CAAD Arbitration 333/2015-T: VAT Deduction on R&D Acquisitions

Process: 333/2015-T

Date: December 7, 2015

Tax Type: IVA

Summary

CAAD Process 333/2015-T addressed a critical VAT deduction dispute involving a non-profit research association conducting marine and environmental R&D projects. The claimant challenged multiple VAT assessments totaling over €600,000 in tax and interest for periods spanning 2010-2011, arguing for full VAT deduction rights on acquisitions of fixed assets and services used in research activities. The Tax Authority denied these deductions, contending that R&D services financed by non-refundable national and European grants do not constitute taxable operations under the VAT Code, thus eliminating the right to input VAT recovery. The claimant operated under the normal quarterly VAT regime with mixed operations and actual allocation of all assets, performing marine research projects on ecological status, mollusk biology, invasive species, and biodiversity conservation. The entity also occasionally provided water and chemical analysis services to private companies, charging VAT at the normal rate. The arbitral tribunal was constituted on August 11, 2015, under Decree-Law 10/2011 (RJAT). The Tax Authority requested a preliminary reference to the Court of Justice of the European Union to clarify the scope of VAT deduction on acquisitions when research services are funded by grants, specifically regarding harmonization of Article 20(1) of the Portuguese VAT Code with Article 9(1) of the EU VAT Directive defining economic activity. This case highlights fundamental questions about the nature of grant-funded R&D activities as economic activities for VAT purposes and the extent to which non-profit research entities can recover input VAT when their activities are predominantly financed through non-refundable subsidies rather than market transactions.

Full Decision

ARBITRAL DECISION

The arbitrators Dr. Jorge Manuel Lopes de Sousa (arbitrator-president), Dr. Magda Feliciano and Dr. Diogo Feio, appointed by the Deontological Council of the Centre for Administrative Arbitration to form the Arbitral Tribunal, constituted on 11-08-2015, agree as follows:

1. Report

A..., NIPC..., with registered office at Rua..., n.º..., ...-... Porto (hereinafter referred to as the "Claimant"), filed a request for arbitral pronouncement, in accordance with the provisions of Decree-Law No. 10/2011 of 20 January (hereinafter referred to as "RJAT") for the annulment of the following VAT assessments issued by the Tax and Customs Authority (hereinafter AT):

a) Assessment No. ... relating to VAT for the period 1003T, which determines a tax amount payable of € 483,579.88;

b) Assessment No. ... relating to default interest on the preceding assessment, which determines an interest amount payable of € 86,487.93;

c) Assessment No. ... relating to VAT for the period 1006T, which determines a tax amount payable of € 26,886.46;

d) Assessment No. ... relating to default interest on the preceding assessment, which determines an interest amount payable of € 4,540.50;

e) Assessment No. ... relating to VAT for the period 1009T, which determines a tax amount payable of € 22,759.73;

f) Assessment No. ... relating to default interest on the preceding assessment, which determines an interest amount payable of € 3,616.61;

g) Assessment No. ... relating to VAT for the period 1012T, which determines a tax amount payable of € 64,588.63;

h) Assessment No. ... relating to default interest on the preceding assessment, which determines an interest amount payable of € 9,612.20;

i) Assessment No. ... relating to VAT for the period 1103T, which determines a tax amount payable of € 31,168.55;

j) Assessment No. ... relating to default interest on the preceding assessment, which determines an interest amount payable of € 4,331.15;

k) Assessment No. ... relating to VAT for the period 1106T, which determines a tax amount payable of € 22,142.84;

l) Assessment No. ... relating to default interest on the preceding assessment, which determines an interest amount payable of € 2,853.70;

m) Assessment No. ... relating to VAT for the period 1109T, which determines a tax amount payable of € 22,518.41;

n) Assessment No. ... relating to default interest on the preceding assessment, which determines an interest amount payable of € 2,675.06.

The Claimant attributes to the disputed assessments defects of error in the quantification of the taxable fact and violation of law, due to errors in factual and legal assumptions, and further requests that it be considered that it has the right to full VAT deduction supported in its acquisitions of fixed assets and other goods and services, and that reimbursement to the Claimant of the value of the assessments be determined, with payment of compensatory interest.

