VAT Deduction Rights for SGPS Holding Companies – CAAD Arbitration 269/2017-T

ARBITRAL DECISION

The arbitrators constituting this Collective Tribunal agree:

I – REPORT

"A… SGPS S.A.", hereinafter referred to simply as "A…" or "Applicant", holder of the taxpayer identification number…, with registered address at Avenue…, no. …, in …, pursuant to the provisions of paragraph a) of article 2.º, paragraph a) of article 5.º, paragraph a) of article 6.º, and articles 10.º et seq. of Decree-Law no. 10/2011, of 20 January, filed a request for the constitution of a Collective Tribunal with a view to obtaining an arbitral decision declaring the illegality and corresponding annulment of the Value Added Tax ("VAT") assessment for the period 2016/06T, identified under no. 2016…, and the demonstration of interest assessment (copies of which are attached under Document no. 1), supported by the VAT correction in the amount of €218,500, and corresponding legal consequences.

The respondent is the Tax and Customs Authority (hereinafter also referred to as "Respondent" or "TA").

The request for constitution of the arbitral tribunal was accepted by His Excellency the President of CAAD and automatically notified to the Respondent.

Pursuant to the provisions of paragraph a) of article 6.º and paragraph b) of article 11.º of Decree-Law no. 10/2011, of 20 January, as amended by article 228.º of Law no. 66-B/2012, of 31 December, the Deontological Council of CAAD designated the signatories to constitute the collective arbitral tribunal, who communicated acceptance of the appointment within the applicable terms and time period.

The Parties were duly notified of such designation and did not manifest any intention to refuse it, pursuant to the provisions of article 11.º, paragraph 1, sub-paragraphs a) and b) of the RJAT, combined with articles 6.º and 7.º of the Deontological Code.

In conformity with the provision of paragraph c), paragraph 1, of article 11.º of the RJAT, the Arbitral Tribunal was constituted on 28-6-2017.

To substantiate the request, the Applicant alleges, in essence and in summary, the following:

The Applicant is engaged in the activities of management of non-financial social participations (CAE 064202) and business consulting and management (CAE 70220).

During the year 2016, the Applicant was subject to an external audit action, of partial scope, in the field of VAT, by the Tax Inspection Services of the Financial Office of …, accredited by the number OI2016…, as may be verified through analysis of the Tax Inspection Report ("Report") attached under Document no. 2, the contents of which are hereby fully reproduced.

Following the aforementioned audit action, the TA proposed corrections of a purely arithmetic nature, having determined tax due, relating to the VAT period 2016/06T, in the amount of €218,500.00 – cf. Doc. no. 2.

In this regard, and given that the Applicant presented, as a tax credit, in the aforementioned taxation period, the amount of €186,375.14, the tax correction proposed by the TA, in the amount of €218,500.00, resulted in the cancellation of the tax credit held by the Applicant and in the issuance of an additional VAT assessment for the amount of €32,124.86 – cf. Doc. no. 1.

The materialization of the correction proposed by the TA – cancellation of the tax credit held by the Applicant and issuance of an additional VAT assessment for the remaining amount owed, rather than the sole issuance of an additional VAT assessment for the total amount of corrections – results from the mechanics associated with the operation of VAT, which permits the TA to cancel the entire credit of the taxpayer for payment of part of the tax owed, with the additional tax assessment being merely a consequential act of the corrections made during the audit.

According to the Tax Inspection Report (cf. Doc. no. 2), the correction proposed by the TA was based on the understanding that the Applicant has no right to deduct the VAT comprised in invoice no. … 030/300016256, issued by "B…, S.A." (hereinafter, simply, "B…"), relating to the acquisition of advisory services in the amount of €1,168,500.00 (VAT included at the rate of 23%) (Doc 4, with the initial petition).

The aforementioned acquisition of services, carried out by the Applicant from B…, which resulted in the issuance of the aforementioned invoice – whose VAT was not accepted as deductible by the TA – is based on a contract executed on 22 April 2015, between these two entities and through which the parties defined different terms and objectives, divided into various phases (Cf. Doc 5, with the petition).

Under the terms of that contract, the Applicant and B… defined as the presuppositions thereof, among others, "the financial restructuring of the Group with the objective of (i) improving current financing conditions; (ii) reducing debt levels and (iii) optimizing capital structure taking into consideration the expansion plan defined by the Management Team and the target dividend policy ("Optimization of Capital Structure")" – (cf. cited Doc. no. 5).

The parties further defined that "(...)subsequently, the Client considers the possibility of opening the capital through the sale of a percentage of the share capital of C… or A… ("Opening of Capital" or "Transaction")" – cf. Doc. no. 5 (emphasis by the Applicant).

Having regard to the broad scope of the work to be developed by B…, the aforementioned contract was divided into the following distinct and independent work phases:

Phase A) Acquisition of minority shareholders' participation;

Phase B) Optimization of capital structure;

Phase C) Opening of capital;

Phase C.1) Preliminary value analysis;

Phase C.2) Indicative offer(s) analysis;

Phase C.3) Due diligence process coordination;

Phase C.4) Negotiation of contracts and closing – cf. Doc. no. 5

Each of the designated phases comprised the performance of different tasks by B…, in conformity with the objectives that each of the phases aimed to achieve.

In the appraisal made by the TA in the tax inspection report, "the contract letter of 2015-04-22, executed between B… and A…, provides for the provision of advisory services namely in the acquisition by A… of the 15% of C… in the possession of minority shareholders so as to become holder of 100% of the capital in order to immediately effect the sale of 50% to a third entity, D…".[1]

Continuing, the TA states that "The outputs generated by the acquisition of this social participation (the 15% of C…) are, in this particular case, the obtaining of capital gains, which as we already know, are not subject to VAT, whereby the tax supported on expenses relating to inputs is not deductible pursuant to article 20.º of the VAT Code.".

And further, "Given what is set out in the preceding points, the tax incurred on the expenses in question cannot be deductible since they are not inputs of the taxed activity, given that the said expenses are connected with an investment of a financial nature, whose outputs will necessarily consist of capital gains resulting from the mere acquisition and disposal of social participations, not meeting the requirements provided in articles 19.º, 20.º in the VAT Code.".

Finally, the TA concludes: "Based on the procedures adopted for validation of the tax assessed and the tax deducted in the period under analysis, a situation of improper tax deduction was detected in the amount of €218,500.00".

The understanding propounded by the TA, to the effect that the Applicant cannot deduct the VAT included in the invoice issued by B…, resulted in the issuance of the aforementioned additional VAT assessment, whose legality is here contested.

The Applicant disagrees absolutely with the understanding adopted by the TA, which calls into question the deductibility of the VAT supported through expenses incurred within the scope of its activity.

Without waiving the right to contest the aforementioned assessment, pursuant to article 9.º of the General Tax Law, the Applicant proceeded to its payment – cf. payment proofs attached as Document no. 6.

The understanding proposed by the TA in the Tax Inspection Report and materialized in the additional VAT assessment issued by the TA is illegal, due to violation of the Applicant's right to deduction, as a mixed subject of this tax.

The Applicant considers the VAT assessment object of the present request invalid for:

Error in the interpretation and application of articles 19.º, 20.º, 22.º and 23.º, all of the VAT Code.

Violation of the principles of pursuit of material truth and of the investigative duty within the scope of the audit procedure, as provided in article 6.º (principle of material truth) of the Complementary Tax Audit Procedure Regime (RCPIT), article 58.º of the GTL (principle of investigative duty), sub-paragraph e) of article 69.º of the CPTA (principle of investigative duty), and article 104.º (supplementary measures) of the Code of Administrative Procedure (CPA);

Violation of the principle of proportionality to which the Tax Authority is bound under article 266.º of the Constitution and article 55.º of the GTL.

Violation of the principle of VAT neutrality underlying Directive 2006/112/CE.

