Flashback on ECJ Cases C-77/01 (EDM) – Concept of “economic activities” – Concept of ancillary “financial transactions”

On April 29, 2004, the ECJ issued its decision in the case C-77/01 (EDM).

Context: Sixth VAT Directive – Articles 4(2) and 19(2) – Undertaking liable to VAT solely in respect of part of its transactions – ‘Economic activities’ – Deductible proportion – ‘Incidental transactions

Article in the EU VAT Directive

Articles 4(2) and 19(2) of the Sixth VAT Directive (Article 9 and 174(2) and 174(3) of the EU VAT Directive 2006/112/EC)

Article 4(2) – Taxable transaction

The economic activities referred to in paragraph 1 shall comprise all activities of producers, traders and persons supplying services including mining and agricultural activities and activities of the professions. The exploitation of tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis shall also be considered an economic activity.

Article 19(2) – Right to deduct VAT

By way of derogation from the provisions of paragraph 1, there shall be excluded from the calculation of the deductible proportion, amounts of turnover attributable to the supplies of capital goods used by the taxable person for the purposes of his business. Amounts of turnover attributable to transactions specified in Article 13B(d), in so far as these are incidental transactions, and to incidental real estate and financial transactions shall also be excluded. …

Facts

EDM is a holding company in the mining sector which, after being a public undertaking, was converted into a legal entity governed by private law, in the form of a limited company, with effect from September 1989.
Under Article 3(1) of its statutes, which derive from Decreto-lei No 313/89 of 21 September 1989 (Diário da República I, Series A, No 218, of 21 September 1989), EDM’s main purpose is:
- (a) Prospecting and exploring for, extracting, developing and exploiting metallic and non-metallic minerals, and the marketing thereof and of the products and by-products resulting from their processing;
- (b) Applied research and technological development aimed directly at productive investment, by means of joint ventures;
- (c) Managing company shareholdings which it owns or whose management powers have been contractually entrusted to it, for companies whose purposes include the activities referred to in paragraph (a);
- (d) Promoting investment projects and the formation of companies whose purpose is connected to the mining industry by encouraging, especially, the association of public and private interests’.
Until its conversion into a limited company, one of EDM’s main purposes was also, under its statutes then in force, to assist companies in which it had a shareholding to obtain loans from credit institutions, by being able to guarantee such loans.
The referring court observes that the management of its shareholdings and scientific and technological research in the mining sector with a view to investment therein, particularly through the creation of new undertakings, were always EDM’s principal activity and it has only occasionally sold its shareholdings in companies, even if the proceeds of those sales attained a considerable sum.
EDM participates in three consortia the sole purpose of each of which is to discover mineral deposits in three different regions of Portugal and to examine the profitability of their exploitation. Under the contracts creating those consortia (hereinafter ‘the consortium contracts’), if a mineral deposit whose exploitation would be profitable is discovered, a company is created to exploit it.
EDM’s activities in the context of each of those consortia consist in technical activity and coordination of operations as manager of the consortium, as well as participation in advisory councils and technical committees established for that purpose. Invoices describing the operations to be carried out and stating their costs are issued by each of the undertakings which are members of the consortium and sent to its manager, namely EDM. Those invoices are used solely for subsequent settlement of the accounts between the undertakings making up the consortium, in accordance with the percentages for sharing of the expenses agreed in each consortium contract.
The order for reference shows that EDM was the subject of an inspection by the Portuguese tax authorities (hereinafter ‘the tax authorities’) in connection with the consideration of an application for repayment it had made. During that inspection, it was established that between 1988 and 1992, EDM deducted VAT as if it carried out only transactions conferring the right to deduct, although, according to those authorities, because of the type of transactions carried out, it should have been treated as a mixed taxable person, subject to the regime of Article 23 of the CIVA, that is to say to the use of the method of calculating the deductible proportion laid down by that provision.
Goods were acquired and services received which were common to the different activities carried on by the taxable person, such as those carried out for its administration or for its headquarters, for which VAT was deducted globally without any apportionment being made between taxable and exempt transactions.

Questions

(1) Does the annual granting of interest-bearing loans by a holding company to companies in which it has a shareholding, where its principal activity is their management and, to a certain extent also, the guaranteeing of loans contracted by them, constitute an “economic activity” within the meaning of [Article 4(2) of] the Sixth Directive …?

(2) Does the performance of operations, in connection with a consortium, as in this case, by a company which both is a member thereof and manages it, particularly where they exceed its share as stipulated in the contract, against payment by the other members of the consortium constitute an “economic activity” within the meaning of the Sixth Directive?

(3) Is an undertaking’s financial activity which generates annual income which is clearly higher than that from the activity described in its statutes as its principal activity to be regarded as “incidental” for the purposes of Article 19(2) of the Sixth Directive?

