TOGCs, VAT and composite transactions

The AG has opined that a composite transaction under which a person transfers their business to a partnership, via separate transfers of 50% of that business to two individuals who then contribute their shares to that partnership, should not qualify as a TOGC for VAT purposes: DB v Dyrektor Krajowej Informacji Skarbowej (Case T-366/25). The AG comes down on the side of applying the VAT system to the individual elements of the transaction rather than the transaction as a whole, citing risk of abuse and difficulties of where to draw the line if applying a composite transaction approach.

Background

In this case, a person who carried on a taxable business wanted to transfer that business to her two daughters to continue carrying it on in partnership. It was proposed that 50% of the business be transferred to each daughter who would then contribute their share into a partnership which would carry on the business. A VAT ruling was sought from the Polish tax authorities that this would qualify as a TOGC, but the tax authority took the view that since each daughter would only receive part of the business (and each part could not be separately carried on) the conditions for a TOGC were not met. In addition, the tax authority noted that the business would not ultimately be carried on by the daughters themselves but a third party, the partnership.

The taxpayers appealed that ruling and the local courts have referred the question to the CJEU.

AG opinion

The AG first notes that the language of Article 19 of the Principal VAT Directive refers to "transferor" and "person to whom the goods are transferred" both in the singular. From this, the AG concludes that the TOGC provisions are not intended to apply where there is a supply by a number of transferors or where there is a supply to a number of transferees. The AG considered that a teleological consideration of the provision confirms that the use of the singular is a deliberate choice on the part of the legislature.

Therefore, if an analysis is done on an individual transaction basis in this case, then it is clear that the transaction(s) do not qualify as a TOGC. The transfer is to the two daughters separately and individually they are not able to carry on the business or part of the business transferred. The fact that they hold 100% of the business between them and therefore between them carry on the business is not sufficient to bring them within the provisions of Article 19.

However, the AG also considers whether it might be possible to adopt a "joint analysis" of the transactions on the basis that to view them as a composite might be more natural and more consistent with the economic reality. The AG notes that the concept of "economic reality" has not been defined but concludes that "the aim of that concept is to avoid adopting a merely formalistic approach to transactions and to see them for what they really are and the effects which they produce, taking into account the aims of the business community". The AG appears to accept that this would be a possible approach, though warns the Court that, if it should adopt such an approach, it should set out clear limits focussing on the timing of the transactions in order to limit the risks of abuse. The AG suggests that there should be no possibility that the intermediate transactions and not the later transactions occur.

In weighing up the two approaches, however, the AG falls clearly on the side of applying the VAT rules to each element of the transaction separately. "While the second option is not without its allure and even appeared to me, at first sight, to be the most logical one, it does not succeed in overcoming certain reservations and, therefore, even taking into account the temporal nature of the succession of transactions, fails to win my full conviction." The AG notes that if such an approach were made conditional on an immediate onward transfer to the partnership, the question would inevitably arise as to what counts as "immediate". The AG also notes that the Court has held that requiring tax authorities to carry out inquiries to determine the intention of a taxable person would be contrary to the objectives of the VAT system and that it is open to the taxpayers in this case simply to transfer the business assets directly to the partnership. Accordingly, the AG concludes that "while the concept of 'economic reality' is intended to focus on the effects of transactions rather than on their form, it cannot be relied on in such a way as to favour the intention of the parties over the consequences of the specific choices they made".

Comment

The CJEU has in the past used the concept of economic reality to apply the VAT system to formally separate transactions as a composite whole. For example, in Mydibel SA v Belgium (Case C201/18) the Court held that a sale a leaseback transaction may be regarded as a single transaction for the purposes of determining whether a person has disposed of property in the context of the operation of the capital goods scheme. Accordingly, there is certainly precedent for applying VAT rules to composite elements of a scheme and the question is whether applying it in this case to several steps which lead to the continuation of the business in the partnership stretches the principle too far.

Several of the AG's objections in this case appear to be focussed on the fact that this is an appeal against an advance ruling, such that the transaction might not actually take place as envisaged. These objections would have less force where the transactions had already taken place (but in any event there seems no reason in principle why any clearance should not be conditional on the transactions taking place as envisaged).

In addition, the assumption in this case appears to be that the partnership is a separate legal entity from the two individuals.

Ultimately, it will be interesting to see which way the CJEU leans in this case. Will it extend its approach to composite transactions set out in the Mydibel case or will it decide that applying that approach to several transactions involving (potentially) multiple entities is a step too far.

On the particular scenario, it is also worth noting that different jurisdictions may take different approaches to the status of partnerships and it may be that the transfer to the two individuals to carry on the business in partnership might automatically result in (essentially) the transfer of the business directly into partnership, avoiding the intermediate steps in this case.