Input VAT deduction in the spouse model may be permissible – BFH ruling V R 29/20

Non-deductible input VAT is a nuisance, and creative approaches are sometimes used to remedy this. However, an input VAT deduction obtained this way often runs counter to the values of the VAT Directive and is therefore inadmissible; the ECJ came to this conclusion most recently with regard to the intermediary model (C-98/21). However, in its ruling of 29 September 2022, published on 12 January 2023, the BFH (Germany’s Federal Fiscal Court) approved a model in which an entrepreneur who was not entitled to deduct input VAT had used his wife as an intermediary.

Situation:  Medical practitioner has a car purchased by his wife

A self-employed medical practitioner had ordered a car for use in performing this activity. Before the car was delivered, the purchase contract for the vehicle was changed to show that the buyer was no longer the medical practitioner but rather his wife. It appears that the medical practitioner did this because he would not have had an input VAT deduction due to his VAT-exempt output supplies. The wife was financially independent of her husband and paid for the car with her own funds. Immediately after delivery, she leased the car to her husband in a leasing contract concluded at the standard market leasing rates. The husband was obligated to have maintenance done on the passenger car at regular intervals, to carry out all necessary repair work, and to carry adequate insurance for the vehicle at his own expense. In reality, the maintenance work was later ordered and paid for by the wife.  She was entered in the insurance policy as an additional user of the car but also had another car. The wife duly submitted the leasing instalments to VAT and claimed an input VAT deduction from the acquisition costs of the car.

Tax office: Lack of status as VAT-taxable person, sham transaction, abuse

The tax office denied the input VAT deduction and argued that the wife was not a VAT-taxable person because she did not offer the car for lease on the general market. Lessors are usually commercial enterprises with corresponding business premises. A leasing transaction with a single car was only conceivable between relatives with similar interests and exclusively for the purpose of obtaining tax advantages. The transfer of the car  belonged to the private sphere because it benefited the spouses´ marital life and economic community. Furthermore, the leasing contract was a fictitious transaction that was irrelevant for tax purposes because the wife was also registered as a user in the insurance policy. Moreover, this arrangement was considered an abuse within the meaning of § 42 of the German Fiscal Code (AO).

BFH:  Input VAT deduction is permissible

The BFH ruled that the wife had indeed become a VAT-taxable person because she had carried out an activity for remuneration on a sustained basis. Since she had purchased the car with her own funds, she had also borne an entrepreneurial risk. The fact that a supply does not necessarily have to be offered on the general market in order to be taxable is in line with the case law of the Federal Fiscal Court. It was also not necessary for the business to be set up in a commercial manner.

Since the leasing contract was actually carried out, there was no sham transaction. The fact that the wife paid for the maintenance work herself and thus deviated from the leasing contract could not change this, since the legal consequences of a leasing contract were generally intended by the parties.

By concluding the leasing contract, the spouses separated the use of the car from the marital life and economic community by placing it on a special basis under the law of obligations.

Section 15 (1a) UStG (German VAT Code) in conjunction with Section 12(1) EStG (German Income Tax Code) also did not prohibit the deduction of input VAT. These provisions stipulate that input VAT from expenses for one's own household or the maintenance of family members may not be deducted. However, since the wife had bought the car specifically for the business activity of leasing and not as a "family car", these provisions were irrelevant.

Furthermore, the input VAT deduction from the purchase of the car was neither an abuse nor contrary to the VAT system, because the wife only differed from a commercial leasing company in that she only acted vis-à-vis a single service recipient close to her. It was normal for an input VAT surplus to arise when a leasing business is founded due to the acquisition of the leased goods.

In its previous case law, the BFH had emphasised the particular importance of the question of whether the spouse had acquired the transferred object using his or her own funds. Only then did he/she have the financial independence to make his/her economic decisions freely and also bear an entrepreneurial risk. The input VAT deduction was then justified by the fact that an additional level of entrepreneurial activity with all its corresponding advantages and disadvantages was established by the spouse. Since this was the case here, there was no legal abuse and it was also irrelevant whether the purpose of the leasing contract was the expectation of a profit or a tax advantage.

However: Free transfer of value by the wife

According to the tax court’s findings, the wife also used the car.  The tax court had assumed that this was to be regarded as the husband's own use if he allowed his wife to use the car he had leased. The decisive factor for this view was that the leasing contract stipulated a full-time lease, and the wife had not contractually reserved her own right to use the vehicle. The Federal Fiscal Court disagreed: The fact that a full-time lease had been agreed was irrelevant for tax purposes if the contract terms had not actually been followed accordingly. Therefore, the wife was to be taxed for a free transfer of value pursuant to § 3 para. 9a no. 1 UStG.

Practical implications:

To obtain input VAT deduction, taxpayers sometimes show great creativity, and some arrangements are indeed questionable. The decisive question is whether the activity is being carried out for the purpose of sustainably generating income, which would require it to meet the various criteria and indications outlined by the ECJ. Whether this can be affirmed depends very much on the individual case and is often rather unclear. The case law regarding abuse also depends on the individual case and essentially on whether the transaction is actually carried out in the way it appears to the outside world. Therefore, the ruling discussed here should not be viewed as offering any sort of carte blanche for trickery. Moreover, it is important to remember that even in the case of an acceptable spouse model as here, the tax relief gained through the input VAT deduction must be paid again elsewhere; in this case in the form of the taxable leasing service.

Dated: 3 February 2023

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