Provision of goods for free, or the free use of goods can be an important part of business for VAT entrepreneurs. It is not uncommon for companies to provide goods as a part of an integrated package. Such packages, for example, include free product samples or free use of certain equipment and/or service (which can only be used together with the products that are actually sold and paid for). Or in some cases, goods or services are simply provided for free for commercial purposes. This set up often triggers discussions with tax authorities on the question whether or not input VAT can be recovered. Recently the European Court of Justice ruled in the Sveda case (C-126/14) that the provision of the free use of goods should not restrict the right to deduct input VAT, provided that it facilitates and relates to VAT taxable sales.
Based on the EU VAT Directive the supply of goods for free in principle constitutes a fictitious VAT taxable supply of goods. Depending on the circumstances, the right to deduct the input VAT incurred on the acquisition or manufacturing of such goods could also be denied by the tax authorities. In both cases, the supplier is confronted with an additional VAT cost.
The supply of goods for free must be distinguished from the useof goods for free. Such use can lead to a fictitious VAT taxable service in case the input VAT for these goods have been deducted (Article 26(1)a VAT Directive), but only in case business assets are used for private use by the taxable person or its staff, or if the VAT entrepreneur cannot be considered to have provided the use for free for business purposes.
From the Sveda case it follows that in case of such free use for taxable business purposes, the VAT entrepreneur in principle has a right to deduct input VAT for the goods used.
Sveda case (C-126/14, ECLI:EU:C:2015:712)
Sveda, a Lithuanian company, commissioned the construction of a "Baltic mythological recreational discovery path". Sveda provided access for free. Visitors could buy food, drinks, souvenirs and other items in shops and restaurants operated by Sveda along the discovery path. Sveda deducted the input VAT on the costs it incurred on the refurbishment of the discovery path. The Lithuanian tax authorities challenged this refund stating that the costs were connected to non-economic activities; i.e. offering access to the path for free.
European Court of Justice (ECJ)
According to the referring Lithuanian court, the expenses relating to the path were ultimately intended for carrying out the economic activities planned by Sveda. The path should thus be regarded as a means of attracting visitors with the intention of providing them with goods and services, such as souvenirs, food and drinks or access to attractions.
The ECJ confirmed this approach and ruled that despite the free use of the path, Sveda acted as a taxable person with regard to the construction of the path. The ECJ furthermore stated that, although the path is intended to be used free of charge, at the same time, it is part of Sveda’s objective of carrying out subsequent VAT taxable transactions. The construction of the path therefore has a direct and immediate link with Sveda’s economic activity as a whole and Sveda is therefore in principle allowed to deduct the input VAT incurred on the construction of the path.
Deviating local VAT rules
We note that some EU Member States are still allowed to apply specific restrictions on the right to deduct input VAT. These restrictions are based on a stand still clause and may deviate from the EU VAT Directive and the court rulings of the ECJ. If that is the case, the Sveda case may not (yet) be relevant in that EU Member State.
The Sveda ruling: implications of "use of goods for free"
The Sveda ruling confirms that when the use of goods is provided for free to (potential) customers with the intention to create or increase VAT taxable sales, such use must be considered for business purposes. As a result the provision itself does not trigger a VAT taxable (fictitious) service. Furthermore, due to the direct and immediate link with the economic activities as a whole, the supplier should in principle not be denied the right to deduct the input VAT. The Sveda case therefore in principle provides a positive outcome for any company providing the use of goods for free as a part of an integrated package, as a means of creating or increasing customer loyalty or any other business purpose. However, there are some points of attention to take into account.
An important point of attention is the fact that, according to the ECJ, the provision of the free use of goods is directly linked to the economic activity as a whole of the supplier. Local tax authorities can take the position that the acquisition- or manufacturing costs of such goods qualify as so called "general costs" and that the input VAT incurred is deductible according to the so called "pro rata" of the taxable person at hand. In the event the taxable person at hand would also carry out VAT exempt activities (e,g. granting (intercompany) loans or granting a VAT exempt lease of a building), the input VAT incurred on the acquisition or manufacturing of such goods would only be partially deductible, and thus trigger additional VAT costs for the supplier.
Even though the ECJ refers to the "the economic activity as a whole", in our view, arguments can be found to counter such a position of the tax authorities. Despite the character of "general cost", if the use is intended to create or increase VAT taxable sales, we find it defensible that the VAT entrepreneur would still be entitled to a full deduction of input VAT.
The various EU Member States all show different approaches towards the VAT treatment of integrated packages. The use of goods for free, as a part of an integrated package, may as a result lead to the situation where the deduction of input VAT is denied. We therefore recommend to closely assess the VAT consequences of such integrated packages before offering them.
Although the Sveda case revolved around the provision of the use of goods for free, arguments can be found to take the position that the same approach should apply with regard to the provision of services for free (e.g. the free use of software).
Supplies free of charge
The Sveda case should be distinguished from the supply of goods for free. Such a supply is subject to a different VAT regime compared to the situation in which the right to use such goods is provided for free. In case of the free supply of goods local tax authorities in principle will either deny the right to deduct input VAT incurred on such goods, or assume a fictitious VAT taxable supply at the time of the actual free supply. Either way, the supply of goods for free will, in principle, trigger an additional VAT cost. Should you use a scheme whereby goods are supplied for free, it may be worthwhile to further investigate the possibility to provide the use of these goods for free (e.g. offer a lease free of charge), instead of supplying the goods for free.
Assess VAT implications
To the extent that you are providing free of charge products or the use of goods or services for free (e.g. lease), or have the intention to do so, we recommend to ascertain the VAT implication of such provision. A high-level assessment of the VAT consequences may prevent possible (future) adverse VAT consequences or show possibilities to optimize your VAT position.