VAT deduction on "aborted deal costs": a matter of effective direct link with a taxable activity

On 12 November 2020, the Court of Justice of the European Union ("CJEU") rendered a ruling (C-42/19) concerning the deductibility of VAT incurred by an active holding company on costs borne for the acquisition of shares in another company that ultimately was aborted ("aborted deal costs").

Relevant Facts

The case concerned a Portuguese holding company (the "Company") that also provides strategic management and coordination services (i.e. a mixed "active" holding) to companies operating in the telecommunications, media, software and systems integration markets.

In 2005, the Company purchased external consultancy services in the form of a market study in order to acquire shares in another telecommunications operator (the "Target"). In addition, the Company paid a commission (subject to VAT) to a bank for services relating to the issuances of bonds to finance the acquisition and planned to provide support and management services to the Target.

The Company fully deducted the input VAT paid on these services from the VAT payable whereas, eventually, the acquisition of the Target did not materialise. As a result, the Company lent to its parent company the capital of the issued bonds. 

The VAT authorities challenged the deduction of the input VAT considering that the purpose of purchasing the services was not to carry out taxable output transactions.

The Company decided to lodge an action with the Portuguese Courts against the tax authorities' decision. In the course of the domestic proceedings, the Portuguese Supreme Administrative Court decided to refer the case to the CJEU.

Ruling of 12 November 2020

In its ruling, the CJEU makes a clear distinction between the input VAT incurred on market study and banking services.

On one hand, the CJEU, referring to its previous case law, allowed the deduction of the input VAT incurred on market study services as these services relate to the Company's recurring activity of management services (i.e. a taxable economic activity). Unfortunately, the CJEU does not specify when an activity is deemed "recurring". In addition, the CJEU reiterates its settled interpretation according to which the deduction of input VAT must be (partially) rejected to the extent the Company also acts as a "passive" holding company.

On the other hand, the CJEU refused the deduction of the input VAT on the commission paid for the banking services. Indeed, as the deal was aborted, the Company lent the capital of the issued bonds to its parent company. As such loan is a VAT exempt transaction for which a company cannot deduct the input VAT, the CJEU refused the deduction of the paid input VAT on banking costs. The Court indeed considered that, regardless of the Company's original intent (to use the capital to perform operations that open the right to deduct), only the effective use made of the services was relevant.

Holding companies deduction and deduction on called off deals

This ruling provides further explanation regarding the application of holding companies' right to deduct VAT.

In line with its previous case law, the CJEU also confirms the possibility to deduct input VAT on aborted deal costs (ruling of 17 October 2018, Ryanair, C-249/17) when they are sufficiently and effectively linked to a taxable economic activity (in this case "active" holding activities).

Further to this ruling, businesses should assess the possibility to recover VAT on aborted deal costs based on their ability to demonstrate their effective link with taxable output transactions.

In case of questions, please do not hesitate to reach out to Geoffroy Galéa and Alain Thilmany

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