From IGP to VAT unity – a story of VAT

VAT for financial services has been a tumultuous arena during the past year

The year 2017 was a turbulent one for the financial and insurance sectors, with no less than four decisions of the European Court of Justice (ECJ) on the VAT exemption for independent group of persons (IGPs).

The long-awaited latest decision, dated September 21 2017, limited the scope of the VAT exemption to IGPs whose members carry on an activity of public interest. This outcome, feared by many, called for a quick reaction.

The IGP mechanism provides for a VAT exemption for the supplies of services by IGPs, which carry out activities that are VAT exempt or outside of VAT's scope, for the purpose of rendering their members the services directly necessary for the performance of said activities. The mechanism further requires that the IGPs claim from their members the exact reimbursement of their share of the expenses, and that the use of the VAT exemption be not likely to cause distortion of competition.

The rule, enshrined in Article 132(f) of the EU VAT Directive, allows entities fulfilling the conditions to share costs amongst themselves while benefitting from a VAT exemption. The mechanism is of particular importance for group of companies which do not benefit from an input VAT deduction right, as the sharing of costs would otherwise lead to substantial amounts of non-deductible input VAT.

The benefits derived from the use of the IGP exemption explain the heavy reliance on this mechanism by the financial, insurance and fund sectors, notably in France and Luxembourg. In Luxembourg, the IGP exemption was especially relied upon by the fund industry due to the increased need of substance caused by recent tax developments, which often requires fund structures to share resources, such as employees and office spaces, leading to the application of incremental and non-deductible input VAT.

The IGP mechanism nevertheless came under scrutiny by the ECJ in 2015, through no less than four applications (cases C-274/15; C-616/15; C-326/15; C-605/15).

The first decision of the ECJ, in Commission v. Luxembourg (C-274/15), led to much debate as the view of the ECJ, whereby "the allocation to the IGP, by one of its members, of expenses incurred by that member in his name but on behalf of the IGP is a transaction which falls within the scope of VAT" (case C-274/15, paragraph 83) threatened the majority of cost-sharing agreements concluded in Luxembourg.

Yet, the remaining three decisions are the ones that brought the coup de grâce. Faced with many interesting questions, the ECJ limited its analysis to the scope of the VAT exemption. By concluding in paragraph 50 of case C-616/15 that "supplies of services which do not directly contribute to the carrying on of activities in the public interest, […] but to the exercise of other exempt activities, in particular in Article 135 thereof, cannot be covered by the exemption […]," the ECJ effectively ruled out the use of the IGP mechanism by the financial, insurance and fund sectors.

VAT was high on the agenda of the EU Economic and Financial Affairs Council (ECOFIN) held on June 22 2018, as ministers of the 28 EU member states were notably due to agree on four short-term fixes, also called quick-fixes, to the current VAT regime.

The Bulgarian finance minister expected that the short-term fixes would be "acceptable to all delegations in substance". That was, however, until France's request to add a fifth fix, providing for an umbrella exemption to address the ECJ's decisions ruling out the use of the IGP for the financial, insurance and fund industries.

In substance, France called for an amendment of Article 137(a) of the VAT Directive to provide an option for member states to allow that IGPs that pool their services and share costs between their members benefit from a VAT exemption, even in the financial and insurance sectors.

The proposed amendment was given a cold reception from the EU Commission, which argued that the fifth fix would not only harm the functioning of the internal market, but also the freedom of establishment due to the limitation of the applicability of the VAT exemption to the territory of one member state. More importantly, France's proposal impinged on the EU Commission's right of legislative initiative.

In the absence of consensus, France, together with Italy, vetoed any agreement regarding the original four quick-fixes.

France's cavalier attitude comes as no surprise, considering the importance of the IGP for French banks. In Luxembourg, where the financial industry – notably the investment funds – also relied on the IGP, the government went down an alternative route by introducing a bill aiming for the adoption of the VAT group.

Article 11 of the VAT Directive indeed allows member states to "regard as a single taxable person any persons established in the territory of that member state who, while legally independent, are closely bound to one another by financial, economic and organisational links".

The main advantage of the VAT group lies in the treatment of the transactions between members of the group, as such transactions – being virtually carried out within a single taxable person – are deemed to fall outside the scope of VAT. The main purpose of the use of an IGP, i.e. the avoidance of incremental and non-deductible input VAT created by the sharing of costs, can therefore be reached through the setting up of a VAT group. The analogy, however, does not go much further.

In spite of their similar objective, the IGP and VAT group mechanisms do not share many features.

Firstly, the IGP does not require its members to share financial, economic and organisational links. This flexibility is however undermined by the limitation of the VAT exemption to the sharing of costs directly necessary for the performance of activities which are exempt or outside the scope of VAT. To the extent companies share financial, economic and organisational links, the VAT group therefore appears to be more flexible, in that the activities of its members are irrelevant.

Second, the VAT group is limited to the territory of a single member state. Although the question remains debated, it seems that nothing precludes the trans-border use of the IGP mechanism.

Third, the use of a VAT group leads to the artificial creation of a single VATable person, encompassing its members. This circumstance has two practical impacts:

i) the VAT group becomes the only interlocutor with the VAT authorities, and a single set of VAT returns is to be filed; and, more importantly,

ii) members of the VAT group are jointly held liable for the VAT debt of the group.

This last feature will potentially have a chilling effect and may constitute a potential hurdle for the setting up of a VAT group for specific sectors.

Finally, the use of a VAT group may lead to detrimental consequences for structures that include foreign branches. Indeed, while transactions between a head office and its branch should fall outside the scope of VAT, the setting up of a VAT group will virtually seclude the head office from its foreign branch, bringing said transactions within the scope of VAT.

