European Court of Justice enacts right of tax deduction in case of construction in state or municipal property

By Todor Todorov, Partner, Head of Tax & Customs department, Kambourov & Partners Attorneys at Law

On 14 September 2017 the European Court of Justice rendered a decision under Case C-132/16, with which it enacted that the EU legislation shall be treated as allowing a taxable person to deduct input value added tax in case the supply is connected with the person’s economic activity, even when a third party enjoys the results of the services free of charge. The case was formed under a request for preliminary ruling sent by the Supreme Administrative Court within a dispute between Iberdrola Inmobilaria and the National Revenue Agency. Kambourov & Partners Attorneys at Law successfully represented Iberdrola in the internal proceedings and before the ECJ.

The enactment concerns a very important question, raised before courts within the last years, i.e. the right of deduction of tax credit under VATA in case of construction in state or municipal property. In these cases, the right of deduction of tax credit for the received construction service is usually refused by the tax authorities on the grounds of the internal legislation with the statement, that the services are intended for supplies effected free of charge or for activities other than the economic activity of the person, as they are investments in public infrastructure, not owned by the person. This approach of the authorities was justified with the arguably inaccurate application of some decisions of the ECJ regarding exclusion from the right to deduct tax credit for goods, which are not allocated to the assets of the company.

Under the dispute between Iberdrola Inmobilaria and the National Revenue Agency, the Supreme Court decided to address a request to the ECJ referring to the fact that in Bulgarian courts an inconsistent practice/case law has been formed, as some panels accept the right to deduct in case the expenses are included in the general expenses of the person, but other panels refuse this right on the grounds that the improved object is not part of the assets of the company.

The ECJ enacted that the fact that the respective municipality also benefits from the service received cannot justify the right to deduct corresponding to that service being denied to the company if a direct and immediate link is established between the services and the undertaking’s economic activity. The ECJ also added that if the works exceeded the needs of the economic activities of the entity, the direct and immediate link would be partially broken and a right to deduct would thus have to be recognised in respect only for the input VAT levied on the part of the costs incurred for the work, which was objectively necessary.

The conclusion of the ECJ is that the VAT Directive must be interpreted as postulating that a taxable person has the right to deduct input value added tax in respect of a supply of services consisting of the construction or improvement of a property owned by a third when those services are used both by the taxable person and by the third party in the context of their economic activity, in so far as those services do not exceed the necessary for the economic activity and where the costs are duly reflecting the price of the following transactions.

As the case concerns the general rules for deduction of VAT credit in cases of investment in public infrastructure, the decision is of significant importance not only for Iberdrola Inmobiliaria, but also for the general investment climate in the country, rendering a decision on one of the recent questions in the Bulgarian tax practice.