The Applicant accordingly requests:

The annulment of the VAT assessment demonstration for the period 2016.06T, identified under no. 2016…, as well as of the corresponding interest assessment demonstration with all other legal consequences and, accordingly, the reimbursement of the tax improperly paid, plus compensatory interest at the legal rate in force, with the corrections that served as their basis, in the amount of €218,500, being considered illegal and annulled.

Alternatively, the Applicant requests the annulment of the VAT assessment demonstration for the period 2016.06T, identified under no. 2016…, as well as of the corresponding interest assessment demonstration with all other legal consequences and, accordingly, the reimbursement of the tax improperly paid, plus compensatory interest at the legal rate in force, with the corrections that served as their basis, in the part corresponding to €86,213.43, being considered illegal and annulled.

Requests the referral for a preliminary ruling to the CJEU, pursuant to article 267.º of the TFEU, with the consequent suspension of the present proceedings, pursuant to article 272.º paragraph 1 of the CPC.

The Respondent (TA) filed a Response, in which it defends by way of objection, referring to what is contained in the audit report for the establishment of the facts.

Thus, the TA considers that:

The taxpayer is registered at AVENUE …, …, …, … (belonging to the Financial Office of …), and commenced activity on 2008-10-20. Its main activity is "Non-Financial Social Participations Management Company" (CAE 064202) and secondary activity "Other Business and Management Consulting Activities" (CAE 70220).

A… provides social participation management services to other companies and management and administration services to its subsidiaries.

For VAT purposes, the taxpayer is subject to the normal scheme with quarterly periodicity, applying the real allocation method (mixed subject).

The tax inspection services proceeded with the following classification:

"III.1.3. VAT Deducted

Risk analysis of deducted VAT

The total VAT deducted by the company in the period analyzed is €219,886.93, of which €218,500.00 relate to a single invoice, issued by B…, NIPC … (Annex 1).

A… was holder of 85% of the share capital of C…, SA, NIPC …, owner of the Portuguese clothing brand E… . The remaining 15% was held by minority shareholders. In 2016, A… agreed with the F… group the sale of 50% of C… .

In 2014, with the objective of selling part of the financial participation in C…, A… executed a contract for the provision of advisory services with B… (Annex 2).

This contract comprised B…'s collaboration in the following points:

Acquisition of minority shareholders' participation;

Optimization of capital structure (financing needs);

Opening of capital (analysis of offers, contract negotiation, etc).

The contract establishes as fees, among other values, percentages on funds received by A… and on the amount of refinanced bank debt. It is also stated that VAT is added to the aforementioned fees.

Once the contract between A… and D… was executed, on 2016-06-16, B… issued invoice no. … 030/300016256 in the amount of €950,000.00, to which VAT at the rate of 23% is added, in the amount of €218,500.00.

In the annex a demonstration is made of the calculation of the invoiced amounts:

1.25% on funds received, €991,139;

0.40% on the refinanced amount, €220,000;

Discount 22%, €261,139."

The general principles underlying the exercise of the right to deduct VAT supported by taxpayers of the tax are provided in articles 19.º and 20.º of the VAT Code, from which it results that for VAT supported in acquisitions of goods and services to be deductible, these must have a direct and immediate relationship with downstream operations that confer that right.

In the case here under analysis, the contract letter of 2015-04-22, executed between B… and A…, provides for the provision of advisory services namely in the acquisition by A… of the 15% of C… in the possession of minority shareholders so as to become holder of 100% of the capital in order to immediately effect the sale of 50% to a third entity, D…

The outputs generated by the acquisition of this social participation (the 15% of C…) are, in this particular case, the obtaining of capital gains, which as we already know, are not subject to VAT, whereby the tax supported on expenses relating to inputs is not deductible pursuant to article 20.º of the VAT Code.

The same applies to the other objective of the contract, also provided in the aforementioned contract letter, which is translated into the possibility of the "sale of a percentage of the share capital of C…", which indeed came to be realized. That is, the sale of part of the capital gives rise to the obtaining of capital gains, not subject to VAT, whereby the tax supported on expenses, namely on advisory services, is similarly not deductible pursuant to article 20.º of the VAT Code.

the tax credit results from the deduction of VAT supported in the acquisition of advisory services from B… which has as its objective the preparation/mediation/negotiation/execution of the contract for the sale of part of the capital of C… to the F… group.

The acquisition of these advisory services had as its final objective the sale of 50% of the social participation of C…, which indeed came to be realized. The revenue associated with this type of operation is the capital gain, which as we have seen, does not fit the concept of economic activity for VAT purposes, hence it is not possible to deduct the tax supported in such expenses.

The same results from the application of the real allocation method, which the company adopted, whereby the VAT supported in the acquisition of goods/services exclusively allocated to operations not arising from an economic activity, cannot be subject to deduction.

Given what is set out in the preceding points, the tax incurred on the expenses in question cannot be deductible since they are not inputs of the taxed activity, given that the said expenses are connected with an investment of a financial nature, whose outputs will necessarily consist of capital gains resulting from the mere acquisition and disposal of social participations, not meeting the requirements provided in articles 19.º, 20.º in the VAT Code.

Based on the procedures adopted for validation of the tax assessed and the tax deducted in the period under analysis, a situation of improper tax deduction was detected in the amount of €218,500.00.

The Applicant was notified by registered mail, through official document no.…, of 2016-10-11, to exercise the right of hearing, however the same was not exercised.

In this way the draft report was converted into a final report, and consequently the additional VAT assessment here contested was issued.

II. PROCEDURAL RULING

The Tribunal is competent.

The request for arbitral decision was presented in a timely manner.

No exceptions were raised.

The Parties have legal personality and capacity, are legitimate as to the request for arbitral decision and are duly represented, pursuant to the provisions of articles 4.º and 10.º of the RJAT and article 1.º of Order no. 112-A/2011, of 22 March.

The Tribunal decided, with proper grounds, with the agreement of the parties, to extend the period for rendering decision provided for in article 21º-1 of the RJAT, in light of paragraph 2 thereof (cf. decision of 18-12-2017)

No nullities are verified, whereby it is necessary to proceed to the merits.

III. GROUNDS

The Facts

A - Facts Established

The Tribunal considers the following facts to be established:

The commercial company Applicant was notified of the additional VAT assessment no. 2016…, relating to the period "201606T", with tax to be paid in the amount of €32,124.86 and of the consequent compensatory interest assessment in the amount of €331.77 (assessment no. 2016… of 11-11-2016);

The Applicant proceeded to the payment of the assessment of €32,124.86 on 10 January 2017 (Doc 6, with the petition);

This assessment was calculated [purely arithmetic corrections] within the scope of a TA audit procedure [Service Order OI2016…];

The VAT correction proposed by the TA within the scope of that audit procedure gave rise to the cancellation of the tax credit held by the Applicant and in the issuance of the additional VAT assessment in the aforementioned amount of €32,124.86;

The classification of the situation made by the TA Inspection Services was, as results from the respective "Report", as follows (transcribing in essence):

"III.1.3. VAT Deducted

Risk analysis of deducted VAT

The total VAT deducted by the company in the period analyzed is €219,886.93, of which €218,500.00 relate to a single invoice, issued by B…, NIPC … (Annex 1).

A… was holder of 85% of the share capital of C…, SA, NIPC…, owner of the Portuguese clothing brand E… . The remaining 15% was held by minority shareholders. In 2016, A… agreed with the F… group the sale of 50% of C… .

In 2014, with the objective of selling part of the financial participation in C…, A… executed a contract for the provision of advisory services with B… (Annex 2).

This contract comprised B…'s collaboration in the following points:

Acquisition of minority shareholders' participation;

Optimization of capital structure (financing needs);

Opening of capital (analysis of offers, contract negotiation, etc).

