New Share Issues - Value Added Tax

VAT deductibility in relation to new share issues - implications of the European Court of Justice decision in the Kretztechnik AG case.

Introduction

Kretztechnik was an Austrian company involved in the development and sale of medical and technical appliances. Sales of its products were subject to VAT and therefore entitled to VAT deductibility on business inputs. The company decided to increase its share capital and so became listed on the Frankfurt Stock Exchange. In order to obtain this listing, it had to pay for certain services, such as legal and audit fees, on which it was charged VAT.

The tax authorities refused Kretztechnik's deduction of the input tax on the grounds that the share transactions for the purposes of which those costs had been incurred were exempt transactions. Kretztechnik challenged that interpretation before the local tax tribunal and a preliminary reference was made to the European Court of Justice to clarify the matter.
This is the first time that the Court has had to consider the issue of new shares by a limited company.

The tax treatment as administered by the Austrian authorities would have accorded with that of Irish Revenue to date in relation to deductibility (in line with the judgment Revenue had always regarded the issue of shares to increase capital as an outside the scope activity). In the light of the judgment this treatment is now being reviewed.

The questions submitted to the Court

The following three questions were referred to the Court:

• In becoming listed on a stock market and in issuing shares in that connection to new shareholders in return for the issue price, does a public limited company make a supply for consideration within the meaning of Article 2(1) of the Sixth Directive.
• If the first question is answered in the affirmative: are Article 2(1) and Article 17 of the Sixth Directive to be interpreted as meaning that all services obtained in connection with a listing on the stock market are to be attributed to an exempt supply and that for that reason there is no right to a deduction of input tax question.
• If the first question is answered in the negative: is there a right under Article 17(1) and (2) of the Sixth Directive to deduct input tax on the ground that the services in respect of which a deduction of input tax is claimed (advertising, agent's fees, and legal and technical advice) are used for the purposes of the undertaking's taxable transactions question.

Judgment

In response to the above questions the Court ruled as follows (question 2 fell automatically because of the answer to question 1):

• "A new share issue does not constitute a transaction falling within the scope of Article 2(1) of Sixth Council Directive (77/388/EEC) of 17 May 1977 on the harmonization of the laws of the Member States relating to turnover taxes - Common system of value added tax: uniform basis of assessment, as amended by Council Directive 95/7/EC of 10 April 1995.
• Article 17(1) and (2) of Sixth Directive 77/388, as amended by Directive 95/7, confer the right to deduct in its entirety the VAT charged on the expenses incurred by a taxable person for the various supplies acquired by him in connection with a share issue, provided that all the transactions undertaken by the taxable person in the context of his economic activity constitute taxed transactions."

Detail of the judgment

The judgment addressed two principal issues, firstly, whether the issue of new shares is within the scope of VAT and, secondly, the question of deductibility of costs associated with such an issue.

In considering whether the issue of shares constitutes a supply the Court pointed out that "it is settled case law that the mere acquisition and holding of shares is not to be regarded as an economic activity within the Sixth VAT Directive" (paragraph 19 of judgment).

It went on the say in the same paragraph that "if therefore, the acquisition of financial holdings in other undertakings does not in itself constitute an economic activity ... the same must be true of activities consisting in the sale of such holdings".

The Court considered that the issue of new shares could not be regarded as a supply of goods as the shares "are securities representing intangible property" (paragraph 22 of judgment).

Neither was it the supply of a service as the aim of the company was to raise capital and not to provide services.
In answer to the first question therefore the Court concluded that the issue of shares was not an economic transaction for the purposes of the Sixth VAT Directive and was therefore an 'outside the scope' of VAT activity.

Having reached this conclusion, the Court considered whether there is any right to deductibility in respect of such an 'outside the scope' activity.

The answer to this question is the critical part of the Kretztechnik judgment, as deductibility has never been allowed to outside the scope activities.

The Court outlined the basic rationale for the system of deductibility clarifying that "for VAT to be deductible, the input transactions must have a direct and immediate link with the output transactions giving rise to a right of deduction" (paragraph 35).

In paragraph 36 of the judgment the Court found that in this case:

• The reason for the share issue was to raise capital
• For the benefit of the company's general economic activities
• The costs incurred in acquiring this capital would feed in to the price of the company's products
• Therefore, the costs relating to the share issue form part of its general overheads and so carry entitlement to deductibility.

Full entitlement applies only where the taxable person engaged exclusively in taxable activities; apportionment applies if the taxable person is engaged in taxable and exempt activities. No entitlement applies if the person is engaged only in exempt or outside the scope activities.

Opinion of Advocate General Jacobs

Because the Court endorsed the views of the Advocate General the comments contained in his opinion are valuable in interpreting the judgment itself.