The request for constitution of the arbitral tribunal was accepted by the President of CAAD and notified to the TAX AND CUSTOMS AUTHORITY on 09-06-2015.

In accordance with the provisions of Article 6, paragraph 2, letter a) and Article 11, paragraph 1, letter b) of RJAT, the Deontological Council appointed as arbitrators the signatories, who communicated acceptance of the charge within the applicable time limit.

On 27-07-2015, the Parties were notified of this appointment and did not express an intention to refuse the appointment of the arbitrators, in accordance with the combined provisions of Article 11, paragraph 1, letters a) and b) of RJAT and Articles 6 and 7 of the Deontological Code.

Thus, in compliance with the provision of Article 11, paragraph 1, letter c) of RJAT, the collective arbitral tribunal was constituted on 11-08-2015.

The Tax and Customs Authority responded in defence of the lack of merit of the request for arbitral pronouncement and requested that a preliminary reference be made to the CJEU, "for the purpose of defining the scope of VAT deduction supported in acquisitions, taking into account that the provision of research investigation services does not constitute a taxable operation under the terms of the VAT Code, being financed by non-refundable national and European funds".

By order of 10-10-2015, the hearing provided for in Article 18 of RJAT was dispensed with and it was decided that the case would proceed with written pleadings.

The Parties submitted written pleadings.

The arbitral tribunal was duly constituted.

The parties have legal personality and capacity, are legitimate (Articles 4 and 10, paragraph 2, of the same statute and Article 1 of Ordinance No. 112-A/2011, of 22 March) and are duly represented.

The case has no nullities.

No obstacles to the examination of the merits of the case are raised.

The Tax and Customs Authority requests that a preliminary reference be made to the CJEU on the "harmonization of the interpretation of Article 20, paragraph 1 of the VAT Code, with Article 9, paragraph 1 of the VAT Directive which defines economic activity".

2. Factual Matters

2.1. Proven Facts

The following facts are considered proven:

A) The Claimant is a non-profit association, linked to the rectory of B..., which has as its activity research in the marine field, being framed in the normal quarterly VAT regime, with the type of operations "Mixed with actual allocation of all assets" and in CIT under the normal regime, for the activity of "Other Research and Development of Physical Sciences", CAE 72190, having started the same on 29-02-2000, proceeding with full VAT deduction;

B) The main activity of the Claimant consists of carrying out research and development projects in the marine and environmental field, having the following projects in progress:

Investigation of long-term ecological status, caused by natural and human pressures in the estuaries of Minho, Mondego and Mira;
Investigation of processes that influence "Mollusca Bivalvia" in estuaries, identification of key genetic and environmental factors;
Investigation of ecosystem-level impacts of invasive species;
Investigation of biodiversity and Conservation of Bivalves, ecogeographic, genetic and physiological information;

C) The provision of services effected by the Claimant within the scope of research and development projects in the marine and environmental field are financed by non-refundable national and European funds;

D) The Claimant provides security and telecommunications services to the Rectory of B..., having concluded contracts with a private security company and a telecommunications operator, the end user of these services being the Rectory of B...;

E) For financial reasons, these services are re-debited to the Rectory for the same amount, thus making this operation null for purposes of VAT and CIT;

F) Exceptionally, the Claimant provides water analysis services and other chemical analyses to private companies, charging VAT at the normal rate in these cases;

G) On 15-05-2014, the Claimant submitted a VAT refund request, by reference to the period 201403T, through the periodic declaration No....;

H) The VAT refund request for the period 2014/03T was the first refund request submitted by the Claimant, which had a credit that accumulated over various fiscal years with a value exceeding one million euros, but only requested refund of 80,000.00, carrying forward € 1,180,056.77 in the declaration for that period;

I) Following the refund request, the Tax and Customs Authority opened service order No. OI2014..., by reference to the fiscal year 2014, and service orders Nos. OI2014... and OI20014..., by reference, respectively, to the fiscal years 2010/2011/2012/2013, all of partial scope for VAT;

J) In the Preliminary Tax Inspection Report drawn up following the inspection action, the content of which is considered reproduced, the following is stated, among others:

e) Legal classification of services provided by the entity

1 - Research and development projects in the marine and environmental field

The provision of services effected by this entity are all financed by non-refundable national and European funds.