The contract establishes as fees, among other values, percentages on funds received by B… and on the amount of refinanced bank debt. It is also stated that VAT is added to the aforementioned fees.

Once the contract between B… and D… was executed, on 2016-06-16, B… issued invoice no. … 030/300016256 in the amount of €950,000.00, to which VAT at the rate of 23% is added, in the amount of €218,500.00.

In the annex a demonstration is made of the calculation of the invoiced amounts:

1.25% on funds received, €991,139;

0.40% on the refinanced amount, €220,000;

Discount 22%, €261,139."

The Applicant has as its business objective activities of non-financial social participation management and business and management consulting;

The aforementioned acquisition of services, carried out by the Applicant from the commercial company B…, SA (abbreviated and subsequently "B…"), which resulted in the issuance of the invoice mentioned below, in r) - whose VAT was not accepted as deductible by the TA - is based on a contract for the provision of services executed on 22 April 2015, between these two entities, through which the parties defined different terms and objectives, divided into the phases mentioned below, in l) (Doc 5, with the petition and below, sub-paragraph l);

The Applicant held at that date (2015) 85% of the share capital of C… (commercial company "G…, SA", holder of the brand "E…").

In 2016 the Applicant agreed with a company of the "F…" Group the sale of 50% of C… .

The Applicant and B… had defined as the presuppositions of the aforementioned contract of 22 April 2015, among others, "the financial restructuring of the Group with the objective of (i) improving current financing conditions; (ii) reducing debt levels and (iii) optimizing capital structure taking into consideration the expansion plan defined by the Management Team and the target dividend policy ("Optimization of Capital Structure")" – cf. Doc. no. 5.

The parties further defined that "(...)subsequently, the Client considers the possibility of opening the capital through the sale of a percentage of the share capital of C… or A… ("Opening of Capital" or "Transaction")" – Cf. Doc. no. 5 (emphasis by the Applicant).

Having regard to the broad scope of the work to be developed by B…, the aforementioned contract was divided into the following distinct and independent work phases:

Phase A) - Acquisition of minority shareholders' participation;

Phase B) - Optimization of capital structure;

Phase C) - Opening of capital;

Phase C.1) - Preliminary value analysis;

Phase C.2) - Indicative offer(s) analysis;

Phase C.3) - Due diligence process coordination;

Phase C.4) - Negotiation of contracts and closing – cf. Doc. no. 5

Each of the designated phases comprised the performance of different tasks by B…, in conformity with the objectives that each of the phases aimed to achieve.

In the appraisal made by the TA in the tax inspection report, "the contract letter of 2015-04-22, executed between B… and A…, provides for the provision of advisory services namely in the acquisition by A… of the 15% of C… in the possession of minority shareholders so as to become holder of 100% of the capital in order to immediately effect the sale of 50% to a third entity, D…".[2]

Continuing, the TA states that "(...)the outputs generated by the acquisition of this social participation (the 15% of C…) are, in this particular case, the obtaining of capital gains, which are not subject to VAT, whereby the tax supported on expenses relating to inputs is not deductible pursuant to article 20.º of the VAT Code (...)".

And further, "(...)given what is set out in the preceding points, the tax incurred on the expenses in question cannot be deductible since they are not inputs of the taxed activity, given that the said expenses are connected with an investment of a financial nature, whose outputs will necessarily consist of capital gains resulting from the mere acquisition and disposal of social participations, not meeting the requirements provided in articles 19.º, 20.º in the VAT Code (...)".

Finally, the TA further considers in the aforementioned Report: "(…) Based on the procedures adopted for validation of the tax assessed and the tax deducted in the period under analysis, a situation of improper tax deduction was detected in the amount of €218,500.00 (...)".

Invoice no. 300016256 issued by "B…", in the amount of €1,168,500.00, relates to professional services, of an advisory nature, contracted between that entity and the Applicant;

That remuneration of B… was fixed in accordance with the aforementioned contract letter of 22 April 2015, that is, on the basis of hourly remuneration of 175 Euros, with a maximum of 25,000 Euros (phases A and B) and 1.25% (success remuneration) on shareholder funds withdrawn or received by the Applicant or shareholders plus 0.40% on the amount of refinanced bank debt [Cf. point 3. of the aforementioned contract letter]

The request for arbitral decision was presented to CAAD on 20-4-2017.

B. Facts Not Established

27. It was not established:

That the advisory services mentioned above, in r), had as their object the acquisition of shares from minority shareholders of the Applicant, with a view to enabling it to achieve 100% ownership of the share capital and, subsequently, to effect the sale of 50% of that capital to a third party [to D…] with obtaining of inherent capital gains (not subject to VAT);

That the aforementioned contract for the provision of advisory services with B… had as its object the sale of part of the Applicant's financial participation in C… .

C. Motivation as to Proof

28. The judge (or the arbitrator) does not have the duty to pronounce on all matters alleged, having instead the duty to select only that which is of interest for the decision, taking into consideration the cause (or causes) of action that foundation(s) the claim formulated by the plaintiff (cf. articles 596º, paragraph 1 and 607º, paragraphs 2 to 4, of the Civil Procedure Code, as amended by Law no. 41/2013, of 26/6) and to state whether it considers it proven or not proven (cf. article 123º, paragraph 2 of the Tax Procedure Code).

According to the principle of free appreciation of evidence, the Tribunal bases its decision, in relation to the evidence produced, on its inner conviction, formed from the examination and evaluation it makes of the means of evidence brought to the proceeding and in accordance with its experience of life and knowledge of people and the world (cf. article 607º, paragraph 5 of the Civil Procedure Code, as amended by Law 41/2013, of 26/6). Only when the probative force of certain means is pre-established in law (e.g., full probative force of authentic documents - cf. article 371º of the Civil Code) does the principle of free appreciation not govern the appreciation of the evidence produced.

In this case, the Tribunal formed its conviction based on the critical analysis of the documents presented by the parties and which were not challenged, on the copy of the administrative proceeding brought by the TA and also on the testimony given at the hearing by the witnesses called by the Applicant, H…, administrative and financial manager of the "C…" Group since 2002, who demonstrated direct knowledge of the situation of the present case; I…, Financial Director of the Applicant, who clearly and convincingly declared that the description in B…'s invoice now in question does not have absolute correspondence with reality, although she was unaware of the reasons why it was issued in that manner and that the reasons that led to contracting the advisory services did not have as their objective the sale of the Applicant's social participation in C…; J…, employee (economist/consultant) of B… since October 2015 who explained what services were provided to the Applicant by B…, having never shown any willingness for alienation unless all other alternatives failed. The witness guaranteed that B… never had any involvement in the acquisition of shares from minority shareholders, rather developed work on negotiations with Banks to find financing solutions.

Equally illuminating and credible was also the testimony given by K…, although in the capacity of a party insofar as he is current administrator of the Applicant.

III. GROUNDS (cont)

THE LAW

The subject matter of the present request for arbitral decision is the act of Value Added Tax ("VAT") assessment for the period 2016/06T, identified under no. 2016 … and interest assessment demonstration (Cf. Document no. 1, attached with the initial petition), supported by the VAT correction in the amount of €218,500, and corresponding legal consequences.

The correction proposed by the TA and which gave rise to the aforementioned assessments, is based, in essence, on the understanding that the Applicant has no right to deduct the VAT comprised in an invoice issued by "B…, SA", in the amount of €1,168,500.00, relating to advisory services in execution of a contract executed between this consultant and the Applicant, on 22 April 2015, pursuant to the instrument attached with the petition for arbitral decision under no. 5 and which is hereby reproduced and incorporated;

According to the Applicant, the VAT assessment object of the present request would be invalid for:

Error in the interpretation and application of articles 19.º, 20.º, 22.º and 23.º, all of the VAT Code.