Issue of shares: Advocate General Jacobs felt that the issue of shares was not a supply and did not form part of the company's turnover. As VAT is a tax on consumption purchasing shares involved becoming part owners of a company, not acting as consumers as such. He stated that "when a company issues new shares ... there is an acquisition of capital, not a supply, and thus no transaction capable of being taxed or exempted" (paragraphs 59-60).

Deductibility: he then went on to consider whether deductibility should be allowed as the referring court had found that the disputed costs related exclusively to the company's admission to the stock market.

Referring to previous case law he stated that "in order for VAT to be deductible, the relevant input transactions must have a direct and immediate link to taxed output transactions" (paragraph 26).

In addition he pointed out that the Court considers general overheads to be a component of the final cost of taxable products (paragraph 27) and so deductible.

The important, and crucial, point in determining deductibility is therefore the establishment of a link between input costs and taxable outputs (see paragraph 74).

In this case the link was between general overheads of the company, which fed in to the cost of the final consumer product.

Revenue interpretation of the judgment

Revenue will implement the judgment fully where the circumstances of the Kretztechnik case are replicated.
Revenue also accepts that deductibility will extend to companies who decide to raise new capital by means of a rights issue, i.e., giving existing shareholders the right to apply for a given number of new shares in proportion to their existing holdings.

The judgment is not however regarded as applying to costs associated with the issue of bonus shares, which are essentially a means of distributing profits rather than the raising of new capital.

Does the judgment apply to issues of bonds and securitiesquestion

In line with the reasoning of the ECJ in the case of Harnas & Helm (case C-80/95) where it was held that there was no reason to treat the issue or holding of bonds differently from the issue or holding of shares, Revenue accepts that the judgment applies to the issue of new bonds or securities where the circumstances outlined in paragraph 36 of the judgment, outlined above, are replicated.

Revenue will also apply the judgment to other means of raising capital such as note issues, eurobonds and similar instruments provided the essential test for deductibility is satisfied, i.e., the input transactions must have a direct and immediate link with the output transactions giving rise to a right of deduction (paragraph 35 of judgment).

Mergers & Acquisitions

The rationale for mergers and acquisitions is different from that of issuing shares, bonds and securities in order to raise capital. Essentially, Revenue is of the view that mergers and acquisitions are not primarily aimed at raising new capital and therefore do not fall within the ambit of the judgment, therefore giving no entitlement to deductibility.

When as a result of company mergers, new shares are issued in the merged company in exchange for existing shares, the issuing company does not increase its capital for the benefit of its activities in general (paragraph 36 of judgment). Revenue does not accept that the judgment applies in these circumstances and is not allowing deductibility in relation to expenses incurred in such transactions.

While this is the general Revenue view as regards the application of the judgment to costs relating to mergers and acquisitions, Revenue is conscious of the complexity of the issues and the number of possible circumstances in which such transactions may arise. Accordingly, Revenue will consider submissions in specific cases where the taxpayers or their advisors consider that the costs related to a merger or acquisition come within the judgment. Any such submissions should indicate in detail, supported by relevant documentation, the basis on which it is considered the judgment applies.

Deductibility in relation to other share transactions

The VAT treatment of other transactions in shares remains unchanged. At a meeting of the VAT Committee in Brussels in 1990 it was agreed that any expenses incurred in relation to buying or selling shares relate to an exempt activity and therefore do not qualify for input credit. Accordingly, no deductibility will be allowed in respect of costs directly attributable to the buying or selling of shares.

This guideline remains operative. In other words, the sale of existing shares is regarded an exempt supply.

Time limit for repayment claims

The time limit for repayment claims is provided for in Section 20(4)(b) VAT Act, 1972. It is fixed at four years in relation to any taxable period commencing on or after 1 May 2003, and on or after 1 January 2005 in relation to any other taxable period. No refunds shall be made outside these time limits.

Interest

In accordance with Section 21A VAT Act, 1972, interest on refunds of tax will be payable in respect of valid claims to which the Kretztechnik judgment applies.

Cases where the ECJ finds against a Revenue interpretation of the law are regarded as entitled to repayment due to a mistaken assumption by Revenue in the application of the law. A detailed article on repayments, interest and time limits is contained in Tax Briefing issue 56 which is available on the Revenue website http://www.revenue.ie/en/index.html.

Queries

Individual queries or repayment claims should be made to the taxpayer's Inspector of Taxes in the first instance.
Queries regarding the general interpretation of this or any other ECJ judgment can be addressed to

Revenue Commissioners
VAT Interpretation Financial Services and Property Branch,
Stamping Building,
Dublin Castle,
Dublin 2.

Enquiries on this article should be addressed to dbarry@revenue.ie.