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Catch 22? Conflict between VAT & TP principles
VAT case law in Sweden indicates that a holding company with an intra-group service function towards other group companies must charge out all their costs in the form of management fees or similar VAT taxable supplies. This is in order to enjoy full deductions for VAT in the business of the holding company. If some costs remain in the holding company, these costs may be considered related to the mere ownership function or a passive investment activity. Such non-economic activities are outside the scope of VAT and are considered to limit the right to VAT deductions. These VAT developments are new in Swedish case law and seem to create a conflict with the transfer pricing (TP) principles, under which shareholders’ costs of a holding company are not allowed to be charged from the holding company to its subsidiaries.
A recent example concerns a Swedish company which had subsidiaries in Sweden and real estate owning sub-subsidiaries in the Baltic countries:
- The Swedish parent company supplied VAT taxable management services directly to the Baltic group companies, and financial services via the Swedish subsidiaries
- The parent company acquired all services for the group externally and re-charged about 10-20% of these costs to the Baltic group companies
- The Swedish parent company´s claim on full VAT deductions was opposed by the Swedish Tax Agency
- The Administrative Court of Appeals (2014-03-13) found that the parent company´s right to VAT deductions should be limited since the holding and investment activities did not constitute an economic activity under the EU VAT Directive. The financing activity was viewed as an integral part of this non-economic activity
- The court granted VAT deductions only to the extent that the acquired services had been re-charged to the Baltic group companies, which had been in line with TP regulations
A similar line of thinking is applied by the VAT authorities in Luxembourg, where VAT deductions for holding companies tend to be decided based on the relation between the VAT taxable service charges and the total costs of the company.
Furthermore, the German Federal Fiscal Court has referred questions on input VAT deduction of holding companies to the European Court of Justice (C-108/14 and C-109/14, Larentia + Minerva mbH & co. KG). The German court considers that parent companies of partnerships are not entitled to full input VAT deductions on the capital they raise for financing the partnerships, since the expenses are considered closely connected with the shareholding function rather than the service supply function.
Most holding companies are likely to show a deficit if only VAT taxable service charges are regarded as income. The deficits are generally covered by dividends etc. It is considered a new development that such companies should have to limit their right to VAT deductions due to their ownership function. The new reasoning means that to the extent that such a company shows a deficit, the corresponding VAT amount will form a cost for the company.
This is troublesome since transfer pricing regulations make it difficult or impossible to re-charge all costs of a holding company.
The transfer pricing principles are based on the arm´s length principle, where re-charged costs have to correspond to the services provided. Therefore, when the costs of the holding company are not linked to the intra-group services, the holding company should not be able to re-charge all the costs to its subsidiaries. Should it choose to recharge anyway, the subsidiaries face tax reassessments in their corporate income taxation.
In practice, the asymmetry in VAT and TP will likely lead to a higher tax burden at the level of the parent company.
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The conflict between VAT principles and transfer pricing principles creates a ‘catch 22’ situation in which holding companies would be ‘forced’ to charge out all costs including shareholders' costs from a VAT point of view in order to enjoy full VAT deductions in its business. At the same time these companies would be ‘forbidden’ to charge out shareholders’ costs from a transfer pricing perspective. It is questionable whether this is really the intention of the EU VAT system.
A fundamental principle of the EU VAT system is that VAT shall not form a cost in the business of fully VAT taxable businesses. Further clarification on the right to VAT deductions for holding companies may come in the upcoming ruling by the European Court of Justice in C-108/14 and C-109/14, Larentia + Minerva mbH & co. KG.
Multinationals should keep abreast of these ECJ rulings in order to remain knowledgeable of the tax environment and to ensure they remain compliant.
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