These service provisions do not constitute an activity of an economic character, due to the fact that there is no underlying reciprocal relationship, characteristic of a commercial relationship, nor the obtaining of permanent profits.

Thus, concluding that these operations do not constitute the exercise of an economic activity, they do not configure a taxable operation, and as such are not subject to VAT, in accordance with the provisions of Articles 1 and 2 of the VAT Code.

As to the deductibility of tax supported in the acquisitions made for the provision of these services, the following is concluded:

Not configuring those operations as taxable, in accordance with the provisions of Article 20 of the VAT Code, in which only tax supported is deductible that has been incurred on goods or services used for the accomplishment of taxable operations subject to tax, the tax supported in acquisitions made for the accomplishment of these services does not confer the right of deduction.

2 - Other services provided

2.1 - With respect to the provision of occasional services of water analyses and other chemical analyses to private companies, it is noted that these services constitute taxable operations subject to tax and not exempt from it, so the tax supported in acquisitions made for the provision of these services confers the right to deduction, in accordance with the provisions of Articles 1 and 20 of the VAT Code.

2.2 - Re-debiting of expenses

With respect to these services, it is verified that the entity re-debits for the same amount, the services provided to it which were invoiced by the communications and private security company.

This re-debit constitutes a provision of service as stipulated in Article 4 of the VAT Code.

4 - Conclusion:

From the foregoing, it is concluded that the taxpayer carries out operations that confer the right to deduction and operations that are not taxable (outside the scope of tax), so we will proceed to correct the VAT improperly deducted.

(...)

III - DESCRIPTION OF FACTS AND GROUNDS FOR CORRECTIONS MERELY ARITHMETIC TO THE TAXABLE MATTER

VAT

1 - Improperly deducted VAT (field 24 of periodic declarations)

As mentioned in point II of this report, the main activity of the taxpayer consists of:

Marine and environmental research, currently having the following projects in progress:
Investigation of long-term ecological status caused by natural and human pressures in the estuaries of Minho, Mondego and Mira;
Investigation of processes that influence "Mollusca Bivalvia" in estuaries, identification of key genetic and environmental factors;
Investigation of ecosystem-level impacts of invasive species;
Investigation of biodiversity and Conservation of Bivalves, ecogeographic, genetic and physiological information.

The VAT Services Directorate has understood that, if an entity carries out research and development activity that has no commercial intent, and therefore the result of that research is not sold (as is the case), there are no taxable operations, so this activity is classified outside the scope of VAT, not conferring any right to deduction of tax supported.

Thus, in these terms, research and development activity does not constitute a taxable operation under the terms of the VAT Code, being in these cases classified as outside the scope of tax.

Now, it was found that the taxpayer improperly deducted all VAT supported in acquisitions made for the pursuit of this type of activity, throughout the period comprising 2006/09T and 2014/03T.

To ascertain the tax improperly deducted by the taxpayer, we based ourselves on its accounting.

In fact, the taxpayer uses cost centers, so acquisitions made for the pursuit of various activities are duly separated.

Thus, we will proceed to correct the improperly deducted VAT with respect to acquisitions made for the pursuit of research and development activity, as indicated below:

[Table content preserved]

2 - Improperly deducted VAT (field 20 of periodic declarations)

To correct improperly deducted VAT relating to tangible fixed assets (field 20 of periodic declarations), we use the criterion described below.

It is verified that the taxpayer, though residually, carries out operations subject to tax and not exempt from it, together with operations not arising from an economic activity, as referred to in point e).

In this context, in the case of goods or services of mixed use partially allocated to the accomplishment of operations not arising from an economic activity, the determination of the amount of non-deductible VAT relating to these cannot be based on the pro rata method provided for in paragraph 4 of Article 23 of the VAT Code, and must necessarily use actual allocation according to the actual use.

