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Incidental supplies on repeat / VAT recovery restriction due to provision of interest-bearing loans
In the case of Mercedes-Benz Spa, the Italian tax authorities requested for a preliminary ruling from the EU Court of Justice (“ECJ”). The case regards the VAT recovery of costs incurred that qualify as general expenses. Mercedes-Benz claimed VAT recovery in full arguing that its financial transactions were to be considered incidental to its business and therefore did not negatively impact the right to recover VAT incurred. The ECJ denied this argument.
Mercedes-Benz Spa is responsible for the strategic direction of the marketing of the Daimler-Chrysler Group brands in Italy. In its VAT return, Mercedes-Benz classified its financial activities, namely the granting of loans to its subsidiaries, as ‘incidental’ to its taxable activities. A qualification as incidental supplies would allow Mercedes-Benz to exclude the VAT exempt interest it received from the calculation of the pro rata on which the VAT recovery right for general expense is based. The Italian tax authorities disagreed, arguing that the granting of those loans was one of Mercedes-Benz’s main business activities. The fact that it was considered a "main activity” was based on the relative size of the interest, since the accrued interest on those loans represented 71.64% of Mercedes Benz’ total turnover.
Mercedes-Benz principally argued that the Italian legislator had incorrectly transposed the EU VAT directive into national law by providing that the deductible proportion in Italian law applies without distinction to all goods and services acquired by a taxable person such as Mercedes-Benz. This irrespective of whether those goods and services are actually used for transactions for which VAT is deductible in full, not at all deductible, or used for both types of transactions. The ECJ however allows Italy to continue this procedure, as the objectives of the EU VAT directive allow member states to authorize the use of rules which are relatively simple to apply.
However, we consider more relevance to a second aspect of the case, which regards the interpretation of what constitutes 'incidental transactions'. As said, incidental transactions are disregarded for the pro rata calculation and this applies in all EU member states. In terms of the provision of interest-bearing loans, being able to do disregard interest earnings may significantly boost the VAT recovery potential.
The EU VAT directive dictates that in order to establish the VAT recoverable proportion, the amount of the turnover relating to ‘incidental real estate and financial transactions’ must be excluded. However, the EU VAT directive does not define that latter concept. While it is not the first time that the ECJ considers incidental supplies, the concept remains somewhat unclear. In the case of EDM (case C 77/01, 29 April 2004), the ECJ had decided that although the scale of the income generated by financial transactions may be an indication that those transactions are not ‘incidental’ in terms of VAT law, the fact that this income is higher than the income produced by what the taxable person regards as its main business activity does not preclude their classification as ‘incidental transactions’.
A later ECJ case provided for some further nuance (case C-174/08, 29 October 2009). This makes clear that although the composition of a taxable persons' turnover constitutes a relevant factor in determining whether certain transactions must be regarded as ‘incidental’, account should also be taken of the relationship between those transactions and the taxable activities of that taxable person and, of course, of their use of the goods and services which are subject to VAT.
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In summary, the fact that the interest earned by a business provides for a significant part of its total turnover is, in itself, insufficient argument to restrict the VAT recovery. In the Netherlands, the tax authorities often review the articles of incorporation of a company to form a view on which activities form main business activities and in doing so generally disregard the use criterion prescribed by the ECJ. The Mercedes-Benz case proves again that in order to claim VAT recovery on general expenses, the relation of revenue values is not at all decisive. The broader context in which transactions are carried out and goods and services are used is leading. And therefore, it all depends. What is to be learned from this case is that the unclarity remains and EU businesses that issue interest-bearing loans to other EU residents, should still review whether they are recovering VAT to their full potential.