AG Opinion

(1) Article 4(2) of Sixth Council Directive 77/388/EEC of 17 May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes – Common system of value added tax: uniform basis of assessment must be interpreted as meaning that the annual granting of interest-bearing loans by a holding company to the companies in which it holds shares, where the holding company’s principal activity is to manage those shareholdings and, to a certain extent, also to guarantee the loans taken out by those companies, constitutes an economic activity provided that those loans are not granted on an occasional basis and are effected with a business or commercial purpose characterised, in particular, by a concern to maximise returns on capital investment.

(2) The performance of operations in the context of consortia as in the present case, by a company which is both a member and the administrator of the consortia, in return for payment in consideration of the value of those operations by the other members of the consortia, constitutes an economic activity within the meaning of Article 4(2) of Sixth Directive 77/388, where those operations exceed the company’s share as stipulated in the respective contracts.

(3) Article 19(2) of Sixth Directive 77/388 must be interpreted as meaning that, in so far as it constitutes an economic activity, the financial activity of an undertaking whose annual revenue is higher than that produced by the activity which is its principal activity, according to its statutes, does not constitute an incidental activity.

Decision

1. In a situation such as that in the main proceedings:

– activities which consist in the simple sale of shares and other securities, such as holdings in investment funds, do not constitute economic activities within the meaning of Article 4(2) of Sixth Council Directive 77/388/EEC of 17 May 1977 on the harmonisation of the laws of the Member States relating to turnover taxes – Common system of value added tax: uniform basis of assessment, and therefore do not come within the scope of that directive;

placements in investment funds do not constitute supplies of services ‘effected for consideration’ within the meaning of Article 2(1) of Sixth Directive 77/388 and therefore likewise do not come within the scope thereof;

the amount of turnover relating to those transactions must consequently be excluded from the calculation of the deductible proportion referred to in Articles 17 and 19 of that directive;

– by contrast the annual granting by a holding company of interest-bearing loans to companies in which it has a shareholding and placements by that holding company in bank deposits or in securities, such as Treasury notes or certificates of deposit, constitute economic activities carried out by a taxable person acting as such within the meaning of Articles 2(1) and 4(2) of Sixth Directive 77/388;

however, the said transactions are exempted from value added tax under points 1 and 5 of Article 13B(d) of that directive;

in calculating the deductible proportion referred to in Articles 17 and 19 of Sixth Directive 77/388, those transactions are to be regarded as incidental transactions within the meaning of the second sentence of Article 19(2) thereof in so far as they involve only very limited use of assets or services subject to value added tax; although the scale of the income generated by financial transactions within the scope of Sixth Directive 77/388 may be an indication that those transactions should not be regarded as incidental within the meaning of that provision, the fact that income greater than that produced by the activity stated by the undertaking concerned to be its main activity is generated by such transactions does not suffice to preclude their classification as ‘incidental transactions’;

it is for the national court to establish whether the transactions concerned in the main proceedings involve only very limited use of assets or services subject to value added tax and, if so, to exclude interest generated by those transactions from the denominator of the fraction used to calculate the deductible proportion.

2. Operations such as those at issue in the main proceedings, carried out by the members of a consortium in accordance with the provisions of a consortium contract and corresponding to the share assigned to each of them in that contract, do not constitute supplies of goods or services ‘effected for consideration’ within the meaning of Article 2(1) of Sixth Directive 77/388, nor, consequently, a taxable transaction under that directive. The fact that such operations are carried out by the member of the consortium which manages it is irrelevant in that respect. On the other hand, where the performance of more of the operations than the share thereof fixed by the said contract for a consortium member involves payment by the other members against the operations exceeding that share, those operations constitute a supply of goods or services ‘effected for consideration’ within the meaning of that provision.

Summary

Activities consisting in the mere sale of shares and other securities (such as holdings in investment funds) do not constitute economic activities and therefore do not fall within the scope of this Directive.

Investments in investment funds do not constitute services ‘for consideration’ and therefore do not fall within the scope of the Directive.

The amount of turnover in respect of these transactions should therefore be excluded from the calculation of the deductible proportion.

On the other hand, the annual granting of loans for remuneration by a holding company to companies in which it has a shareholding, as well as its investments in bank deposits or securities, such as treasury bills and certificates of deposit, constitute economic activities performed by a taxpayer acting as such.

However, these transactions are exempt from VAT.

When calculating the proportion for the purpose of deduction, these transactions should be regarded as ancillary transactions insofar as they imply only a very limited use of goods or services for which VAT is payable; While the magnitude of the proceeds from financial transactions falling within the scope may indicate that those transactions should not be classified as incidental, the fact that more income is derived from such transactions than from the activity that the undertaking concerned classifies as principal activity, do not exclude those acts as such from classification as ‘incidental acts’.

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