Indeed, given the nature of the activity developed, the application of an objective criterion that permits ascertainment with approximate accuracy of the amount of VAT that the taxpayer actually has the right to deduct will necessarily have to adapt to the situation and concrete organization of the same and in the global context of its activity.

Thus, as a criterion to be used that permits obtaining the amount of deductible VAT, knowing that the operations subject represent over the years a small percentage, relative to the total of operations, it was chosen to use for determination of the amount of deductible VAT, the result of the quotient obtained through the relationship between expenses incurred for the pursuit of the activity outside the scope of tax and the total of expenses incurred.

In these terms, we will calculate the value of the deduction percentage, as follows:

[Table content preserved]

We then proceed to correct the deductible VAT relating to Tangible Fixed Assets, as indicated below:

[Table content preserved]

3 - Correction to the field Regularizations in favor of the taxpayer (Field 41 of periodic declarations)

The taxpayer regularized VAT in favor of the State during the period 2006/09T to 2014/03T relating to credit notes received from suppliers. This VAT had already been previously deducted by the taxpayer and is now being corrected.

Thus, we will proceed to correct that field, canceling the VAT regularized in favor of the State relating to expenses incurred for the activity outside the scope of tax, as follows:

[Table content preserved]

(Note: Field 40 of the periodic declarations - Regularizations in favor of the taxpayer, was not altered, as this concerns tax relating to credit notes issued in favor of customers for which tax had already been paid previously.)

Thus, we will correct the amounts indicated in the following table for the years 2006 to 2014:

[Table content preserved]

(NOTE: Verifying that the correction relating to the period 2006/2009 (€501,270.88 = €504,933.22 - €3,662.34), is greater than the carryforward declared by the taxpayer in the period 2009/12T (-145.903.226), we will consider the latter as the amount to be corrected for that period, due to the fact that this correction refers to periods already beyond the statute of limitations period. This correction will be made in the period 2010/03T through the addition of this amount in field 41 of the periodic declaration.)

Thus we obtain, period by period the amounts of VAT determined (for the years 2010 to 2014), indicated in the following table:

[Table content preserved]

(Notes:

1 - The VAT paid relates to:

1.1 - The re-debiting of expenses made by the entity with respect to acquisitions made from the private security company and the telecommunications company;

1.2 - To occasional service provisions of water analyses and chemical analyses provided to private companies

1.3 - Intra-community acquisitions made

(2) - The tax payable in the period 2010/03T is €446,225.36 = €445,903.22 + €322.14 due to the fact that in this period the correction relating to the period 2006 to 2009 is being made)

Following the corrections now proposed, the refund request for the VAT credit for the period 2014/03T will be entirely rejected.

K) The Claimant was notified to exercise the right to be heard on the Tax Inspection Report, and submitted, on 11-11-2014, the document which forms part 4 of the Administrative File, the content of which is considered reproduced, in which it states, among others, the following:

However, it remains unproven that it is not the intention of our Centre to sell the results of our investigations.
In truth, the fact that we do not have commercial intent does not imply that we cannot commercialize the results of the investigations we conduct.
If it were so, it should not even be possible to register as a VAT taxpayer.
Now, such commercialization is part of our main activity.
Moreover, this is provided for in the Articles of Association of the Association, in which it states that the object of A... is "the provision of services in the field of scientific research activity, in the scope of marine sciences and environmental medium".
This object is also found in the Articles of Association of A..., specifically in § 3 of Article 3.9.
And this situation will, in our opinion, be absolutely identical to that of many other institutions dedicated to research activities.
Obviously, the results of that research can only be commercialized when they actually appear and when there is an interested market in their acquisition.
Do large pharmaceutical laboratories, for example, always invoice directly the results of the investigations they conduct?
When through such investigations they do not reach results that would allow their commercialization, is the right to VAT deduction that they directly or indirectly supported in the development of their work denied them?
Surely not.
Nor would this be compatible with the well-known intention of encouraging research and development actions.
In fact, it is not always possible to obtain from investigations commercially exploitable results.
And that is what happens in our case.
There is, in truth, no impediment or absence of intention in the eventual utilization of the results of their investigations for purposes of obtaining revenue.
Thus the results appear...
It is also stated, on pages 3/11, that "the entity, exceptionally, provides water analysis services and other chemical analyses to private companies, charging VAT at the normal rate in these cases
Why is it said "exceptionally"?
Is it that it only provides these types of services when its managers decide to do so, as a simple matter of disposition?
Of course it will not be so.
The services in question will obviously be provided whenever we have the technical and scientific conditions to do so and when customers appear.
Nothing would prevent, in the same way, that another type of service – resulting from the results of the investigations carried out – could be developed on the same basis that there are interested customers.
In the case of research and development projects in the marine and environmental areas, it is also alleged, on pages 3/11, that "these service provisions do not constitute an activity of an economic character, due to the fact that there is no underlying reciprocal relationship, characteristic of a commercial relationship, nor the obtaining of permanent profits.
One may ask what legislation requires the "reciprocal relationship" referred to there.
Where is it required, in order for the VAT supported to be deductible, the obtaining of "profits of a permanent character"?
There is not, therefore, in our opinion, any justification for the corrections that it is planned to make, neither of a legal order, nor from a reasonableness perspective.
Being so, we hope that Your Excellencies reflect on the considerations we have made through this present exercise of the right to be heard and, as a consequence, revise the content of the Project's conclusions.

