VAT andHolding Companies

David Farrugia

1. Holding companies

Typically set up and incorporated with the principal aim of holding shares in subsidiary companies.

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Holding companies at a glance

Very commonly used in many structures around the globe. Malta is not an exception and over the past decade has established itself as the seat of various holding company structures.

“Taxable person” 2

Is a holding company a ‘taxable person’ ?

The term “taxable person” is defined under Council Directive 2006/112/EC of 28 November 2006 (the “VAT Directive”) as “any person who, independently, carries out in any place any economic activity, whatever the purpose or results of that activity”.

In turn, “economic activity” includes any activity of producers, traders or persons supplying services, including mining and agricultural activities and activities of the professions as well as exploitation of tangible or intangible property for the purposes of obtaining income therefrom on a continuing basis.

On such basis – is a holding company a ‘taxable person’?

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Activities of holding companies

Pure holding companies versus mixed holding companies

Pure holding companies: merely set up to hold shares in subsidiary companies - with the only income being restricted to dividends and any eventual capital gains arising from such shares.

Mixed holding companies: contrary to pure holding companies, mixed holding companies would also be involved in other business activities (e.g. granting of credit facilities and loans, holding of IP rights) in addition to the actual holding of shares in their subsidiaries.

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The Polysar Case (ECJ C-60/90)7

Dividends

POLYSAR Investments Netherlands BV

POLYSAR Ltd (Canada)

POLYSAR Holding Ltd (Canada)

100 %

100 %

Dividends

Subsidiary Subsidiary

DividendsDividends

Key facts:

Polysar Investments Netherlands BV (“Polysar”) (a company incorporated in the Netherlands) held shares in foreign companies which were engaged in the production and sale of synthetic rubber and similar products.

On an annual basis Polysar

received substantial amounts in dividends and paid out dividends to the parent company. Polysar itself was not engaged in any trading activities.

Polysar: the key issues

Polysar challenged an assessment by the Dutch Authorities - Polysar claimed that it was entitled to a refund of the VAT charged by third parties.

The Regional Court of Appeal sought a preliminary ruling from the ECJ on various issues, mainly:

whether a holding company whose activities are concerned solely with the holding of shares in subsidiary companies must be regarded as a taxable person in terms of the VAT Directive; and

if, in the event of a negative answer (to the first question) would the holding company be considered as a taxable person if it forms part of a link in and an integral part of a world-wide group of undertakings which in the main outwardly appears under a single name, namely the group name.

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Polysar: the court’s decision

The Court in its judgment established that:

“…… Article 4 of the Sixth Directive is to be interpreted as meaning that a holding company whose sole purpose is to acquire holdings in other undertakings, without involving itself directly or indirectly in the management of those undertakings, without prejudice to its rights as a shareholder, does not have the status of a taxable person for the purposes of value added tax and therefore has no right to deduct tax under Article 17 of the Sixth Directive.”

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Polysar: the Court’s analysis

The mere acquisition of financial holdings in other undertakings does not amount to the exploitation of property for the purpose of obtaining income therefrom on a continuing basis – because any dividend yielded by that holding is merely the result of ownership of the property.

In this respect the fundamental issue to consider is whether the holding company involves itself directly or indirectly in the management of the companies in which it acquired such holding(s).

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Case C-16/00 (the “Cibo case”)

In Case C-16/00 (the “Cibo case”) the ECJ considered the main criteria to be assessed when determining what level of involvement in the subsidiaries’ management is deemed to constitute an economic activity.

Cibo Participations SA (“Cibo”) was a holding company that provided (against payment) management services to its subsidiaries – this included the availability of qualified staff to work in its subsidiaries – primarily in general, administrative, financial, commercial and technical management.

Cibo argued that on such basis it is involved in the management of its subsidiaries.

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Involvement in subsidiaries

On the other hand, the French Authorities claimed that Cibo derives most of its turnover from the receipt of dividends.

The French Authorities held the view that apart from its financial role – Cibo does no more than act as consultant and direct group policy, in respect of which it receives remuneration. Consequently:

Cibo is neither directly nor indirectly involved in the management of its subsidiaries; and

the expenditure arising from its acquisitions of shareholdings has no connection with the services which it provides to its subsidiaries – it merely relates to its ownership of shares and receipt of dividends, which fall outside the scope of VAT.

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What does ‘involvement’ imply?

In the Cibo judgment the ECJ ruled that:

“The involvement of a holding company in the management of companies in which it has acquired a shareholding constitutes an economic activity … (within the meaning of the Directive) …, where it entails carrying out transactions which are subject to value added tax by virtue of Article 2 …(of the Directive) …, such as the supply by a holding company to its subsidiaries of administrative, financial, commercial and technical services”

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Cibo: the Court’s analysis

A holding company whose sole purpose is to acquire holdings in other undertakings and which does not involve itself directly or indirectly in the management of those undertakings does not have the status of a taxable person (basing itself on the findings of the Polysar case).

Expenditure incurred by a holding company in respect of the various services which it purchases in connection with the acquisition of a shareholding in subsidiary forms part of its general costs and therefore has, in principle, a direct and immediate link with its business as a whole.

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The deductible proportion3

The deductible proportion of input VAT: other judgments

To what extent should holding companies be entitled to deduct their input VAT?

The Cibo judgment made various references to other judgments in this respect – notably ECJ C-142/99 (Floridienne and Berginvest). The latter judgment considered the question:

‘Must share dividends and interest on loans always be excluded from the denominator of the fraction used to calculate the deductible proportion, even where the company receiving such dividends and interest has involved itself in the management of the undertakings paying them, save in the exercise of its rights as shareholder?’

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Dividends and deductibility

In terms of dividends, the ECJ in Floridienne and Berginvest established that the receipt of dividends is dependent on the financial results of a company at year end and is not linked to a particular shareholder’s identity or to the provision of services by such shareholder.

Floridienne and Berginvest’s main arguments: no link between the taxable management activities provided to their subsidiaries and the dividends – dividends are received irrespectively of whether such activities are provided or not.

Belgian Government & Commission held that the involvement in the subsidiaries amounted to exploitation of an asset for the purpose of obtaining income from it – in the form of dividends.

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Financing activities

With regards to interest, Floridienne and Berginvest held that making capital available to a third party constitutes an economic activity consisting in exploiting assets only when it involves more than merely managing an asset and is directly linked to another taxable activity. In this case the two companies had merely reinvested the dividends paid to them by their subsidiaries in the form of loans to some of these subsidiaries – with no link between the management services provided to subsidiaries.

Belgian Government and Commission’s main arguments:

the income from loans to subsidiaries constituted the direct, permanent and necessary extension of a taxable activity - accordingly such income must be included in the denominator to calculate the deductible proportion.

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The link with taxable activities

In its ruling the ECJ in Floridienne and Berginvest held that the following must be excluded from the denominator of the fraction used to calculate the deductible proportion:

share dividends paid by the subsidiaries to a holding company which is a taxable person in respect of other activities and which supplies management activities to the same subsidiaries; and

interest paid by the subsidiaries to the holding company on loans it made to them, where the loans do not constitute, for the purposes of Article 4(2) of the Sixth Directive, an economic activity of the holding company (as a taxable person acting as such)

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Attribution to economic and non-economic activities

The recent case C-496/11 (“Portugal Telecom case”) decided by the ECJ on 6 September 2012 considered the apportionment method for holding companies involved in the supply of goods/services that give rise to the right of deduction and goods/services in respect of which no right of deduction is available.

Specifically, the Portugal Telecom case confirmed that where goods and services are used both for economic and non-economic activities, the provisions of Article 17(5) establishing the apportionment mechanism do not apply for apportionment between these activities – it is up to the member states to determine the method of application which objectively reflects the input expenditure actually attributed to each of these activities.

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Expenses incurred in the issue of shares

In Case C-437/06 (the ‘Securenta Case’) the ECJ confirmed that the link between the economic activity of the company and the expenses on which it incurred VAT is also a requirement with regards to the expenses incurred in the issue of shares.

The Court held that when a taxpayer simultaneously carries out economic activities, taxed or exempt, and non-economic activities outside the scope of the Directive, deduction of the VAT relating to expenditure connected with the issue of shares is allowed only to the extent that such expenditure is attributable to the taxpayer’s economic activity in terms of Article 2(1) of the Directive.

Therefore such costs may be deducted only to the extent that they are considered to be a cost component of the output transactions in respect of which there is a right of deduction.

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Expenses incurred in the disposal of shares

The ECJ in Case C-29/08 (the “AB SKF Case”) held that a disposal of shares in a company that constitutes a disposal of ‘a totality of assets’ in terms of Article 19 of the VAT Directive is not an economic activity subject to VAT if it satisfies the conditions imposed by the Member State in question in this respect.

In the absence of the abovementioned exemption (applicable to a transfer of a going concern), the disposal of shares by a holding company in a subsidiary is a clear case of an economic activity if:

such holding company was directly involved in the management of the subsidiary by virtue of taxable management activities; and

such disposal was carried out in order to restructure a group of companies with the scope of obtaining income on a continuing basis

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Link with general economic activity for exempt supplies

The AB SKF Case also confirmed that the sale of shares in the case in question should be exempted under Article 135(1)(f) of the VAT Directive (which inter alia exempts transactions, including negotiation in shares).

Another important factor considered by the Court in the AB SKF case (basing itself on the fundamental principle of fiscal neutrality) is that a link between the input costs and a taxable person’s general economic activity may be established even where such person carried out an exempted transaction, as long as the inputs of such supply do not have any effect on the price of the shares but are components of the general cost of the taxable person.

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Concluding considerations

A holding company whose sole purpose is to acquire shares in subsidiaries without involving itself in the management of such subsidiaries is not considered to be a taxable person (Polysar).

Key distinction between ‘mixed’ and ‘pure’ holding companies. The attribution system under A.17(5) (or A.173 under current Directive)

is applicable for apportionment for activities with a right to deduct and activities without such right - not for apportionment between economic and non-economic activities (Portugal Telecom & Securenta).

Link between input costs and the general economic activity may also be established in connection with exempt supplies (AB SKF).

In view of the significant implications at stake all corporate groups should not ignore the various factors affecting their VAT position, particularly the nature of transactions/activities between the holding company and the subsidiary companies.

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David Farrugia

DFK Malta

david.farrugia@dfkmalta.com

Thank you