Brian Keenan Senior Manager Indirect Tax Services

Background to the case and the questions asked

Kretztechnik AG (Kretztechnik) is an Austrian company in the business of development and supply of electro-medical appliances. The product supplied by Kretztechnik is subject to VAT and it is accordingly entitled to 100% VAT recovery on its costs.

In January 2000, Kretztechnik decided to increase its share capital by 25%, issuing €2.5m shares on the Frankfurt Stock Exchange. The Austrian authorities took the view that this was an exempt transaction and therefore VAT was not recoverable in respect to the costs incurred in relation to the share issue (such as advertising, legal and technical advice).

The Court was asked to decide on the following questions:

• Does a public limited company make a supply for consideration within the meaning of Article 2(1) of the Sixth Directive when it issue shares.
• If the first question is answered in the negative, is there a right under Article 17(1) and (2) of the Sixth Directive to deduct input VAT on the grounds that the services on which a deduction is claimed are used for the purposes of an undertaking’s taxable transactions.

Question 1
In relation to the first question, the Court relied heavily on its previous judgment in case C-442/01, KapHag Renditefonds (KapHag), in which the Court held that the admission of a new partner in return for a cash contribution to the assets of a partnership did not constitute an economic activity. The significant finding in KapHag was that there was no supply to the new partner either by the existing partners or by the partnership.

Relying on this judgment, the Court takes the view that an issue of new shares by a company is not a supply of goods or of services for consideration within the meaning of Article 2(1) of the Sixth Directive.

Question 2
The second question addressed by the Court was whether, in the event that it finds that an issue of shares was not a supply for consideration within the meaning of Article 2(1), VAT was recoverable on the costs incurred in relation to a share issue.

It is the Court’s opinion that as there was no supply, the costs involved were costs that were attributable to overheads which related to the economic activity of the company and accordingly VAT is recoverable on these costs to the extent of the company’s taxable activities.

While a first share issue was the point addressed by the Court, it is the opinion of Ernst & Young's Indirect Tax Services group that the principle should not be restricted to a first share issue. It is noteworthy that at paragraph 21 of the judgment, the Court states that '… the nature of the transaction does not differ according to whether it is carried out by a company in connection with its admission to a stock exchange or by a company not quoted on a stock exchange'.

An argument may be made that the scope of the judgment could also apply to subsequent share issues, management buy-outs, etc. In general, the principle should also apply to any transaction where there is an issue of new shares by a company to raise capital, or indeed a proposed share issue that has been abandoned.

Irish VAT interpretation

This will completely overturn the Irish Revenue practice in this area. The Revenue has always relied on the judgments in case C-60/90, Polysar Investments Netherlands BV v Inspecteur der Invoerrechten en Accijnzen (a holding company cannot recover VAT) and in case C-80/95, Harnas & Helm CV v Staatssecretaris van Financiën (a private person cannot recover VAT) as precedents for its position that the issue of shares is not an economic activity and is outside the scope of VAT and, therefore, VAT on costs associated with this activity is irrecoverable.

The Ernst & Young Indirect Tax Services group is of the opinion that the Revenue was wrong to rely on these cases. These cases were never precedents since they did not relate to entities engaged in economic activities. A decision of the Irish Appeal Commissioners, published in April 2003, found that VAT on costs associated with an aborted share issue should be deductible on the basis that a share issue was not a supply and therefore the associated costs should be regarded as overheads of the business. The Appeal Commissioners' rationale for their decision was remarkably similar to the Court’s judgment. The Revenue’s response to that decision was the following paragraph, which was published in its Tax Briefing publication in December 2003:

'Following publication by the Appeal Commissioners of a decision concerning a claim for recovery of professional fees arising from a proposed issue of shares enquiries have been received as to whether a change in Revenue practice will ensue. Revenue's view continues to be that such expenditure does not relate to a taxable supply and is not deductible. Accordingly, there is no change in Revenue policy as regards recovery of VAT on expenses relating to an issue of shares.'

In view of this judgment, the Irish Revenue should be forced to rethink its position. However, it should be borne in mind that it has failed to fully implement judgments of the European Court of Justice in the past: the principle established in case C-16/00, Cibo Participations SA and Directeur régional des impôts du Nord-Pas-de-Calais, and reinforced in this latest case (in that where there is no supply for VAT purposes, costs are attributable to a business’ overall economic activities), has already been ignored by the Irish Revenue.

It is the opinion of the Indirect Tax Services group that the Revenue has not interpreted EU case law correctly to date and has accordingly unlawfully blocked VAT recovery for companies that have issued shares.

Companies that incurred VAT on costs associated with share issues, IPOs, etc. and that have not deducted VAT incurred on associated costs should contact a member of the Indirect Tax Services group to obtain advice on how to proceed to obtain a VAT refund.

Update

Since the time of writing this article, the Revenue have confirmed in Revenue e-brief No. 16/2005 that they are considering the implications of this judgment and will, as soon as possible, issue a more detailed analysis of its effects in Ireland. They also confirmed that they accept that the judgment will require a change in their approach to the question of VAT deductibility in relation to share issues.

In the meantime, they advise that taxpayers wishing to claim repayment of VAT in accordance with the judgment are welcome to lodge a claim to that effect with the taxpayer's Revenue office and that these claims will be processed once Revenue have completed its more detailed analysis of the effects of the judgment.