Services in relation to claims for damages

Facts

The claimant had concluded an operating agreement with a client for the development and operation of a specific project. The claimant was required to pre-finance the costs and bear the risk associated with the planning, development, and set-up of the project. She was only to receive remuneration once the project had actually commenced. After the client terminated the operating agreement, the claimant successfully sued the client for damages. It claimed input VAT deduction in respect of consultancy costs incurred in this context, but the tax office refused this claim. The action brought against this decision was successful. The tax office lodged an appeal against the tax court’s decision, arguing that the expenditure did not serve to generate turnover. Furthermore, the claimant was not in the process of winding up, as no resolution to dissolve the company had been passed and no insolvency proceedings had been opened. The link between the consultancy services and the economic activity was therefore, at most, indirect. The claimant, on the other hand, argued that she had needed the damages awarded in order to compensate her own subcontractors.

Federal Fiscal Court (BFH) ruling

The consultancy services procured by the claimant constitute general expenses relating to the claimant’s entire economic activity, meaning that the right to deduct input VAT exists. The claim to be recovered in this case arose exclusively from the claimant’s economic activity – even if this activity had not actually been carried out but had merely been intended. It follows from the case law of the European Court of Justice that, for reasons of neutrality, no distinction may be made between expenditure incurred prior to the actual commencement of the activity, during the activity, and for the purpose of terminating the activity. It follows from this that, even after the cessation of the business activity as such, input VAT is deductible where it relates to services intended to satisfy claims arising exclusively from the previous business activity.

Furthermore, the right to deduct input VAT arises as soon as the taxable person has the intention, supported by objective evidence, to carry out taxable supplies. That right remains in force even if the intended economic activity is not subsequently carried out. If, at the same time, the deduction of input VAT on expenditure incurred for the purpose of winding up the business were to be denied, VAT would not be neutral in relation to the result of the economic activity.

The Fiscal Court was entitled to regard it as irrelevant that no insolvency proceedings had been opened in respect of the claimant’s assets and that no resolution had been passed to wind up the business. Nevertheless, the consultancy expenses in question served directly to facilitate the conduct of an originally planned taxable activity.

Analysis

The tax office’s refusal to allow input VAT deduction is based on the view that damages are not taxable and that, consequently, expenses related to them do not give rise to a right to input VAT deduction. This line of argument falls short, as the enforcement of claims is, in the present case, inextricably linked to a specific economic activity. That input VAT on expenses incurred in connection with the unwinding of a business is deductible is in line with established case law. The Federal Fiscal Court’s ruling is convincing and, in our view, also compelling.