The position of holding companies is one of the most complicated and litigated areas of legislation on value-added tax (VAT). For decades holding companies and their investors have been arguing with national tax authorities in Europe over the recoverability of VAT on costs. In the absence of clear and practical rules in the VAT legislation, both taxpayers and tax authorities have been exploring the boundaries, with over-engineered structures and unreasonable standpoints of tax authorities as a result.
In principle, only “taxable persons” carrying out economic activities are entitled to recover VAT on costs. The scope of VAT is that only activities of an economic nature are subject to VAT. Such economic activities comprise all activities of producers, traders and persons supplying goods and/or services. The exploitation of tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis is also considered an economic activity.
However, ownership alone is not seen as an economic activity giving a right to deduct. Therefore, a holding company whose sole purpose is to hold shares in other undertakings, without involving itself directly or indirectly in the management of those undertakings, does not have the status of a taxable person. Early in the 1990s this was confirmed by a judgment of the European Court of Justice (ECJ) in the landmark case Polysar.
Since then, a number of judgments have followed in which the ECJ has nuanced the right for holding companies to recover VAT on costs. With all the judgments that through the years have been released, determining the position of holding companies has become overly complicated. The judgments may have provided clarity in the individual cases, but read together they created the greatest complexity. In fact, they have swamped the VAT system.
The Sonaecom Case
Recently, Advocate General Kokott has paved the way for a different approach. In Kokott’s opinion in the Sonaecom case—which revolves around the recovery of VAT on professional service costs in the event of an envisaged, but ultimately unrealized, purchase of shares—the position of holding companies needs to be closely considered.
Kokott discusses the engineering that is undertaken in order to ensure holding companies can claim back the VAT. Once engineered, the holding companies carry out activities other than the passive holding of shares. They render, for instance, management services, based on agreements put in place. What then happens is that the VAT arising from these (taxable) activities is much lower than the deduction claimed.
Kokott states that this is somewhat concerning at first sight and raises the question whether the scope of the deduction should be limited in such cases (i.e. deduction of large amounts of VAT is “created” with a relatively small management fee). However, Kokott then states, on closer inspection the concern is dispelled. First, the disproportion occurs only on the basis of a selective approach which does not take account of the fact that the taxable services by the holding company are supplied over a number of years. Second, VAT law does not prescribe a mandatory connection between the amount of the deduction and the amount of the tax liability.
Kokott, who is widely seen as very influential and not afraid to address matters, calls construction that ensures VAT deduction “artificial” but shows understanding for the ones seeking shelter in constructing.
If controlling holding companies, which are economically active through the affiliated companies controlled by them, had been recognized in principle as having the right to deduct from their expenditure as a holding company, they would not be reliant on having recourse to seemingly artificial constructions of taxable services in order to prevent a definitive VAT burden within the group, Kokott states.
In today’s society where words like “construction” and “structuring” are no longer morally accepted, Kokott’s comments are cutting edge. She paves the way for treating holding companies equally with single traders. It is in her view perfectly true that holding a share does not make a shareholder an economically active taxable person. Whether a fully controlling shareholder is economically active through its controlled company to the same extent as a single trader and should, like a single trader, therefore be relieved of the VAT based on that activity, is another question, which the ECJ has never expressly answered in the negative.
Kokott is hinting at a fundamental change on how we treat holding companies for VAT. She does not say it in as many words but her message is basically that if, from a legislative perspective, structuring is undesirable, then legislators should provide reasonable and reliable legislation. It may be a matter of time, but these comments will resonate with the legislator as well as the ECJ.
A new and sustainable approach would help the holding companies that have not sought shelter in engineering. Currently, these are the ones that get into lengthy discussions with the tax authorities over the VAT recovery. Among them may be holding companies whose investors, fearing the (media) attention that legal proceedings may bring, actively choose the fiscally less favorable route in order to stay out of the spotlight. It does not feel right that the companies (unconsciously) who choose not to structure cannot claim back the VAT, because they are basically in the same boat.
What Should Holding Companies be Considering Now?
Holding companies and their investors should:
- regularly think through their investment strategy from a VAT point of view;
- be mindful of the progress of these steps before having contracts concluded and invoices issued and avoid nose-diving VAT flights;
- ensure that an appropriate “structure” is timely put in place to avoid unnecessary VAT leakage when making new investments;
- frequently reevaluate their portfolio to make sure that all their investments are (still) in line with the initial set-up; and
- engage with their advisers on previous scenarios as they may be able to make improvements.
Jan Sanders is a VAT Partner and Ibrahim Ahmed is a VAT Adviser at PKF Netherlands.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.