Input VAT Incurred on Purchases Used for Free of Charge Transactions: Is the Deduction Systematically Denied?

Input VAT Incurred on Purchases Used for Free of Charge Transactions: Is the Deduction Systematically Denied?

The legal basis of a commercial company is to make a profit, so sales of goods or services are generally carried out for consideration. However, sometimes businesses make goods available or give them away free of charge as part of customer loyalty campaigns, employee incentives, or production needs.

If the goods and services are used for the purposes of its taxable transactions, the taxable person has the right to deduct VAT incurred on the purchases of its goods or services in the Member State in which the transactions are carried out.

Thus, in principle, the tax on goods transferred without consideration is not deductible, regardless of the status of the beneficiary or the form of distribution, except when the goods are of very low value.

  • Can the VAT incurred on the purchase of these goods be deducted?
  • How can we verify that we have used our right for deduction correctly?
  • How can we check that we have not exceeded the thresholds, if applicable?
  • What are the risks of an incorrect deduction?

All these questions come up very often from our clients on a subject that is not taken lightly by the tax authorities nor the European Court of Justice (ECJ).

This rule, although clear, leaves room for different interpretations by national tax authorities and courts.

The ECJ has already given its position on several decisions in the context of promotional programs, commercial gifts or samples, and advertising items when they are given away free of charge. The Commission has attempted harmonisation, via Directive 2016/1065 of 27 June 2016, which clarifies the VAT regime applied to vouchers (single-use vouchers and multiple-use vouchers).

However, despite consistent European decisions, market developments always bring cases that raise questions before national courts. In this respect, the last decision of the ECJ for Case 475/23 reminded the national courts of the legal reasoning to be followed.

The Facts of Case 475/23

According to the judgment of court, the facts of Case 475/23 are below:

VGL, a company established in Austria, produces various moulded parts in the course of its economic activity. It processes those parts in Romania, where it is registered for VAT purposes. To that end, it concluded a framework contract with Austrex Handels GmbH (‘Austrex’), established in Austria, under which Austrex is able to use the services of a subcontractor, namely Global Energy Products SA (‘GEP’), established in Romania.

Once the processing has been carried out, the moulded parts are sent and invoiced by VGL to customers in the European Union. It is apparent from the file before the Court that VGL states its Romanian VAT number when invoicing those parts.

In the course of its processing activity, VGL makes available to Austrex, pursuant to a right of use transferable to GEP, a building located in Cluj-Napoca (Romania), which VGL owns. VGL also makes available, free of charge, for the use of GEP, which processes the parts produced by VGL, a crane which VGL acquired and installed on the grounds of that building.

VGL’s right to deduct the input VAT paid for the acquisition of the crane was challenged by the administration, and the national court of appeal referred a preliminary question to the ECJ.

The Decision

The court recalls that, to benefit from the right to deduct, two conditions must be met.

  • First, the person concerned must be a ‘taxable person’ within the meaning of the [Directive 2006/112/EC].
  • Secondly, the goods or services relied on to [found] that right must be used by the taxable person for the purposes of his own taxed transactions, and [those goods must have been purchased from another taxable person].

For this second condition to be met, it is necessary that: ​​

  • [There is] a direct and immediate link] between a particular input transaction and a particular output transaction or transactions giving rise to the right to deduct is, in principle, necessary. The right to deduct VAT charged on the acquisition of input goods or services presupposes that the expenditure incurred in acquiring them is a component of the price of the output transactions giving rise to the right to deduct.
  • [In the absence of a direct and immediate link], where the costs of the goods and services in question are part of that taxable person’s general costs and are, as such, components of the price of the goods or services which that taxable person supplies, such costs do have a direct and immediate link with the taxable person’s economic activity as a whole. In that regard, it is clear from the case-law of the Court that the [...] existence of such a link must thus be assessed in the light of the objective content of the transaction in question.

[The court considered] that without the crane acquired by VGL, the processing of the moulded parts, the weight of which is greater than 10 tonnes, would not have been possible. [Therefore,] its acquisition was essential to carry out this processing and, consequently, in the absence of such an acquisition, VGL would not have been able to carry out its economic activity consisting of selling moulded parts.

The fact that Austrex and its subcontractor GEP derive a direct benefit from the crane in question, because of its provision free of charge, cannot [lead to VGL being denied the] right to deduct VAT relating to its acquisition if the existence of a direct and immediate link is established between this acquisition and either one or more taxed output transactions carried out by VGL, or the whole of its economic activity, which it is for the referring court to verify.

Once again, as it previously had with Case C-132/16, the court considers the essential nature of the activity to confirm the direct and immediate link between an expense and its use in the context of an economic activity giving rise to a deduction. However, it limits this right to deduction to what was necessary for said economic activity.

It confirms a clear position of the ECJ: The principle of “free of charge” does not trigger systematically the denial of deduction of the input VAT incurred on the expenses used for the transaction carried out free of charge.

In this case, it was not a free transfer of property but a free provision of the property for the benefit of another taxable person; however, an analysis of the purposes of the goods purchased and the use of them is always necessary.

In the case of promotional programs, it is necessary to analyse whether adjustments are due on the deduction of input VAT or, on the contrary, whether VAT becomes payable on the goods or services provided free of charge.

It is therefore very important to check whether you have a right to deduct your input VAT when you are in one of the following cases:

  • Supply samples to customers or prospects – Some countries regulate the products concerned in a formal way (special mention on the container, limited capacity, etc.) while others are less strict.
  • Supply gifts to customers or employees – In general, a threshold is set in each country per customer and per year. This time limit can be calendar year or rolling depending on the country, and the thresholds can vary: £50 in the United Kingdom, €20 in Ireland, €73 in France, €227 in the Netherlands, etc. Local specific conditions could be added to this threshold.
  • Supply sales with bonuses as "buy one, get one free" – VAT treatment may depend on the invoicing. This could differ from one country to another.
  • Supply of gifts for any new subscription – The ECJ has provided an interpretation of the Directive in Case 505/22; local administrations do not yet follow this decision restrictively.
  • Goods or services put at disposal for free.

VAT incurred on the purchase of goods transferred or made available free of charge cannot always be deducted. To ensure a correct deduction, it is important that companies are vigilant about the circumstances and framework in which these transactions were made and the consequences that this implies in terms of VAT.

How Ryan Can Help

At Ryan, we assist our clients in more than 50 countries and handle these types of questions on VAT deductions on a daily basis, taking into account all local specificities.

Ideally, companies should consider the implications of their loyalty programs or promotional offers before setting them up. If this is not possible, a review can be carried out at a later stage, when preparing the VAT return, i.e., when the question of deducting the VAT on the purchases of goods that were used in these promotional schemes is raised.