Violation of the principles of pursuit of material truth and of the investigative duty within the scope of the audit procedure, as provided in article 6.º (principle of material truth) of the Complementary Tax Audit Procedure Regime (RCPIT), article 58.º of the GTL (principle of investigative duty), sub-paragraph e) of article 69.º of the CPTA (principle of investigative duty), and article 104.º (supplementary measures) of the Code of Administrative Procedure (CPA);

Violation of the principle of proportionality to which the Tax Authority is bound under article 266.º of the Constitution and article 55.º of the GTL.

Violation of the principle of VAT neutrality underlying Directive 2006/112/CE.

It is thus important to determine whether the corrections made, which gave rise to the additional VAT assessments and compensatory interest, are in accordance with the rules governing this tax at European and domestic level, whether the exercise of the right to deduct the tax supported relating to the expenses in question should (or should not) be accepted, a nuclear issue in these proceedings.

In this context, the considerations previously made by this Tribunal in similar questions brought for appraisal will be followed closely, namely in Proceedings no. 16/2016– T/CAAD, no. 148/2012 - T/CAAD, no. 18/2013 – T/CAAD nos 15/2015 – T/CAAD and 179/2016-T[3] and 178/2016-T.

Of the Nature and Scope of Exercise of the Right to Deduction

With regard to the exercise of the right to deduction in VAT, some preliminary considerations are warranted, both regarding its nature and concerning its scope of application and exercise by taxpayers.

As is well known, VAT is an indirect tax of community origin, multiphase, which tends to affect all acts of consumption[4]. The right to deduction is an essential element of the operation of the tax, and must guarantee its characteristic of neutrality and non-cumulative taxation.

In reality, the right to deduction is consubstantiated as the essential element of the operation of the tax, the "cornerstone of the value added tax system"[5], based on the so-called method of tax deduction, the tax credit method, the indirect subtractive method or also the invoice method. In accordance with this method, and in conformity with article 19.º of the VAT Code, through an arithmetic operation of subtraction, the tax calculated on sales and provision of services (outputs) and identifiable in the respective invoices is deducted from the tax supported on purchases and other expenses (inputs).

As determined by the second paragraph of paragraph 2 of article 1.º of the VAT Directive (hereinafter VAT Directive)[6], "in each transaction, the VAT, calculated on the price of the good or service, shall be exigible, with prior deduction of the amount of the tax that has directly burdened the cost of the various elements making up the price." The mechanism of exercise of the right to deduction permits the taxpayer to eliminate from its burden the VAT supported upstream, thus not reflecting it as an operational cost of its activity, thereby removing the cumulative or cascade effect, providing economic neutrality of the tax.

In accordance with the VAT Directive, the VAT Code establishes, as a general rule, the deductibility of the tax due or paid by the taxpayer in acquisitions of goods and services made from other taxpayers.

The express situations of exclusion from the right to deduction are exceptional and refer to specific cases enumerated by the national legislator in exhaustive terms, in accordance with what is established in the VAT Directive, depending on the type of expenses in question[7].

The rules governing the exercise of the right to deduct the tax contemplate objective requirements, more linked to the type of expenses, subjective requirements, relating to the taxpayer, and temporal requirements, concerning the period in which it is possible to exercise the right to deduct VAT, which must be verified simultaneously to exercise such right[8].

As objective requirements for exercise of the right to deduct the tax we have, namely, the fact that the VAT supported must be stated in an invoice in the name and in the possession of the taxpayer and issued in legal form (that is, it must comply with, in its requirements, the general terms provided in article 36.º, paragraph 5 or article 40º, paragraph 2, both of the VAT Code), that it is Portuguese VAT, and that the expense itself confers the right to deduct VAT (that is, it should not be an expense excluded from the right to deduction, pursuant to article 21.º of the VAT Code).

As subjective requirements for exercise of the right to deduct the tax it is determined, namely, that the goods and services must be directly related to the exercise of the activity in question. In conformity with article 168.º of the VAT Directive, transposed in part by article 20.º, paragraph 1, sub-paragraph a), of the VAT Code, the taxpayer may deduct the VAT supported in the Member State where it is established in transmissions of goods and provision of services, as well as in operations assimilated in intra-community acquisitions of goods and imports located there, "(...)when the goods and services are used for the purposes of its taxed operations (…) ".

This provision, in conformity with the rules of European Union law, thus requires that there be a nexus of causality between the good or service acquired (input) and the taxed output, for the VAT to be susceptible of being deductible.

That is, the VAT supported upstream in a given operation is only deductible insofar as it may be related downstream to an effectively taxed operation, and the relationship must be assessed based on the inclusion and incorporation of the cost supported in the price of the taxed operation.

In this context the CJEU, in the BLP Case[9], concluded that the goods or services upstream must present a direct and immediate relationship with one or several operations subject to tax downstream, and that the right to deduct VAT presupposes that the expenses in question must form an integral part of the constituent elements of the price of the taxed operations.

Inevitably, the analysis of the scope of that expression " (…) direct and immediate relationship (…)", must be carried out on a case-by-case basis, and it is incumbent on the national judicial bodies to apply the criterion to the facts of each case brought before them and to take into consideration all the circumstances in which the operations in question are conducted[10].

Nevertheless, as concluded by the Advocate General in the Midland Bank Case, the use of the two adjectives "direct" and "immediate" cannot but mean a particularly close relationship between the taxable operations carried out by a taxpayer and the goods or services provided by another taxpayer[11].

However, the density of that relationship may differ depending on the quality of the taxpayer and the nature of the operations carried out, and these variables may also have repercussions on the burden of proof of the existence of the relationship, which falls on the operator interested in the deduction.

Thus, according to CJEU jurisprudence, whenever a taxpayer pursues economic activities aimed at carrying out exclusively taxable operations, it is not necessary, in order to be able to deduct the tax in its entirety, to establish, for each upstream operation, the existence of a direct and immediate relationship with the specific taxable operation[12].

What the legislator merely requires is that the goods and services be used or be susceptible of being used "for the purposes of the taxpayer's own taxable operations". It is not necessary that there be a relationship with a specific taxable operation, being sufficient that there be a relationship with the company's activity.

As for the adjective "immediate", this denotes great temporal proximity between the two operations. However, this does not mean that the tax on the upstream operation must become exigible before the downstream operation has been carried out: it is sufficient that the period of time between the two operations is not excessively long, a fact that reinforces the financial character of the deduction.

Thus, in a first phase, one must determine whether the upstream operation subject to VAT presents a direct and immediate relationship with one or several operations that confer the right to deduction, presupposing the inclusion of its cost in the price of the operations.

If this is not the case, it is then important to analyze whether the expenses incurred for the acquisition of goods or services upstream form part of the general expenses linked to the whole of the taxpayer's economic activity, presupposing the incorporation of their cost in the prices of the goods or services supplied by the taxpayer in the scope of its economic activities.

Lastly, as a requirement for exercise of the right to deduction we have the temporal requirement, whereby "The right to deduction arises at the moment when the deductible tax becomes exigible", remaining, however, the cumulative requirement of possession of the invoice or receipt of payment of VAT that forms part of import declarations.

For its part, in accordance with the rules of paragraph 1 of article 19.º of the VAT Code, it is stipulated that the right to deduction is conferred, namely, by the tax due or paid by the taxpayer in acquisitions of goods and services made from other taxpayers and the tax paid for the acquisition of services referred to in sub-paragraphs e), h), i), j) and l) of paragraph 1 of article 2.º of the VAT Code.

In conformity with paragraph 1 of article 20.º of the VAT Code, confer, namely, the right to deduct VAT the transmissions of goods and provision of services subject to tax and not exempted therefrom, and the transmissions of goods and provision of services that consist of operations carried out abroad which would be taxable if carried out in Portugal.

