VAT grouping: BFH refers internal supplies to the ECJ again and changes jurisdiction on voting rights

After the ECJ had ruled on the two ECJ cases "Finanzamt T" and "Norddeutsche Diakonie", experts breathed a sigh of relief because they no longer had to fear that the ECJ might reject the German concept of VAT grouping altogether. However, the ECJ did not confirm the non-taxability of internal supplies as clearly as they had wished. The V. Senate of the BFH (Federal Financial Court in Germany) is therefore referring the "Finanzamt T" case to the ECJ for a second time. The XI. Senate, on the other hand, is publishing its follow-up decision in the "Norddeutsche Diakonie" case and adapting to the ECJ case law.

Case: Finanzamt T

In the case of the V. Senate (case number ECJ: C-269/20, case number BFH first preliminary reference proceedings: V R 40/19, second preliminary reference proceedings: V R 20/22) concerned a foundation as the head of the VAT group with economic and non-economic (sovereign) activities. The subsidiary U-GmbH provided, among other things, cleaning services for both the sovereign and the economic areas of the foundation. The ECJ ruled in the first  preliminary ruling proceedings that it was compatible with EU law if, under German law, the taxable person was not the VAT group, but the head of the VAT group. In addition, the ECJ denied a free transfer of value if, as in this case, a supply is provided by the economic part of the VAT group to the sovereign part.

The BFH had not asked whether internal supplies between the members of a VAT group were subject to VAT in the first reference proceedings.  In this respect, Advocate General Medina opened a Pandora's box when she argued in her opinion that this was the case. In the two ECJ judgements "Finanzamt T" and "Norddeutsche Diakonie", it was stated that the VAT Directive precludes "...members of a VAT group (...) continuing to be identified, within and outside their group, as individual taxable persons (...)". Experts differ in their opinions as to whether this means that the taxability of internal supplies is now no longer an issue.  The V. Senate of the BFH felt it necessary to clarify the question of the taxability of internal supplies and therefore referred the "Finanzamt T" case to the ECJ again.

In its order for reference, the V. Senate deals in detail with the various aspects that must be taken into account when interpreting the VAT Directive in this respect. Some of these are:

The historical origin of the VAT group regulations speaks for the taxability of internal supplies. When Germany introduced the VAT group, the VAT system did not yet provide for input VAT deductions. It was therefore absolutely necessary that internal supplies be non-taxable to avoid an accumulation of taxes within associated taxable persons. Theoretically, the introduction of the input VAT deduction eliminated the need for the non-taxability of internal supplies, according to the V. Senate.

The tax group also strives to simplify administrative overhead. The V. Senate said that, at any rate, simplifying the taxation procedure did not require internal supplies to be excluded because only requiring one VAT return for an entire VAT group was already the simplification needed. However, having this VAT return also include internal supplies Would not change anything.

The V. Senate questions whether the purpose of the VAT Directive's VAT group provision is also to simplify the material law by removing internal supplies from the VAT’s scope because if the recipient of the internal supply is not entitled to deduct input VAT, the non-taxability of internal supplies means that these, in fact, are not taxed. Because some Member States have used their authorisation to introduce a VAT group, while others have not, this could lead to distortions of competition within the EU. Therefore, the V. Senate would also like to know whether it makes a difference for the taxability of internal supplies if the recipient of the supply is entitled to deduct input VAT as it seems conceivable to the V. Senate that the ECJ would only accept the non-taxation of internal supplies if output tax and input tax balance each other out anyway. In Germany, the VAT group has been a popular means of optimising input VAT, so taxpayers would hardly be served by such a compromise. Moreover, it would then be necessary to always check whether deducting the input VAT is permissible – an added step that would be contrary to the VAT group’s stated purpose of simplifying the administrative effort.

The assumption that internal supplies are taxable is also compatible with the current wording of § 2 (2) UStG (German VAT Code) because the provision can be interpreted in this sense in conformity with EU law.  Although, according to this provision, members of a VAT group are "not independent", this only refers to the joint VAT declaration. The fact that the effects of the fiscal unity are, according to the wording of § 2 para. 2 UStG, "limited to internal supplies between the parts of the taxpayer located in Germany" is also not challenged by the V. Senate. The legislator had not intended to establish the non-taxability of internal supplies, but only to restrict the tax group to Germany.

Case: Norddeutsche Diakonie

The XI. Senate of the BFH had submitted the case "Norddeutsche Gesellschaft für Diakonie mbH" to the ECJ (case number ECJ: C-141/20, case number BFH referral case: XI R 16/18, rehearing: XI R 29/22), in which the head of the VAT group held the majority of shares in the controlled company with 51%, but did not have the majority of voting rights.  The managing directors of the head of the VAT group and the controlled company were identical.

In its previous case law, the BFH had always required that the head of the VAT group must have a majority shareholding in the controlled company and also hold the majority of voting rights to confirm that these entities were indeed financially integrated. In the "Norddeutsche Diakonie" case, however, the ECJ ruled that the Member States cannot require the VAT group head to have a majority of voting rights.

The BFH therefore expressly abandons its previous case law for the case involving a non-majority of voting rights but emphasises elsewhere in the judgement that it should nevertheless be adhered to "in principle". It refers to the fact that financial, economic, and organisational integration do not have to be equally strong. It is therefore justified to regard a majority shareholding despite voting rights of only 50% as merely a weaker financial integration if, as in the present case, there is identity of persons in the management bodies. In this scenario, the VAT group head could use its voting rights to enforce its decisions and prevent deviating instructions by the shareholders' meeting (which the BFH did not consider sufficient in its previous case law). The XI. Senate points out that the requirement to have a majority shareholding remains unchanged, and that a tax group between sister companies is therefore still out of the question.

In view of the XI. Senate's arguments, financial integration is still unlikely to exist in the future for voting rights below 50%, as the VAT group head cannot prevent divergent decisions at the controlled company.

Practical implications

Due to the renewed referral of the "Tax Office T" case with respect to the internal supplies, the VAT group issue is still resolved. If internal supplies were to be taxable, this would have a considerable effect on German business practices, and the VAT group would no longer be a suitable means of optimising input VAT. The Advocate General had argued this thesis with great self-confidence, whereas the ECJ's opinion on the matter was very brief and ambiguous, so clarification is absolutely necessary.

Due to the change in case law regarding the requirement of a majority of voting rights in the "Norddeutsche Diakonie" case, taxpayers should definitely re-examine their multi-level business structures. Under certain circumstances, this can mean that in cases where there was assumed to be no VAT group due to the lack of a majority of the voting rights, there is now assumed to be one. Since rulings do not create new law, but in principle merely recognise for the first time what has always been true, such structures would also have to be treated as VAT groups for the past. However, since the case law of a supreme federal court has changed here, it would be wise to examine whether protection of legitimate expectations can be claimed pursuant to § 176 (1) no. 3 AO (General Fiscal Code in Germany).

Dated: 28 March 2023

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