Cost sharing exemption limited to public interest activities

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        <h3>Update</h3>
        <p>HMRC have released guidance on the restrictions to the cost sharing exemption to be introduced in the UK following these decisions. See HMRC&nbsp;<a href="https://www.gov.uk/government/publications/vat-information-sheet-0218-impact-on-existing-cost-share-groups-following-changes-to-hmrcs-policy/vat-information-sheet-0218-impact-on-existing-cost-share-groups-following-changes-to-hmrcs-policy" target="_blank">VAT Information Sheet 02/18</a> and <a href="https://www.gov.uk/government/publications/revenue-and-customs-brief-3-2018-changes-to-the-vat-exemption-for-cost-sharing-groups/revenue-and-customs-brief-3-2018-changes-to-the-vat-exemption-for-cost-sharing-groups" target="_blank">Revenue &amp; Customs Brief 3(2018)</a>.</p>
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The European Court of Justice (ECJ) has held that the cost sharing exemption for independent groups of persons whose activities are exempt from or are not subject to VAT is limited to persons carrying on activities in the public interest only: DNB Banka (Case C-326/15) and Aviva Towarzystwo (Case C 605/15). As such, groups carrying on an economic activity, such as in the field of financial services and insurance, are not able to benefit from the exemption.

Background

The 2006 VAT Directive (Article 132(1)(f)) provides that the supply of services by independent groups of persons (IGP), who are carrying on an activity which is exempt from VAT or in relation to which they are not taxable persons, for the purposes of rendering their members the services necessary for the exercise of that activity, where those groups merely claim from their members exact reimbursement of their share of the joint expenses, provided that such exemption is not likely to cause distortion of competition.

DNB Banka in Latvia was a subsidiary of DNB Nord in Denmark, whose parent was DNB Bank, also in Denmark. The DNB Bank group sourced IT services from Microsoft for use by group companies. DNB Bank was invoiced for the services and subsequently allocated the costs across the group, including costs to DNB Banka. DNB Banka also received other recharging invoices from DNB Nord relating to various shared management expenses. DNB Banka took the view that these recharges were exempt from VAT under the cost sharing exemption in Article 132(1)(f).

The Latvian tax authorities rejected this analysis and when the case came before the Latvian courts, the matter was stayed and questions referred to the ECJ. In particular, these questions related to the extent to which the exemption can apply across different Member States, whether the formation or identification of an IGP requires any formalities and whether a Member State can restrict its application where a person applies an uplift to the recharge.

A case also raising questions about the scope of the cost sharing exemption also arose between Aviva and the Polish tax authorities. Aviva Group made plans to set up a series of shared-services centres in a number of Member States to provide the services which are directly necessary for carrying on the activity of insurance by the entities in that group, such as human resources, financial and accounting services, information technology services, administrative services, customer services and services connected with the creation of new products. Aviva planned to carry on that activity by creating a European Economic Interest Grouping (EEIG) which would not profit from its activity, its members being exclusively companies from the Aviva Group. In those circumstances, Aviva submitted a request to the Polish Minister of Finance contending that the activity of the EEIG should benefit from the cost sharing exemption, such that the exemption would apply to the costs passed on by the EEIG. The Polish tax authorities disagreed, arguing that the condition regarding distortion of competition would not be met.

Decision of the ECJ

In both cases, the ECJ has essentially ignored the specific questions raised by the domestic courts. Instead, the court has considered the general scope of the cost sharing exemption as necessary preliminary point and determined the appeals on that point instead.

In particular, in both cases, the court noted that the exemption in Article 132(1)(f) is contained in a part of the VAT Directive entitled “Exemptions for certain activities in the public interest”. Therefore, as a preliminary point, the exemption should be limited to activities carried out in the public interest. This analysis was borne out by a review of the purpose of Article 132. This was to facilitate certain activities in the public interest by ensuring that those activities could gain access to certain services and goods by avoiding increased costs that would result if they were subject to VAT.

Therefore, it was clear that this exemption had no application in relation to activities which were normal economic activities (such as insurance or other financial services), which do not constitute an activity in the public interest.

Limitation to certain professions

In a separate case (European Commission v Germany (Case C-616/15)), the court has upheld infraction proceedings by the EU Commission against Germany in relation to the scope of the exemption. The EU Commission argued that the German rules which restricted the exemption to activities in the health care sector only were contrary to EU law. The ECJ has again upheld the Commission’s complaint, whilst, again, emphasising that it is only IGPs which carry on activities in the public interest that are entitled to benefit from the exemption.

Comment

The decision will come as a surprise in many Member States where the exemption has been adopted much more widely than in relation to charities and other public benefit activities. That includes the UK which only formally adopted the provision in 2012 but does not in any way limit its application (other than by reference to the distortion of competition condition) to public benefit activities.

However, in the short term, it should be noted that Member States are not entitled to apply “direct effect” of Community provisions against their citizens where domestic law has been adopted which is more advantageous. Therefore, unless and until a Member State changes domestic law to limit the application of the exemption to public benefit activities, taxpayers will, in principle, be entitled to rely on the wider provisions of domestic law to apply the exemption.