was the shareholder’s contribution. The Court also notes that the position could have been different in the event where W’s purchases would have been necessary for W to acquire its participation in X and Y (in other words, if the purchases had been “acquisition costs” to secure the participation of W).

As a conclusion, the Court ruled that an active holding company such as W cannot recover input VAT on supplies purchased from third parties and contributed to its subsidiaries in exchange for rights to the subsidiaries’ profits when those supplies:

  • are directly and immediately linked not with W’s taxable activity but with the subsidiaries’ own VAT-exempt activity;
  • those supplies are not cost components of taxable services (accounting and management) supplied by W to the same subsidiaries;
  • those supplies are not overheads of W’s economic activity.

The above is a triple failure to make a link between the purchases contributed and W’s taxable activity, and in our view essentially highlights a link, via a look through, with X and Y’s VAT exempt activity.

It is worth noting that, if a right to deduct input VAT had been found, the Court would have been invited to discuss whether the scheme constitutes an abuse of right. As the right to deduct was denied – applying the basic (yet complex) rules on the right to deduct (especially when it comes to the link and assessing the nature of “cost component” of output supplies) – the Court did not analyse the second question referred to it. One may find interesting developments in the Advocate General’s opinion, which held that the interposition of a holding company in between suppliers and subsidiaries with a limited input VAT deduction right, leading – as in the case at hand – to mitigate VAT leakage at group level (as the holding claimed full input VAT deduction, and no VAT was applied on the services contributed to the subsidiaries), could be an abuse of right.

Luxembourg developments

On 17 March 2022, the Luxembourg Supreme Court (Cour de cassation) ruled on a case about the quantum of the right to deduct input VAT of an active holding company. This judgment was positively welcomed by the taxpayers as the Court ruled that the approach of the Luxembourg VAT authorities to limit the amount of deductible input VAT up to the output VAT applicable on the output supplies (the so-called 1:1 ratio) was incorrect.

The case was about a Luxembourg active holding company, which was part of a real estate group and was also engaged in financing activities and the procurement of management services to its subsidiaries. Said management services were not directly provided by the Luxembourg holding company but were fully outsourced to another group entity based in France. The French entity invoiced its services to the Luxembourg holding company on a cost-plus method basis; the Luxembourg holding company then charged the services back to other group companies. The amounts charged back were computed based on the value of the underlying assets of the group companies. The business model triggered a disproportion between the amounts of the services purchased and then charged back, leading to higher input VAT deducted than applicable on output supplies at the level of the holding company.

The Luxembourg VAT authorities considered that the right to deduct should be allowed only up to the amounts charged back: input VAT incurred on the excess was deemed non deductible, absent, as per the VAT authorities, any direct and immediate link with taxable output supplies. The Luxembourg Supreme Court confirmed the decision taken by the Court of Appeal (which itself confirmed 3 decisions of the first-tier tribunal) stating that input VAT was deductible in full, insofar as all the costs incurred by the Luxembourg holding company, on services outsourced to the French affiliate, were directly and immediately linked with the amounts the Luxembourg holding company had charged back to its subsidiaries. Such a link was sustained by an expert’s report ordered by a decision of the first-tier tribunal. The disproportion between (higher amounts of) costs and (lower amounts of) revenue is not a valid reason to deny input VAT deduction on costs, once this link is established between the costs and output supplies qualifying for input VAT deduction.

Balancing those decisions: different fact patterns, but the same challenge: what are the requirements to demonstrate the link?

The CJEU’s decision may have shut the door for holding companies seeking to deduct input VAT on supplies received from third parties which are then contributed to subsidiaries in exchange for a right to a portion of their profits, where these supplies are used by the subsidiaries for exempt transactions. The conclusion seems to result from a “look-through” approach, whereby the Court looked at the actual contemplated use of the supplies: in the case at hand, to be used by subsidiaries for VAT-exempt real estate construction works and sales.

The scheme may have seemed suspicious: VAT would have become deductible for W only because this holding company interposed itself in between third-party suppliers and the subsidiaries. Other business models would, on the other hand, have triggered some non-deductible VAT: if invoiced directly by the suppliers to the subsidiaries, X and Y would have incurred non-deductible VAT. If the same services had been procured by the holding company (as part of a buy and resell scheme), VAT would have been deductible by W, but the VAT cost would have been pushed to the subsidiaries, unable to recover the VAT applied on items procured by their holding company. Business reasons to have this interposition of the holding company were detailed by W. As outlined in the CJEU’s judgment, those reasons do not prevent non-deduction based on basic rules, and neither would they have prevented the denial of input VAT deduction based on abuse-of-right provisions (of the German law) and how the CJEU construed the concept.

On the other hand, a few months earlier, a very positive decision for the taxpayer was issued: no matter the disproportion, as long as the direct and immediate link is there, the deduction is secured.

The fact patterns were very different: in Luxembourg, the expert’s report was key, as it supported in itself the fact that all services outsourced to a French affiliate by the holding company were actually cost components of amounts charged back by the holding company to subsidiaries holding the assets/properties. In the case of W, there was no expert report, but both the Advocate General and the Court have found what the link actually was leading to: the services purchased by W were ultimately serving the VAT-exempt business of X and Y.

Taxpayers should therefore remain cautious and they should make sure, to the greatest extent possible, that there is a link, between a cost on which they wish to claim the input VAT deduction and an output supply that qualifies for input VAT deduction. If not, demonstrating the overheads/general expense nature of the costs – and how this means they are generally cost components of a business qualifying (at least partially, with a consequent reassessment of the right to recover) for input VAT deduction – becomes a trickier proposition.

Some questions remain: was W’s contribution of services to X and Y actually a transaction outside the scope of VAT, despite W consequently being entitled to a share in X and Y’s profits, without any price or fee being agreed? How can you actually demonstrate the general expense nature of a purchase? Will the VAT authorities use this judgment to challenge the existence of the link and the right to deduct input VAT, while some of their audits may already do so? Time, and further guidance from empowered bodies (courts and tribunals, tax authorities, EU lawmakers), will hopefully tell.

Contact us

Marie-Isabelle Richardin

VAT Partner, PwC Luxembourg

Tel: +352 49 48 48 3009

Frédéric Wersand

VAT Partner, PwC Luxembourg

Tel: +352 49 48 48 3111

Stéphane Rinkin

Tax Partner, PwC Luxembourg

Tel: +352 49 48 48 2044

Chantal Braquet

VAT Partner, PwC Luxembourg

Tel: +352 49 48 48 4146

David Schaefer

VAT Partner, PwC Luxembourg

Tel: +352 49 48 48 3202

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