L) On 25-11-2014, the Tax and Customs Authority drew up the Tax Inspection Report, with reproduction of the Project referred to and addition of reference to the exercise of the right to be heard, in which it states the following:

VIII - RIGHT TO BE HEARD

The taxpayer was notified in accordance with the provisions set out in Article 60 of the General Tax Law and in Article 60 of the Complementary Tax Inspection and Customs Procedural Regime, by letter No. .../... of 2014,… to the company's registered office, to exercise within the period of fifteen days the right to be heard on the Preliminary Tax Inspection Report (hereinafter referred to as Project), having exercised this right through the sending of a letter to our services in which it states, in summary, the following:

The justification pointed out for the correction to deductible VAT proposed by us, "is found in the claim that this will be VAT supported with a view to carrying out service provisions that do not constitute an economic activity", and that "it however remains unproven that it is not the intention of our center to sell the results of our investigations".

It further states that "in truth, the fact that we do not have commercial intent does not imply that we cannot commercialize the results of the investigations we conduct".

It further alleges that "such commercialization is part of our main activity", as appears from the Articles of Association of the association, where it states that the object of A... is "the provision of services in the field of scientific research activity, in the scope of marine sciences and environmental medium".

Now, as mentioned in the Preliminary Report, research and development projects in the marine and environmental field are service provisions financed by non-refundable national and European funds.

In fact, the association has never sold the result obtained in the research and development projects carried out, as it itself acknowledges.

Reiterating the content of the project, the VAT Services Directorate has understood that, if an entity carries out research and development activity that has no commercial intent, and therefore the result of that research is not sold (as is the case), there are no taxable operations, so this activity is classified outside the scope of VAT, and does not confer any right to VAT deduction.

Effectively, although the results of that research tend to have commercial or industrial applications, the accomplishment of a research and development activity without immediate commercial objectives, nor the existence of a concrete recipient for the results of the projects in development, does not permit that it be stated with precision to be faced with the accomplishment of services or transmissions of goods subject to tax.

The understanding set out above was corroborated through dispatch No. .../2002, of the Secretary of State for Fiscal Affairs, issued in the Information of 2002.03.25, prepared by that Office, clarifying that, when research constitutes an activity with scientific purpose, it does not constitute a taxable operation under the terms of the VAT Code. This will be the case whenever the research activity does not have significant economic value or when, even if it does, it does not revert to the direct or indirect benefit of the financer. In these cases, the research activity is outside the scope of VAT, as is the financing operation.

Thus, it is concluded that these operations do not constitute the exercise of an economic activity, not configuring taxable operations, and as such are not subject to VAT, in accordance with the provisions of Articles 1 and 2 of the VAT Code.

As for the acceptance of registration as a VAT taxpayer, it should not be forgotten that the same carries out taxable operations subject to tax, as explained.

M) Following the inspection, the following VAT assessments and default interest were drawn up: