Is the VAT on the expenses incurred for a sale of shares recoverable? (update of the Tax Newsletter of 4th quarter 2010)
Only a few months after having accepted the possibility, in certain specific cases, of deducting the VAT related to the costs incurred for a sale of shares, the Conseil d’Etat (French Supreme Administrative Court), in two leading cases rendered on December 23, 2010, provided actual instructions that should make it possible, at least in theory, to determine whether the VAT on a given expense related to the sale of shares is deductible. [CE, 8e and 3e s.-s., December 23, 2010, Société Pfizer Holding et SA Michel Thierry, No. 307698 and No. 324181].
In substance, the Conseil d’Etat now distinguishes between the ‘expenses incurred in order to prepare the sale’ and the ‘expenses inherent to the transaction itself ’.
Expenses incurred in order to prepare the sale (e.g., attorney’s fees for services rendered in connection with vendor due diligence) are considered in any event as forming part of the company’s overhead costs, and consequently the related VAT is deductible under ordinary conditions when the sale does not occur. When the sale occurs, these expenses remain, in principle, treated as overhead costs but the French tax authorities are entitled to challenge VAT deductibility if they establish that the sale has a patrimonial nature, which will be the case if the proceeds of disposal have been distributed, or if the expenses incurred have been included in the share sale price.
Expenses inherent to the transaction (e.g., brokerage fees or, more generally, any intermediation expense enabling the effective performance of the transaction) are regarded in principle as presenting a direct and immediate link with the share sale (transaction not subject to VAT). The VAT on such expenses is thus not deductible unless the taxpayer proves that these expenses have not been included in the share sale price.
The Conseil d’Etat further specified that expenses paid to the same intermediary in charge of both preparing and performing the transaction follow the VAT treatment applicable to expenses inherent to the transaction.
Attractive in principle, this new instructions manual is still questionable in certain respects and raises a number of practical uncertainties.
It is certain that the vendors of shares will as a minimum, and regardless of the type of expenses, have to prove the non-incorporation of the expenses in the sale price. This proof should in particular be supported by the cost accounting system of the selling company, or more generally, by express clauses of share sale contracts specifying that the vendor will bear the expenses it incurred for the sale of shares.
This being said, bringing this proof could be insufficient to justify the deductibility of the VAT on such expenses. Indeed, the Conseil d’Etat now provides, as pointed out above, and at least for the expenses incurred prior to the sale, that the VAT deductibility could be challenged by the tax authorities if the transaction has a ‘patrimonial nature if the proceeds of disposal have been distributed, regardless of the modalities of the distribution’.
This requirement of non-distribution of the proceeds of disposal, constituting one of the main new developments of the cases, seems, in itself, questionable since its effect is to make the VAT treatment depend on the use the selling company makes of the proceeds, which does not seem to be in line with the European Community case-law (see, in particular, the BLP Group case of April 6, 1995). It is further questionable as the Conseil d’Etat seems to make it a condition of VAT deductibility solely for the expenses incurred in order to prepare the sale.
Certain questions are thus still unresolved by the two decisions of the Conseil d’Etat:
- Could the VAT related to expenses inherent to the transaction (considered, by definition, to be strongly related to a sale which is not subject to VAT) thus be deductible under the sole condition that the taxpayer demonstrate the non-incorporation of the expenses in the sale price, whereas VAT on expenses incurred in order to prepare the sale (considered as being more related to the company’s whole economic activity) would only be so if the taxpayer further demonstrates the non- distribution of the proceeds of disposal?
- What is the impact of a partial distribution of the sale price on the VAT treatment of the expenses related to such sale (in his conclusions, the government attorney provides that in such an event ‘pro-rata will be have to be done’)?
- Is there a time-limit from which a distribution will no longer characterize a patrimonial transaction likely to result in a challenge of VAT deductibility?
We provide below a practical guide summarizing the questions to be analyzed by a taxpayer incurring expenses related to a sale of shares.
Click here to view diagram.