It is recognized unanimously by CJEU jurisprudence that the mechanism of the right to deduction is an essential element of the operation of VAT as it was designed in the VAT Directives, assuming a fundamental role in guaranteeing the neutrality of the tax and the equality of fiscal treatment[13]. Thus, it is settled jurisprudence of the CJEU that, being the right to deduction a fundamental element of the VAT regime, it is only possible to limit this right in cases expressly provided for by the VAT Directive, and even then, with respect for the principles of proportionality and equality, and it is not possible to empty the common VAT system of its content.

As emphasized in the BP Soupergaz Decision, the so-called indirect subtractive method, of invoices, of tax credit or system of fractional payments, is the essential mechanism of operation of this type of tax. As referred to in the conclusions of this Decision, "(...)In this regard, the right to deduction provided for in articles 17 et seq. of the Sixth Directive, which forms an integral part of the mechanism of value added tax, cannot, in principle, be limited and is exercised immediately in relation to the totality of the taxes that have burdened the operations carried out upstream, has an impact at the level of the fiscal burden and must be applied similarly in all Member States, so that only derogations expressly provided for by the directive are permitted (...)" [14].

And in the Commission/France Decision, the CJEU adds that, "The characteristics of value added tax (…) allow us to infer that the deduction regime is aimed at entirely freeing the entrepreneur from the burden of VAT, due or paid, within the scope of all his economic activities. The common system of value added tax thus guarantees perfect neutrality as to the fiscal burden of all economic activities, whatever the purposes or results of such activities, provided that such activities are themselves subject to VAT" [15].

It should also be noted that, as emphasized in the Metropol Decision, " (...)the provisions that provide for derogations to the principle of the right to deduct VAT, which guarantees the neutrality of this tax, are to be interpreted strictly(...)" [16].

The scope of the right to deduction in VAT is so broad that it is clear jurisprudence of the CJEU that this should even be granted with respect to so-called preparatory activities, not requiring that the activity has already begun for VAT to be deductible, being able to be deducted with respect to this type of activities[17].

It should be noted in this regard that, according to the CJEU's understanding, a position that has already been subscribed to by the Tax Administration[18], the right to deduction, once acquired, subsists even if the projected economic activity does not give rise to taxable operations or the taxpayer, for reasons beyond its control, has not been able to use the goods or services that gave rise to the deduction within the scope of taxable operations[19].

As the CJEU emphasizes, it is the acquisition of the good by the taxpayer, acting in that capacity, that determines the application of the VAT system and therefore the mechanism of deduction[20]. The taxpayer acts in that capacity when acting for the purposes of its economic activity, within the meaning of article 9.º, paragraph 1, second paragraph of the VAT Directive[21]. Moreover, as concluded in the Intiem Case, the mechanism of VAT deduction regulated by the Sixth Directive "must be applied in such a way that its scope of application corresponds, as far as possible, to the scope of the professional activities of the taxpayer"[22].

That is, as the CJEU notes, the principle of VAT neutrality, as regards the fiscal burden on the company, requires that investment expenses incurred for the needs and purposes of a company be considered economic activities conferring an immediate right to VAT deduction[23].

It is also important to note that, in conformity with CJEU jurisprudence, the principle of VAT neutrality requires that the deduction of tax paid upstream be granted if the substantial requirements have been met, even if the taxpayers have neglected certain formal requirements. In this context, according to the CJEU, as long as the Tax Administration has the necessary data to determine that the taxpayer, as the recipient of the operations, is the debtor of VAT, it cannot impose, as regards its right to deduction, additional conditions that may have the effect of making the absolute exercise of that right impossible[24].

In summary, from CJEU jurisprudence it is clear that the exercise of the right to deduct VAT is a fundamental right, which cannot be limited except in cases expressly permitted by the rules of European Union Law or by the general principles of law accepted in this field, such as the principle of abuse of right.

The Legal Regime of SGPS and VAT – Some Notes

The concept of holding company is generally used to refer both to companies that limit themselves to passively managing portfolios of securities, in a logic of risk distribution, and to companies that hold controlling participations and that actively intervene in the management of their subsidiaries, providing or not remunerated services to them.

It is customary to distinguish, among other modalities, between the pure holding and the mixed holding and between the financial holding and the management holding. In the first case, the distinguishing criterion lies in the exclusive character of its business purpose, whereby the pure holding dedicates itself solely to the holding of social participations and the mixed holding also has as its purpose activities of a commercial and industrial nature. In the second case, the differentiating criterion lies in the purpose to which the management of social participations is directed, whereby the management holding aims, more than the mere holding of social participations, at the framing and direction of the subsidiary companies, whereas the financial holding is aimed only at the profitability of the investment concentrated in the participations.

With regard to SGPS, we find its legal regime defined in Decree-Law no. 495/88, of 30 December – successively amended by Decree-Law no. 318/94, of 24 December, by Decree-Law no. 378/98, of 27 November and by Law no. 109-B/21, of 27 December – which provides in its article 1.º that SGPS "have as their sole contractual object the management of social participations in other companies as an indirect form of exercise of economic activities" (paragraph 1), with "participation in a company being considered an indirect form of exercise of the economic activity thereof when it does not have an occasional character and reaches at least 10% of the capital with voting rights of the subsidiary company, either alone or through participations of other companies in which the SGPS is dominant" (paragraph 2), considering itself "that the participation does not have an occasional character when it is held by the SGPS for a period exceeding one year" (paragraph 3).

Pursuant to article 4.º of the same legal instrument, SGPS are permitted "the provision of technical administration and management services to all or some of the companies in which they hold participations or with which they have entered into subordination contracts" (paragraph 1), such provision of services being "subject to a written contract, in which the corresponding remuneration must be identified" (paragraph 2).

In this framework, it is customary to qualify the SGPS as a pure holding – to the extent that it is limited as to its business purpose, pursuant to the provisions referred to above, which prevents it from directly developing economic activities of a commercial, industrial or other nature not mentioned in the aforementioned provision of services – and as a management holding – since its activity goes beyond the mere acquisition, holding and disposal of social participations, being able, complementarily to its main activity, to provide, in certain circumstances, technical administration and management services to all or some of the companies in which it holds participations or with which it has entered into subordination contracts.

In summary, it flows from the legal regime of SGPS that the management of social participations in other companies, as an indirect form of exercise of an economic activity, constitutes the sole business purpose that, legally, any SGPS may have and pursue; this without prejudice to, as we have already said, its respective activity exceeding the simple acquisition, holding and disposal of social participations.

The existence of a direct and immediate relationship between the goods and services acquired and one or several activities of supply of goods or provision of services that confer the right to deduction is, as we have seen previously, as a rule, indispensable for the right to deduct the VAT incurred in goods and services acquired to be recognized to the taxpayer and to determine the extent of that right.

Recently, the CJEU has gone even further in addressing the question of the direct and immediate nexus between the acquisitions and the taxable operations downstream, having in the Sveda decision[25] downplayed the requirement of direct use of the acquisition of goods or services, concluding that only by attending to the ultimate purpose of the acquisition will the rationality and neutrality of the VAT system be achieved. By disregarding the immediate allocation of the input, given its connection to the final objective, the CJEU considers that an indirect nexus is therefore sufficient, provided that it is demonstrated that the inputs integrate the ultimate objective of pursuing an activity that confers the right to deduction or insofar as it confers it.

The CJEU has thus been following the interpretative trend that gives prevalence to neutrality in the VAT system, moving away from restrictive formulas in its concrete application, and for this reason, has emphasized, on several occasions, that the rules of the VAT Directive that provide for limitations on the right to deduction – articles 176.º and 177.º – have an exceptional character within the VAT system, derogating from the principle of neutrality, whereby they must always be subject to strict interpretation[26].

In the national legal system, the VAT Code defines that taxpayers of the tax are, among others, "individuals or legal entities that, in an independent manner and with habituality, carry out activities of production, commerce or provision of services, including extractive, agricultural activities and those of liberal professions, and likewise, those that, in the same independent manner, carry out a single taxable operation, provided that such operation is connected with the exercise of the aforementioned activities, wherever it occurs, or when, independently of such connection, such operation meets the presuppositions of actual incidence of income tax on individuals (IRS) or corporate income tax (IRC)" (article 2.º, paragraph 1, sub-paragraph a)).

On the other hand, we find the right to deduct VAT regulated in articles 19.º to 26.º of the VAT Code, being important to highlight the following provisions here:

"Article 19.º

Right to Deduction

1. For the determination of the tax due, taxpayers deduct, pursuant to the following articles, from the tax levied on taxable operations which they have carried out:

a) The tax due or paid for the acquisition of goods and services from other taxpayers (…)"

"Article 20.º

Operations that Confer the Right to Deduction

1. VAT can only be deducted that has burdened goods or services acquired, imported or used by the taxpayer for carrying out the following operations:

a) Transmissions of goods and provision of services subject to tax and not exempted therefrom;"

"Article 23.º

Methods of Deduction Relating to Goods of Mixed Use

1. When the taxpayer, in the exercise of its activity, carries out operations that confer the right to deduction and operations that do not confer that right, pursuant to article 20.º, the deduction of the VAT supported in the acquisition of goods and services that are used in carrying out both types of operations is determined as follows:

a) In the case of a good or service partially allocated to the carrying out of operations not arising from exercise of an economic activity provided for in sub-paragraph a) of paragraph 1 of article 2.º, the tax not deductible as a result of such partial allocation is determined pursuant to paragraph 2;

b) Without prejudice to the provision in the preceding sub-paragraph, in the case of a good or service allocated to carrying out operations arising from exercise of an economic activity provided for in sub-paragraph a) of paragraph 1 of article 2.º, part of which do not confer the right to deduction, the tax is deductible in the percentage corresponding to the annual amount of operations that give rise to deduction.

2. Notwithstanding the provision in sub-paragraph b) of the preceding paragraph, the taxpayer may carry out deduction according to the real allocation of all or part of the goods and services used, based on objective criteria that allow determining the degree of use of such goods and services in operations that confer the right to deduction and in operations that do not confer that right, without prejudice to the Directorate-General of Taxes being able to impose special conditions on him or to cease this procedure in the event that it is verified that they cause or may cause significant distortions in taxation."

THE CONCEPT OF ECONOMIC ACTIVITY FOR VAT PURPOSES

It follows from article 9.º of the VAT Directive that those who independently pursue an economic activity are generically considered taxpayers of VAT, whatever its purpose or result. Thus, the quality of taxpayer of the tax arises from the carrying out of operations integrated within the scope of the objective incidence of the tax, which, before anything else – that is, before being qualified as transmissions of goods or provision of services – must embody an economic activity.

The exercise of an economic activity thus constitutes the presupposition upon which the subjective and objective incidence of VAT rests. Effectively, no one can be said "taxpayer" who does not carry out an economic activity, nor when this is lacking can we be facing taxable transmissions of goods or provision of services. The delimitation of the notion of economic activity becomes thus an exercise of paramount importance in the application of the tax and a particularly delicate exercise insofar as VAT, as a general consumption tax, possesses a vocation for universality. Whatever constitutes economic activity must be defined in terms as broad as possible, if we are to guarantee neutrality and equality in the tax[27].

Article 9.º of the VAT Directive determines that economic activity should be understood as "any activity of production, commercialization or provision of services, including extractive, agricultural activities and those of liberal professions or equivalent".

This is a notion of economic activity that generically encompasses all production and commerce of goods and any provision of services, whatever their nature. Given such a broad notion of economic activity, the CJEU has been called upon to fix the limits of what should be considered to have or not have economic content.

One of the types of operations whose economic content proves controversial within the VAT system is that relating to operations concerning social participations, which are particularly complex.

The qualification of these operations as economic or not has important consequences in the application of VAT, the most relevant being conditioning the right to deduction.

SGPS AND OPERATIONS RELATING TO SOCIAL PARTICIPATIONS

«The starting point for the classification of social participations under VAT is the Polysar decision, of 1991 [issued on 20 June 1991, in case C-60/90], in which the CJEU establishes the principle that the acquisition and holding of social participations does not represent genuine economic activity. A company that merely acquires and manages social participations does not carry out genuine transmissions of goods nor provision of services but mere applications of capital (…)»

In the eyes of the CJEU, the acquisition and holding of participations can only be said to be economic activity if it involves "direct or indirect interference" in the management of the subsidiaries. Whenever a holding actively intervenes in the management of the subsidiaries, we can say that through them it exercises an economic activity, justifying recognition of the quality of taxpayer and the right to deduct the VAT in which it incurs upstream.

The conditions under which the management of participations can give rise to economic activity would be summarized more in the Harnas & Helm decision, of 1997 [issued on 6 February 1997, in case C-80/95]. In this decision, the CJEU held that these operations embody economic activity when one of three conditions is met: (a) being carried out within the framework of a commercial trading activity in securities; (b) being carried out with a view to ensuring direct or indirect interference in the management of the company in which participation was taken; or (c) constituting the direct, permanent and necessary continuation of a taxable activity. (…)

As regards the holding of participations, we should consider it always an operation devoid of economic content and, for that very reason, outside the field of application of the tax [in this sense, the Sofitam decision (issued on 22 June 1993, in case C-333/91) of the CJEU].

As regards the acquisition of social participations, the CJEU is of the understanding that this does not embody an economic activity for VAT purposes, except for the three conditions that we have already referred to. Certainly, we can also say here that there is economic activity when the acquisition is aimed at "direct or indirect interference" in the management of the subsidiary. If we look at it carefully, however, the scope of the qualification is in this case limited, insofar as the acquisition of participations constitutes a passive operation and not an active operation. The costs incurred with an acquisition of participations – costs with legal or financial consulting, for example – cannot therefore be associated with a specific downstream operation, being able only to be associated with the general activity that the company develops. Those costs are never direct costs but general expenses, similar to the expenses incurred by a company with a view to the acquisition of so many other assets.

Thus, the VAT supported in expenses necessary to an acquisition of participations will be deductible under the general terms, meaning that it will be fully deductible when the taxpayer only carries out taxed operations and partially deductible when the taxpayer, alongside taxed operations, carries out exempt operations [in this sense, the Cibo decision (issued on 27 September 2001, in case C-16/00) of the CJEU]. (…)

The notion that a holding only exercises economic activity when it somehow intervenes in the via of the subsidiaries is reasonably intuitive. The criterion that the CJEU has used [to assess direct or indirect interference in the management of the subsidiaries], however, is that there is intervention only when the parent company carries out taxable provision of services for the benefit of the affiliates, as occurs when it provides them with financing, consulting or computer services.»[28]

Having then, as reference, holding companies in general, the first question to be clarified, in this scope, is whether a holding is or is not a VAT taxpayer, that is, whether it develops or not an economic activity (emphasis ours), being important, for such, to analyze whether, beyond the mere holding of social participations, any activity of provision of services is or is not pursued, namely, to its subsidiaries.

In the case of its action being merely passive, it will be a company that does not exercise an economic activity for VAT purposes, since the dividends and interest it receives constitute mere fruits resulting from the ownership of an asset and not the benefits arising from its economic exploitation, whereby that company cannot be considered a taxpayer for VAT purposes.

If it is a holding company that has active intervention in the management of its subsidiaries, with the result of carrying out taxable outputs, it should be considered as an entity that exercises an economic activity, assuming the quality of VAT taxpayer.

As regards, specifically, SGPS, it is important to note that it flows from its legal regime that its sole business purpose is the management – and not the mere holding – of social participations, which added to the fact that the law itself recognizes its competence for the provision of administration and management services to the subsidiaries, results in the exercise of an economic activity for VAT purposes. Such conclusion is not prevented, effectively, by the fact that its sole business purpose is "the management of social participations in other companies as an indirect form of exercise of economic activities"; which also therefore does not apply, for VAT purposes, to the assessment of the right to deduct VAT, which must therefore be determined in conformity with the general criteria.

This very thing was decided by the CJEU in the Portugal Telecom decision (issued on 6 September 2012, in case C-496/11), in which it concludes that if it is «to be considered that all services acquired upstream have a direct and immediate nexus with downstream economic operations with the right to deduction, the taxpayer in question [an SGPS that, within the scope of the provision of technical administration services to its subsidiaries, re-invoices them, with VAT, the costs incurred with the acquisition of consulting services and others] would have the right, under article 17.º, paragraph 2, of the Sixth Directive, to deduct the entirety of the VAT that has burdened the upstream acquisition of the services in question in the main proceeding. This right to deduction cannot be limited by the mere fact that the national regulation, by reason of the business purpose of the said companies or their general activity, qualifies the taxable operations as accessory to their main activity.»

Refining our analysis further, it is now important to discern whether an SGPS that actively intervenes in the management of its subsidiaries, carrying out taxable operations under VAT, nevertheless carries out operations outside the field of incidence of the tax, with respect to those same social participations.

It is peacefully accepted that holding companies may have a dual status for VAT purposes, that is, they may be taxpayer and end consumer, since they may be involved in taxable activities – namely provision of services to subsidiaries – and in non-economic and therefore non-taxable activity – the mere holding and enjoyment of social participations.

Accordingly, it is important to define in what terms the assessment of the right to deduct VAT should be made, for which there are three possible tests, namely:

(i) Is the VAT supported in inputs directly related to taxable outputs?

This test flows directly from paragraph 2 (second paragraph) of article 1.º of the VAT Directive, which establishes that "in each transaction, the value added tax calculated on the price of the good or service at the rate applicable to that good or service shall be exigible with prior deduction of the amount of the value added tax that has directly burdened the cost of the various elements making up the price".

By way of example, Mariana Gouveia de Oliveira refers that this would be «the case of an SGPS that incurred costs directly related to the provision of services to one of its subsidiaries, for example, with the engagement of a service provider that was strictly allocated to a subsidiary and whose costs were invoiced with VAT to that same subsidiary.

In such cases, it seems to us that there is a direct link between the VAT supported in the inputs and the taxed outputs of the SGPS. The VAT thus supported should be entirely deducted.»[29]

(ii) Is the VAT supported in inputs directly related to one of the economic activities pursued?

Even in cases where there is no direct relationship between the inputs and the taxed outputs, the right to full deduction of VAT may nonetheless be recognized if that direct link is established between the inputs and a clearly delimited set of taxed economic activities.

This very thing was decided by the CJEU in the Abbey National decision (issued on 22 February 2001, in case C-408/98), in which it was held that «if the various services acquired by the transferor in order to carry out the transfer present a direct and immediate relationship with a clearly delimited part of its economic activities, so that the costs of the said services form part of the general expenses inherent to the said part of the company, and that all operations included in that part of the company are subject to value added tax, the said taxpayer may deduct the entirety of the value added tax that has burdened the expenses which he incurred to acquire the said services».

Thus, in such cases, VAT may be deducted provided there is a direct and immediate relationship with the economic activity developed, excluding the right to deduction when it is VAT supported in the exercise of an activity not subject to VAT.

(iii) Is the VAT supported in general costs of economic activity?

In the case where there is no such direct relationship between the inputs and the taxed outputs, it is still important to verify whether the right to deduct VAT should be recognized whenever the expenses incurred with the acquisition of goods and services qualify as general expenses of the activity and integrate the constituent elements of the price of the operations carried out by the taxpayer that confer the right to deduction.

The CJEU addressed this question, specifically regarding services acquired by a holding company (audit services of companies, intervention in the framework of negotiation of the price of acquisition of shares and mounting of the takeover of companies in legal and tax matters), in the Cibo Participations SA decision (issued on 27 September 2001, in case C-16/00), in which it was held that despite there being no direct and immediate relationship between the various services acquired by a holding in the framework of taking a participation in a subsidiary and one or several downstream operations that confer the right to deduction, the costs of the services acquired fall within the general expenses of the taxpayer and are, as such, constituent elements of the price of the products of a company; in that measure, concludes the decision, such services have a direct and immediate relationship with the whole of the taxpayer's activity[30].

In this regard, as emphasized by Mariana Gouveia de Oliveira, the verification of this criterion «must involve a dual analysis: on the one hand the analysis of a functional relationship, i.e., the existence of a functional/causal link between the input and the taxable activity of the taxpayer and, on the other hand, an economic relationship, i.e., a reflection at the level of the price of the outputs», aiming with such simultaneous functional and economic analysis to assess «whether the inputs relate to the "maintenance of the source producing" the taxable activity, similar to the criterion used for purposes of assessing deductible expenses under corporate income tax and whether such costs are susceptible of being reflected in the formation of the prices of the taxable outputs (even if in the specific case, by external vicissitudes, they end up not actually being passed on).»[31]

Sérgio Vasques refers that the «CJEU hesitates between a functional criterion, which looks at the reason for the costs, and an economic criterion, which attends to the impact of the costs on the prices that the taxpayer practices. The CJEU's decisions on social participations, however, show that an economic criterion proves largely inoperative, as it is generally impossible to prove the integration of a cost in the price of goods and services traded by economic operators, dependent on a very varied set of circumstances. The passing on of the cost to prices may, at best, be presumed. And that is why recourse to a functional criterion always proves to be determinant in establishing the nexus with a given passive operation or with the whole of the taxable activities.»[32]

In conclusive summary, we have that an SGPS that dedicates itself to active management of its subsidiaries is an economic operator and a VAT taxpayer (emphasis ours).

In the development of its taxable activity, the SGPS may incur VAT in inputs directly connected with its activity of management of the subsidiaries, as well as general operating costs.

As to the former, given the taxable nature of the output, there is no doubt as to the existence of the right to deduction. As regards expenses that are not in a direct and immediate relationship with the taxed outputs, but which nevertheless constitute general expenses of the SGPS's activity, the right to deduct the VAT should also be recognized.

Of the Concept of Economic Activity and Its Relation with the Right to Deduction Relating to Acquisition of Social Participations - CJEU Jurisprudence (cont)

The CJEU has been classifying the operations developed by a VAT taxpayer as non-economic activities, which should remain outside the scope of the VAT Directive, not conferring the right to deduction, and as economic activities. Only economic activities are encompassed within the scope of the Directive, distinguishing between non-taxed, taxed and exempt activities and between taxed and non-exempt activities (that is, effectively taxed).

As emphasized by Advocate General Mengozzi in the VNLTO Case[33], given the principle of neutrality that informs the common VAT system, a person should only bear VAT if it has been levied on goods and services used for private consumption and not for their taxable professional activities.

That is, it is not possible to deduct the VAT supported upstream if this relates to the activity of the taxpayer that does not have the nature of economic activity within the meaning of the VAT Directive.

As we referred above regarding the scope of the "direct and immediate relationship" between the inputs containing VAT subject to deduction and the taxed operations of the taxpayer, the CJEU has been adopting an increasingly broad interpretation, namely, for the matters that now interest us with respect to the management of social participations, whereby the establishment of a causal nexus between the deductible VAT and a determined, individualized and concretized operation, cannot be accepted[34].

As we have seen, according to CJEU jurisprudence, "there is also a right to deduction in favor of the taxpayer, even in the absence of a direct and immediate nexus between a given upstream operation and one or several downstream operations with the right to deduction, when the costs of the services in question form part of its general expenses and are, as such, constituent elements of the price of the goods it supplies or the services it provides. Such costs have, in fact, a direct and immediate nexus with the whole of the taxpayer's economic activity"[35]. However, it is imperative that there be a relationship with the taxpayer's economic activity, the need for its unequivocal demonstration persisting.

As noted in the cited Cibo Case[36], "1) The interference of a holding in the management of companies in which it took participations constitutes an economic activity within the meaning of article 4.º, paragraph 2 of Council Sixth Directive 77/388/CEE, of 17 May 1977, relating to the harmonization of the laws of the Member States regarding turnover taxes - Common system of value added tax: uniform taxable base, insofar as it implies the carrying out of transactions subject to value added tax pursuant to article 2.º of that directive, such as the supply, by the holding to its subsidiaries, of administrative, financial, commercial and technical services; 2) The expenses incurred by a holding with the various services it acquired in the framework of taking a participation in a subsidiary form part of its general expenses, whereby they have, in principle, a direct and immediate nexus with the whole of its economic activity. Therefore, if the holding carries out both operations with the right to deduction and operations without the right to deduction, it follows from article 17.º, paragraph 5, first paragraph of Sixth Directive 77/388 that only the part of the value added tax proportional to the amount relating to the first category of operations can be deducted." (cf. §§ 1 to 3 of the conclusions)

As emphasized by the CJEU in the I/S Fini and Skatteministeriet Case[37], the concept of taxpayer is always tied to that of economic activity, and it is precisely this economic activity that justifies the qualification of the taxpayer with the right to deduct. Now, if the exercise, in an independent manner, of an economic activity is, by itself, a condition of subjective incidence of this tax, hence the possibility of conferring the right to deduction, and if the right to deduction is, as we have seen, the guarantor of the neutrality of the tax, the delimitation of that concept must necessarily be as broad as possible.

As provided for in article 9.º, paragraph 1, 2nd paragraph, 2nd part, of the VAT Directive, in the definition of VAT taxpayer "(…) It is in particular considered economic activity the exploitation of a tangible or intangible good with the aim of obtaining revenue on a permanent basis (…)."

Now, it is at the level of the management of social participations that there has been considerable debate about determining the scope of this concept, the conclusions of the EDM Case being especially relevant in this context[38].

As noted by Advocate-General Philip Léger in his conclusions in this Case[39], " (…) it is settled jurisprudence that the simple exercise of the right of ownership by its holder cannot, by itself, be considered an economic activity".

Already previously, in the cited Polystar Case[40], relating to a pure holding, the CJEU had concluded that the mere acquisition and holding of social participations, without intervention in the management of other companies, should not be considered an economic activity, within the meaning of the Sixth Directive, not conferring on its author the quality of taxpayer.

In the conclusions of the EDM Case[41] the CJEU further refers that the simple sale of shares and other negotiable securities, such as participations in investment funds, as well as the revenue inherent to these funds, do not constitute an "economic activity" within the meaning of the Sixth Directive, whereby they are not encompassed within the scope of its application.

In conformity with this ruling, the simple taking of a financial participation in another company does not constitute an exploitation of an asset with the aim of obtaining revenue of a permanent nature, insofar as the possible dividend, fruit of such participation, results from the simple ownership of the asset and not the consideration for any economic activity[42]. Already with regard to interest received by a holding in respect of loans granted to its subsidiary companies, these cannot, according to the conclusions of that Decision, be excluded from the scope of VAT application.

In the same logic, the transfer of the said participations does not likewise meet the concept of economic activity, as referred to in the Satam/Sofitam Case[43]. Not being the consideration for an economic activity, within the meaning of the Sixth Directive, the perception of dividends does not enter the field of application of VAT, nor can it be qualified as a consideration of any services provided by the SGPS to its subsidiary, which are consumed in an intervention in its management (e.g., technical management support services).

It is particularly important to note that in the Floridienne and Berginvest Case[44], which underlies a holding company, the CJEU states that it should be considered as economic activity the intervention in the management of the subsidiaries, insofar as it implies transactions subject to VAT, such as the supply of administrative, accounting and computer services.

That is, it is particularly important to emphasize that the CJEU, regarding the acquisition of financial participations, has already decided that the situation is different, falling within the scope of the exercise of an economic activity, in the case of the acquisition of a financial participation in a company being accompanied by the " (…) direct or indirect interference in the management of the companies (…)"[45] in which the taking of participation was verified, without prejudice to the rights that the holder of the participation has in the capacity of shareholder or partner[46], insofar as such interference implies the carrying out of transactions subject to VAT pursuant to the VAT Directive, such as the supply of administrative, accounting and computer services.

The CJEU thus distinguishes, in this measure and as seen, holdings that interfere, directly or indirectly, in the management of the subsidiaries, from those that do not[47].

As to the treatment to be given to the management (acquisition, holding and disposal) of social participations beyond the case of holdings, in the context of a parent company's participations in subsidiaries or associates, it flows from CJEU jurisprudence that operations relating to shares or participations in companies are encompassed within the scope of application of VAT when carried out within the framework of a commercial trading activity in securities or when they constitute the direct, permanent and necessary continuation of taxable activity[48].

Being the acquisition of social participations a passive operation, to assess the deductibility of VAT relating to expenses associated with it we will, necessarily, have to analyze to what extent that participation is held and what are the downstream operations that resulted from those expenses – will such operations or not be economic activities taxed and not exempt from VAT?

As referred to by Rui Bastos[49], "(...)Accordingly, the acquisition of participations from a pure investment perspective, aimed at obtaining revenue such as dividends, remits its holding outside the concept of economic activity, whereas acquisition in a context of commercialization of securities would remit it to the exercise of a taxed, albeit exempt activity.

And the same author continues, "(...)the same should not occur in a context of acquisition of a participation that represents the direct and necessary continuation of the commercial or industrial activity of the acquiring company, in a context of business restructuring or in a process of expansion, opting for the acquisition of a subsidiary, to the detriment of the constitution of a permanent establishment, the same not occurring in a context of intervention in the management of the subsidiaries and, concomitantly, in taxed activities exercised by them."

In the SKF Case, the CJEU, invoking the principle of equality of treatment and fiscal neutrality, concludes that the economic nature of takings of participations accompanied by interference by the parent company in the management of the subsidiaries should be extended to situations of transmission of participations that end that interference.

In the framework of the transmission of shares, the CJEU considers in the SKF Case that the right to deduct the VAT paid upstream on provision of services intended to carry out a transmission of shares[50] is conferred, by force of article 168.º of the VAT Directive, if there exists a direct and immediate relationship between the expenses related to the upstream provision of services and the whole of the economic activities (taxed) of the taxpayer, the so-called "general expenses".

In that proceeding, the transmission of shares in question[51], carried out with a view to restructuring a group of companies by the parent company, was considered an operation of obtaining revenue of a permanent nature of activities that exceed the framework of the simple sale of shares. This operation presented a direct nexus with the organization of the industrial activity exercised by the group and thus constitutes the direct, permanent and necessary continuation of the taxable activity of the taxpayer, whereby that operation of sale of shares would be encompassed within the scope of application of VAT, susceptible to conferring the right to deduct the VAT of the respective inputs.

The CJEU considers that these provision of services have a direct and immediate relationship with the whole of the taxpayer's economic activity, permitting the right to deduct the entirety of the VAT of the said provision of services.

It was debated whether the inputs associated with the disposal of social participations could be susceptible of permitting the deduction of VAT, by way of their qualification as general expenses of the activity, in the case of that disposal not being subject to VAT, a more frequent situation, as we have seen, in holdings, or then, being subject but exempt, as occurs with the parent company that manages a group of companies.

In the case of non-subjection, the Advocate-general, relying on the conclusions of the Krettztechnik Case, no. 36, considers such type of expenses susceptible of being qualified as general expenses, thereby possessing a direct and immediate relationship with the whole of the taxpayer's economic activity, enabling its deduction...