In Luxembourg, the law on VAT groups, recently adopted, features interesting elements.

Firstly, and in line with the VAT Directive, the law requires that members of the VAT group share financial, economic and organisational links.

The requirement for a financial link to exist will be met between entities sharing, directly or indirectly, links of controls, to be analysed in light of Article 1711-1 of the Commercial Company Law of 1915, and to be assessed by an auditor or a certified public accountant. According to a report by the Commission on Finance and Budget, the reference to the rules governing the use of consolidated accounts aims at facilitating the understanding of the criterion. This reference to the Commercial Company Law seems to implicitly restrict the use of the VAT group to commercial companies, therefore excluding any type of taxable persons which would not fall within its scope. Yet, Article 11 of the EU VAT Directive refers to "any persons". This autonomous VAT concept is arguably larger than the one relied upon by the Luxembourg legislator. On the other hand, the bill does not require that members qualify as VAT taxable persons, in line with ECJ case law, notably case C-85/11, paragraph 46.

The other requirements are less problematic. The economic link will exist between persons whose activity is similar, complementary or interdependent, or where a member of the group carries out an activity for the benefit of other members. The organisational link refers to a common direction, a cooperation in the organisation of the members' activities, or the existence of a controlling power of a single person – a definition directly borrowed from the Belgian rules.

Second, setting up a VAT group remains an option. This flexibility is nevertheless undermined by three factors: (i) the obligation to opt in for at least two years; (ii) the limitation of the membership to a single VAT group per person; and (iii) the obligation for all the persons fulfilling the conditions to join the VAT group. The latter restriction is subject to an exception, carved out for a member which would not intervene in the production and distribution chain, and whose absence in the group would not lead to an undue tax advantage for the VAT group or said member. These rules simply aim to prevent tax evasion and avoidance.

The original draft of the law also provided for the obligation to exclude the member carrying out an activity which, because of its nature, is not specific to the group's activities and is normally not performed within a company which carries out a comparable activity, to the extent however that the inclusion of said member in the VAT group leads to a distortion of competition. The State Council nevertheless pointed out the provision as unclear – a euphemism – and called for its amendment. In its most recent draft, the provision was removed altogether.

Finally, the objective of administrative simplification fails to convince. Indeed, while a single set of VAT returns will be filed by the VAT unity, the drawing up of such returns will require the preparation of VAT returns for each member, to be then consolidated in a single file. In addition, and despite the opinion of the VAT Committee laid out in Working Paper 948 on April 11 2018, members of the VAT group will receive an auxiliary VAT number, alongside the one granted to the VAT group itself. These auxiliary numbers will be used by the members in their transactions with third parties, and European sales lists will remain to be filed separately for each member. Intra-group transactions will also have to be documented.

At this stage, the VAT group appears to be a partial solution to the applicability of VAT on the sharing of costs between members of a group.

The requirement that the members share financial links, coupled with the limitation of the membership to a single VAT group per person, entails less flexibility for the constitution of the group, and may well lead to exclusion of specific types of structures from the benefit of the VAT group.

In addition, the co-liability of the members for the VAT debt of the group will constitute a hurdle that many may refuse to cross.

Released almost a year ago, the ECJ's decisions on the IGP still echo today. However impactful the decisions may be, France appears to be firmly committed to spearheading a group of member states – including Luxembourg – in favour of the adoption of an amendment of the VAT Directive. Other member states remain against such a modification.

Considering the importance of its financial, insurance and investments fund sectors, Luxembourg could not afford to wait for a potential amendment of the VAT Directive. The government's move towards the adoption of the VAT group will be welcomed by many, despite the potential hurdles that some structures will face in the setting up of their VAT group.

At this stage, one would have difficulties asserting that the story has come to an end. There may well be more acts to add to this tale.

Thierry Charon

Loyens & Loeff 18-20, rue Edward Steichen L-2540 Luxembourg Tel: +352 466 230 thierry.charon@loyensloeff.com www.loyensloeff.com Thierry Charon co-heads Loyens & Loeff's VAT, customs and international trade practice group in the Benelux region. Thierry specialises in VAT, customs, excise duties, international trade, real estate and transfer pricing matters. He counsels clients active in the real estate and finance sectors in Luxembourg, Belgium and across Europe and international organisations and foundations. He is the chairman of the European VAT Club and is a member of the European Commission's VAT Expert Group (composed of individuals with the requisite expertise in VAT and organisations representing businesses and tax practitioners which can assist in the development and implementation of VAT policies within the EU) and of other global and Luxembourgish associations specialised in the tax, legal, funds and banking industries. He is recognised as a leading indirect tax expert by International Tax Review and Legal 500 EMEA and as an expert in tax law by the Best Lawyers guide (2017).

Olivier Coulon

Loyens & Loeff 18-20, rue Edward Steichen L-2540 Luxembourg Tel: +352 466 230 olivier.coulon@loyensloeff.com www.loyensloeff.com Olivier Coulon works as an associate for the Loyens & Loeff's VAT, customs and international trade practice group. He advises clients on indirect tax matters, especially VAT, customs, excise duties and registration duties. Olivier particularly advises clients on VAT in the framework of financial and real estate transactions. Olivier also focuses on matters of international trade, such as export control and trade – including financial – sanctions. He is a regular contributor to www.worldtradecontrols.com, and publishes in dedicated international journals. Before joining Loyens & Loeff, Olivier worked for an international law firm located in Brussels. He has been a member of the Brussels Bar since 2014.