Wood chip drying is not taxable, but foils input VAT deduction

Factual background

The plaintiff operated a biogas plant with a connected combined heat and power plant. It supplied part of the heat generated to a hospital in return for payment and, therefore, received a CHP bonus for the supply of electricity to the grid operator. In 2012, it also acquired a drying plant, which was also operated with the heat from the combined heat and power plant. It used this to dry wood chips free of charge for a sister company, which in turn used the wood chips to heat apartment blocks. The sister company thus saved expenses of around 600 € and the claimant was able to receive a 45,000 € higher CHP bonus.

The tax office took the view that the plaintiff had to pay VAT on a transaction which must be treated as made for consideration.

BFH decision

Transaction which must be treated as made for consideration

The BFH (German Federal Fiscal Court) ruled that the plaintiff had not made a supply of heat free of charge within the meaning of sec. 3 para. 1b sentence 1 no. 3 UStG (German VAT Code), as the first requirement for this would be that the supply fulfils the criteria of a supply of goods. This requires that the sister company has been given the power to dispose of the heat. Since the sister company was not authorised to dispose of the heat used in the drying process in its own name, but only the plaintiff was able to determine the use of the heat, the requirement was not met.

Rather, the plaintiff had provided supplies of services free of charge, which consisted of the drying of wood chips. However, this was not a transaction which must be treated as made for consideration in the form of the use of an item (the drying plant) allocated to the company for non-business purposes pursuant to § 3 (9a) no. 1 UStG. For this to be the case, the use of the drying plant itself would have to characterise the service; here, however, the service is characterised by the drying of the wood chips (editor's note: it would have been different if the drying plant had been rented out free of charge).

A transaction which must be treated as made for consideration in the form of a supply of services within the meaning of § 3 (9a) no. 2 UStG does not exist either, as, unlike supplies of goods, only gratuitous services for non-business reasons are covered here. By utilising the heat, the plaintiff had achieved a higher remuneration for its electricity supplies to the grid operator. The drying service was aimed at this, which was sufficient for a business interest. The business interest of the sister company was also of secondary importance, as it had only saved around 600 €, while the plaintiff had gained 45,000 €.

Input VAT deduction

The expenses incurred in connection with the drying service, in particular the acquisition costs of the drying system, do not entitle the plaintiff to deduct input VAT because they were not included in taxed transactions, but rather in transactions outside the scope of VAT. If a taxable person obtains input services in order to supply them free of charge to a third party, and at the same time to enable his own economic activity, he is entitled to deduct input VAT if the input supply does not go beyond what was necessary/essential to fulfil this purpose; the costs of the input supply are included in the price of the output transactions and the benefit to the third party is at most incidental. In so deciding, the Senate is following the case law in the Mitteldeutsche Hartstein-Industrie case. Based on these principles, an input VAT deduction is not possible, as the input supplies from the purchase of the drying plant were directly and immediately linked to the free drying of the wood chips. The connection with the paid electricity supplies was indirect at best. In exceptional cases, merely indirect causation could be sufficient. However, this would require that the purchase of the drying plant not only promoted the company's own economic activity, but made it possible in the first place, which was not the case.

In the case of input supplies that are related both to the taxable output supplies and to the non-taxable wood chip drying, input VAT is to be apportioned in accordance with §15 (4) UStG, whereby the exclusively energetic method that has been used by the tax authorities in such cases to date is not appropriate according to current BFH case law. This also applies to the acquisition costs of the combined heat and power unit itself.

Correction

As further questions of fact needed to be clarified, the BFH referred the case back to the tax court. The Senate also stated that the plaintiff had not been authorised to fully allocate the combined heat and power plant to the company and to claim the full input VAT deduction. In the event of such an incorrect allocation under substantive law and the input VAT deduction wrongly claimed as a result, the input VAT deduction must be corrected in subsequent years in accordance with §15a UStG if the VAT assessment for the year of allocation can no longer be amended under procedural law. The application of § 15a UStG is based on the fact that, according to BFH case law, a change in the circumstances relevant for the input VAT deduction should not only exist if something has changed in fact, but also if the legal assessment of the utilisation turnover changes while the circumstances actually remain the same. The Senate thus agrees with the judgement V R 11/12 and the ECJ judgement C-532/16 in the case SEB bankas.   

Impacts

Combined heat and power plants keep the Federal Fiscal Court busy time and again, and the judgement discussed here shows how closely you have to look. At first glance, the case XI R 15/24 (judgement of 4 September 2024) appears to be very similar to the one discussed here: The operator of a combined heat and power plant supplied heat free of charge to, among others, an entrepreneur who used it to dry wood. After the BFH initially had the ECJ clarify that the risk of untaxed final consumption is not an unwritten characteristic of a transaction which must be treated as made for consideration, it affirmed the transaction which must be treated as made for consideration. The difference to the present case XI R 4/23 is subtle, but decisive: In case XI R 15/24, there was a supply of heat, and in the case of free supplies, unlike in the case of supplies of services, the non-business purpose is not a prerequisite for a transaction which must be treated as made for consideration.

The BFH also consistently applies the principles developed by the ECJ in the Mitteldeutsche Hartstein-Industrie case, which can be summarised as follows: If an input supply primarily serves one's own business interests, it can be harmless for input VAT deduction if a third party benefits free of charge. Here too, however, it is clear that it is the subtleties that matter: In the Mitteldeutsche Hartstein-Industrie case, the operator of a quarry had upgraded a municipal road so that it could accommodate the quarry's heavy goods traffic. The municipality received the upgraded road without having to pay anything. In this case, the ECJ and subsequently the BFH (XI R 26/20) affirmed the input VAT deduction because the upgrading costs did not exceed what was necessary for the operation of the quarry and were part of the cost elements of the taxed output transactions. The case discussed here differs from this, as the purchase of the drying plant was not necessary for the taxed output turnover.

Taxable persons should always carefully examine arrangements with gratuitous elements. The BMF (German Federal Ministry of Finance) letter dated 24 January 2024 on input VAT deduction for free gratuitous transactions should also be observed. It may be advantageous to agree on a low fee.

Author: Nadia Schulte