Right for shell companies to deduct VAT

VAT Alert

Right for shell companies to deduct VAT

30 Aug 2024

Judgement of the Court of Justice of the EU C-341/22 dated 3 March 2024, Feudi di San Gregorio case

By Mario Spera - Principal of Bernoni Grant Thornton

1. Foreword

With judgment C-341/22 dated 3 March 2024, Feudi di San Gregorio case, the European Court of Justice (hereinafter, CJEU) analysed a case that concerns specifically the Italian regulation regarding the possibility for so-called “shell companies” to obtain a refund of VAT, although a specific rule denies such right to these companies, since they are considered as non-operating companies.

The question arises in relation to the provision of art. 30 of Law 23 December 1994, no. 724, stating that non-operating companies are those companies established in Italy (including any permanent establishments in State territory) whose total revenues are below certain amounts established by law. The qualification as “shell company” would prevent the right to obtain a refund of deductible VAT, and such refund would be lost if the qualification as non-operating company remained for three consecutive years. However, circular letter no. 5/E dated 2 February 2007 of the Italian Revenue Office (concerning the requests for the non-application of the regulation on non-operating companies) specified that such system was aimed at discouraging the utilization of so-called shell companies, since they substantially aim to benefit from more favourable regulations without any effective commercial activity being performed.

The CJEU mainly focussed on the compatibility of the Italian rules with EU ones, specifically with the principles of fiscal neutrality and proportionality and, mainly, on whether it is possible to deny the right of deduction established under art. 167 of Council Directive 2006/112/EC (VAT Directive).

To this end, the Italian Court of Cassation asks “whether the status of taxable person and, consequently, the right to deduct input VAT paid may be denied to a company that carries out transactions subject to VAT while not reaching the income threshold provided for by the Italian legislation at issue, where that company does not demonstrate that objective circumstances rendered it impossible to achieve income higher than that threshold”. As a consequence, the referring court is uncertain whether the Italian regulation is compatible with the right to deduct VAT, which is a fundamental principle of the VAT system, and with the principle of fiscal neutrality and the principle of proportionality, stating that “while the prevention of possible tax evasion, avoidance and abuse is an objective recognised and encouraged by the VAT Directive, the measures adopted by the Member States must not, however, go beyond what is necessary to attain that objective and, in particular, those measures cannot be used in such a way that they would systematically call into question the principle of VAT neutrality”.

2. The status of taxable person

Under art. 9(1) of the VAT Directive, ‘“Taxable person” shall mean any person who, independently, carries out in any place any economic activity, whatever the purpose or results of that activity’. In particular, the Court underlines the objective nature to be attributed to the concept of “activity” (“whatever the purpose or results of that activity”); this is a well-established principle in the EU case law, as also highlighted in judgment C-604/19 dated 25 February 2021, Gmina Wrocław case, point 69. 

Given the above, in the Feudi di San Gregorio case, it is underlined that a person cannot be “denied the status of taxable person for VAT purposes where that person, during a given tax period, carries out transactions that are subject to VAT and the economic value of which does not reach the threshold prescribed by national legislation, which corresponds to the return that can reasonably be expected from the assets held by that person” (see point 25).

Moreover, with reference to the right of deduction (art. 167 of VAT Directive), its nature as “fundamental principle of the common system of VAT” cannot be denied, as it is aimed at ensuring a perfect VAT neutrality to relieve the taxable person of the input tax increased on purchases. Therefore, the taxable person, “acting as such at the time when he or she acquires goods or receives services, uses those goods or services for the purposes of his or her taxed transactions, he or she is entitled to deduct the VAT due or paid in respect of those goods or services” (see point 27). In this regard, the opinion expressed by the CJEU is important, i.e.: deduction cannot be denied to a taxable person, especially when the goods and services which such deduction should be applied to are used to realize taxable transactions.

3. Conclusions of the CJEU

The right of deduction under analysis requires “the existence of a direct and immediate link between a particular input transaction and a particular output transaction or transactions giving rise to the right to deduct” (see point 29). However, the right to deduct VAT can be admitted even where there is no such a link, where the costs of the goods purchased and services received are part of the taxable person’s general costs and are components of the price of the downstream transactions performed.  In fact, in this context, it can be assumed that “such costs do have a direct and immediate link with the taxable person’s economic activity as a whole” (see point 30).

The last element to be considered is the fact that fight against frauds is a principle recognized by the EU regulation and is aimed at preventing taxable persons from using the right of deduction fraudulently. On this point, the CJEU recognizes that the right of deduction can be denied if it is claimed fraudulently or unlawfully. However, since this possibility is an exception, “it is incumbent on the tax authorities to establish, to the requisite legal standard, the objective evidence from which it may be concluded that the taxable person committed VAT fraud or knew or ought to have known that the transaction (...) was connected with such a fraud” (see point 34).

Therefore, the Italian rule on shell companies discussed in the judgment does not seem to play this role, to the extent that it is theoretically based on an assumption that imposes such companies to generate a certain amount of revenues calculated according to the criteria indicated under art. 30 of Law no. 724/1994. However, this assumption is based on different criteria from those required under the VAT Directive and from those aimed at demonstrating the existence of fraudulent/unlawful conduct.

Considering such indications, the European Court concluded that a domestic law that deprives taxable persons of the right of deduction only because the amounts of transactions realized are insufficient based on theoretical presumptions established by a law is not in line with EU provisions.