News from the ECJ on VAT groups

The European Court of Justice (the “ECJ” or the “Court”) has been dealing with the issue of VAT groups for quite a while. Most recently, the ECJ (ECJ judgments of 1 December 2022, Case C-141/20 Norddeutsche Gesellschaft für Diakonie and Case C‑269/20 Finanzamt T) had to address several questions referred by the German Federal Court of Finance (Bundesfinanzhof) with regard to the compatibility of the German provisions on VAT groups with EU law. In conclusion, the Court upheld the provision under German VAT law which considers the controlling company of a VAT group to be the sole taxable person in the VAT group (Organkreis) (see section B below), expanded financial integration beyond the level applied up to now by the tax authorities (see section C below) and questioned the status of internal transactions being or not being subject to taxation (see section D below).

A. Background

In two requests for a preliminary ruling (dated 11 December 2019 – XI R 16/18 and 7 May 2020 – V R 40/19) both XI. and V. Senate of the German Federal Court of Finance sought information on the interpretation of Article 4(1) and (4) and Article 21(1)(a) and (3) of Sixth Council Directive 77/388/EEC of 17 May 1977 (now replaced by the VAT System Directive). Specifically, the Court had to decide on whether (i) instead of the VAT group (the group treated as a single entity for tax purposes), a Member State can designate a member of that group (under German tax law the controlling company of a VAT group) as the taxable person, (ii) in addition to a majority shareholding financial integration also requires a majority of the voting rights and (iii) becoming a member of a tax group involves by categorisation a loss of the controlled company’s independence.

B. Controlling company’s sole tax liability is compliant with EU law

With respect to the relevant taxable person, the ECJ referred to its previous case law according to which the VAT group as such is generally to be considered the taxable person (ECJ judgments of 22 May 2008 – C-162/07 Ampliscientifica and Amplifin and of 17 September 2014 – C-7/13 Skandia America [USA], filial Sverige). However, the Court qualified this by saying that, as the Advocate General stated in her Opinion, where several legally independent members of a VAT group together constitute a single taxable person, there must be a single interlocutor. It continued that for this reason German tax law, which designates the controlling company of a VAT group to be the sole taxable person and representative of the group, who assumes the group’s VAT obligations vis-à-vis the tax authorities, does not conflict with EU law. It believes that this, however, requires that the controlling company of a VAT group is in a position to impose its will on the controlled companies and that the role of a controlling company of a VAT group as the sole taxable person does not entail a risk of tax losses. The Court stated that German tax law contains a sufficient liability provision in section 73 of the German Tax Code (Abgabenordnung) which provides that, if applicable, the controlled companies are liable for the taxes of the controlling company for which their tax group is relevant for tax purposes.

C. No majority of voting rights required for financial integration

However, according to the Court, the requirements under German law for financial integration of controlled companies are incompatible with EU law. The German understanding to date is that such integration requires a majority of the voting rights in addition to a majority shareholding. The Court considers this requirement to be incompatible with a narrow interpretation of EU law. It holds the view that a majority shareholding already means financial integration – regardless of the actual voting rights. Holding a majority of the voting rights does not, a priori, constitute a measure that is necessary and appropriate to combat tax evasion.

D. Internal transactions still not subject to taxation?

The ECJ also found the categorisation of controlled companies as non-independent entities under section 2(2) no. 2 of the German VAT Act (Umsatzsteuergesetz) inadmissible. It stated that contrary to German law, integration into a VAT group does not per se result in a loss of the controlled company’s independence. The Court instead holds that it is necessary to determine in the individual case whether or not the relevant controlled company carries out an independent economic activity, i.e. whether it performs its activities in its own name, on its own behalf and under its own responsibility, and bears the resulting economic risk itself.

E. Consequences in practice

It is good news that the controlling company of a VAT group may continue to be considered the sole taxable person in accordance with previous practice, i.e. the ECJ’s judgments have provided more legal certainty in this respect. In addition, there will be no billion euro claims for tax refunds by controlling companies of VAT groups which tax authorities had feared would arise and which were still assumed after the Opinion of Advocate General Laila Medina.

The narrow interpretation of financial integration means an expansion of the VAT group concept to cover those companies which had been excluded from such integration to date due to the lack of a majority in voting rights. Although we will have to await the final judgment of the German Federal Court of Finance, it is to be expected that the national interpretation with respect to financial integration will be adjusted to reflect this change. As the existence of a tax group for VAT purposes is not optional, existing structures where shareholdings deviate from voting rights should be examined for the existence or non-existence of a VAT group. Where the tax authorities’ current understanding of VAT groups is more favourable, companies can invoke protection of legitimate expectations even if case law changes following the ECJ proceedings.

It will be necessary to closely observe how the courts handle transactions within the tax group which have so far been treated as non-taxable (“internal transactions”) in the follow-up case law. The ECJ opinion suggests that members of VAT groups in principle continue to be independently entities and that they can thus carry out taxable transactions within the VAT group. In this case, the VAT group would be degraded to a mere formal vehicle where the controlling company of a VAT group only performs certain obligations for the entire group. This would have far-reaching consequences in practice, especially with regard to billing within the group, but also on a potential deduction of input VAT.

Existing VAT groups are well-advised to review already at this point in time whether there is a need for action. This applies especially in view of the future treatment of internal transactions. We will monitor the further developments and are happy to help you react appropriately.