Flashback on ECJ cases C-204/03 (Commission v Spain) – The receipt of subsidies by itself cannot limit the taxpayers’ right to deduct

On October 6, 2005, the ECJ issued its decision in the case C-204/03 (Commission v Spain).

Context: Failure of a Member State to fulfil its obligations – Articles 17 and 19 of the Sixth VAT Directive – Subsidies – Limitation of the right to deduct.

Article in the EU VAT Directive

Article 17(2), 17(5) and 19 of the Sixth VAT Directive (Articles 168, 173 of the EU VAT Directive 2006/112/EC).

Article 168 (Origin and Scope of the Right of Deduction)
In so far as the goods and services are used for the purposes of the taxed transactions of a taxable person, the taxable person shall be entitled, in the Member State in which he carries out these transactions, to deduct the following from the VAT which he is liable to pay:
(a) the VAT due or paid in that Member State in respect of supplies to him of goods or services, carried out or to be carried out by another taxable person;
(b) the VAT due in respect of transactions treated as supplies of goods or services pursuant to Article 18(a) and Article 27;
(c) the VAT due in respect of intra-Community acquisitions of goods pursuant to Article 2(1)(b)(i);
(d) the VAT due on transactions treated as intra-Community acquisitions in accordance with Articles 21 and 22;
(e) the VAT due or paid in respect of the importation of goods into that Member State.

Article 173 (Proportional deduction)
1. In the case of goods or services used by a taxable person both for transactions in respect of which VAT is deductible pursuant to Articles 168, 169 and 170, and for transactions in respect of which VAT is not deductible, only such proportion of the VAT as is attributable to the former transactions shall be deductible.
The deductible proportion shall be determined, in accordance with Articles 174 and 175, for all the transactions carried out by the taxable person. 2. Member States may take the following measures:
(a) authorise the taxable person to determine a proportion for each sector of his business, provided that separate accounts are kept for each sector;
(b) require the taxable person to determine a proportion for each sector of his business and to keep separate accounts for each sector;
(c) authorise or require the taxable person to make the deduction on the basis of the use made of all or part of the goods and services;
(d) authorise or require the taxable person to make the deduction in accordance with the rule laid down in the first subparagraph of paragraph 1, in respect of all goods and services used for all transactions referred to therein;
(e) provide that, where the VAT which is not deductible by the taxable person is insignificant, it is to be treated as nil.

Article 174 9(Proportional deduction))
1. The deductible proportion shall be made up of a fraction comprising the following amounts:
(a) as numerator, the total amount, exclusive of VAT, of turnover per year attributable to transactions in respect of which VAT is deductible pursuant to Articles 168 and 169;
(b) as denominator, the total amount, exclusive of VAT, of turnover per year attributable to transactions included in the numerator and to transactions in respect of which VAT is not deductible.
Member States may include in the denominator the amount of subsidies, other than those directly linked to the price of supplies of goods or services referred to in Article 73.
2. By way of derogation from paragraph 1, the following amounts shall be excluded from the calculation of the deductible proportion:
(a) the amount of turnover attributable to supplies of capital goods used by the taxable person for the purposes of his business;
(b) the amount of turnover attributable to incidental real estate and financial transactions;
(c) the amount of turnover attributable to the transactions specified in points (b) to (g) of Article 135(1) in so far as those transactions are incidental.
3. Where Member States exercise the option under Article 191 not to require adjustment in respect of capital goods, they may include disposals of capital goods in the calculation of the deductible proportion.

Facts & Questions

By its application, the Commission of the European Communities seeks a declaration from the Court that, by providing for a deductible proportion of value added tax (‘VAT’) for taxable persons who carry out only taxable transactions, and by laying down a special rule which limits the right to deduct VAT on the purchase of goods and services which are subsidised, the Kingdom of Spain has failed to fulfil its obligations under Community law, and, in particular, Articles 17(2) and (5) and 19 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 (OJ 1977 L 145, p. 1), as amended by Council Directive 95/7/EC of 10 April 1995 (OJ 1995 L 102, p. 18; ‘the Sixth Directive’).

AG Opinion

By limiting the right to deduct value added tax in the conditions defined by Articles 102(1) and 104(2) of Law No 37/1992 of 28 December 1992 on value added tax as amended by Law No 66/1997 of 30 December 1997, the Kingdom of Spain has failed to fulfil its obligations under Articles 17 and 19 of the 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

Decision

1. Declares that, by providing for a deductible proportion of value added tax for taxable persons who carry out only taxable transactions, and by laying down a special rule which limits the right to deduct VAT on the purchase of goods and services which are subsidised, the Kingdom of Spain has failed to fulfil its obligations under Community law, and, in particular, Articles 17(2) and (5) and 19 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, as amended by Council Directive 95/7/EC of 10 April 1995;

2. Orders the Kingdom of Spain to pay the costs.

Summary

By introducing a pro rata deduction of VAT for taxable persons who only carry out taxable transactions and by introducing a special rule limiting the deductibility of VAT on the purchase of goods or services financed by means of subsidies, the Kingdom of Spain has failed to fulfill its obligations under Community law, in particular Articles 17(2) and (5) and 19 of the Sixth Directive.

Source