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Deduction of input tax despite a free-of-charge contribution

In principle, businesses can deduct as input tax the VAT that is legally due on the supply of goods or other services that have been provided for their businesses by other businesses and that is shown separately on invoices as defined in Section 14 of the VAT Act (Umsatzsteuergesetz, UStG). There is no entitlement to input tax deduction if the incoming supplies were purchased with the intention of using them for a non-economic activity (e.g., free-of-charge supply) (essential link between incoming supplies and outgoing supplies). Then again, up to now, free-of-charge contributions through the acceptance of unpaid benefits in kind have had to be taxed. Based on the new rulings by the ECJ and the Federal Fiscal Court (Bundesfinanzhof, BFH) this view is now outdated.

ECJ’s stated opinion on input tax deduction

If a company, in the course of its business activity, provides a free-of-charge supply or other service then, potentially, the input tax deduction for the related incoming supply may be granted. The ECJ decided this in its ruling from 16.9.2020 (C-528/19), although the precise circumstances in the respective cases will need to be carefully examined. Specifically, the crucial factors for input tax deduction are that

  • the incoming supply that was purchased should not exceed what is necessary/essential in order to achieve this aim,
  • the costs of the incoming supply are included in the (imputed) price of the output transactions that were carried out, and
  • the benefit to a third party (e.g., the general public) is, at all events, immaterial.

Furthermore, in the above-mentioned ruling from 16.9.2020, the ECJ specified that, in compliance with EU law, the (German) national regulation relating to the taxation of unpaid benefits in kind has to be restrictively interpreted and, consequently, such taxation has to cease. 

BFH case law has been amended

The BFH subsequently had to decide whether or not a business has the right to deduct input tax if it first has to build a public road in order to provide access to a quarry so as to be able to pursue its business activity (limestone quarrying). Since the road was built predominantly to serve the commercial interests of the business and, ultimately, resulted in VATable output transactions, the BFH, in its ruling from 16.12.2020 (case reference: XI R 26/20 (XI R 28/17)), complied with the ECJ’s order for reference; accordingly, an indirect link to the incoming transactions is sufficient for an input tax deduction to be possible. 

Moreover, according to the BFH and in a departure from its previously held legal position, the taxation of unpaid benefits in kind cease to apply because the costs incurred for road building constitute the cost elements of the output transactions. Furthermore, there is an overlap between the economic interests of the business and the interests of a third party (in this case, the general public) that will likewise, potentially, generally obtain a benefit.

Please note: The modified BFH ruling, in compliance with the ECJ, will be of practical relevance particularly for those businesses that provide incoming supplies that directly lead to free-of-charge contributions to third parties. Thus, for example, taking over the task of carrying out development measures, in particular, would, on the one hand, make it possible to deduct input tax and, on the other hand, not give rise to any tax liability for the output transactions.

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