1. Summary
“ECJ case-law in respect to the (non) application of VAT exemption to services supplied by independent groups of persons to their members aligned with the inaction of the Portuguese Authorities leads to huge uncertainty for financial and insurance groups incorporated in Portugal, which, in most situations, end up opting to dismantle their ACEs and choose less competitive arrangements. The more years pass without an action, the less competitive Portugal is in comparison to its EU neighbors”
2. Article
i) The VAT exemption and its application
For the past years, independent groups of persons incorporated in the EU, and particularly in Portugal, have been hampered by the uncertainty around the scope of application of the VAT exemptions foreseen in the EU VAT Directive[1]. Particularly, the VAT exemption for services supplied to members within these structures carrying out a VAT exempt activity[2] has been giving rise to some challenges, which will be discussed below.
In brief, this VAT exemption is intended to prevent entities offering certain (VAT exempt) services from bearing (irrecoverable) VAT when outsourcing part of their activities. Often, groups of entities create a common structure [in Portugal, typically Agrupamentos Complementares de Empresas (“ACEs”)] and pool specific activities into one entity,which is responsible to acquire / produce the necessary services and proportionally re-distribute the costs throughout the members. Provided some conditions are met, this re-distribution might be VAT exempt and the ACE members may reduce their costs with irrecoverable VAT[3], ending up in a comparable position to larger competitors which have the capacity to perform those activities internally.
Transposed to the original version of the Portuguese VAT Code[4], this VAT exemption should apply to services supplied by ACEs to their members when:
a) the members carry out a VAT exempt activity (i.e., the members have a VAT recovery ratio lower than 10%, as per the wording in force since 1999);
b) such services are “directly necessary” for the members’ activities;
c) the services are rewarded at cost; and
d) the VAT exemption must not be likely to cause distortion of competition.
Like in other EU countries, this VAT exemption started being used as a competitive tool by financial and insurance groups, who could pool the cost of back-office services such as IT, call centers and security into an ACE and proportionally re-distribute such costs by the members (with lower irrecoverable VAT amounts when compared to the scenario where such services would be individually purchased by each of the members to third-parties).
This was (and is) particularly the case in countries like Portugal, which did not implement the VAT grouping scheme – an optional arrangement foreseen in the EU VAT Directive[5], according to which legally independent taxable persons, closely bound to one another by financial, economic and organizational links, can be deemed as a single taxable person for VAT purposes[6].
As detailed below, over the last years, ACEs have been highly scrutinised by the Portuguese Tax Authorities. Furthermore, recently, the Supremo Tribunal Administrativo (“STA”) released two decisions which may – even more – make life difficult for these structures. At the EU level, the (not so recent) decisions issued by the European Court of Justice (“ECJ”) in cases DNB Banka (C-326/15) and Aviva (C-605/15) gave rise to further uncertainty, being expected that, sooner or later, ACEs incorporated within the financial and insurance markets lose the benefit from this VAT exemption.
ii) Challenges
During the last years, ACEs incorporated in Portugal have been under the radar of the Tax Authorities, which performed VAT adjustments to services supplied by these entities due to alleged non-abidance with the aforementioned conditions.
As a matter of example – with respect to condition i)[7] – instances have come across where the Authorities argue that ACEs supplying services to both members carrying out a VAT exempt activity and members not carrying out a VAT exempt activity (i.e., members with a pro rata equal or below and above 10%, respectively) could not benefit from the VAT exemption under analysis. The Tax Authorities consider that, in such a scenario, all services supplied by the ACE should be VATable.
This contamination effect stems from the Circular Letter no. 30084, from 10 November 2005, which has been guiding the Tax Authorities since its publication.
A few cases reached the Higher Courts: as a matter of example, both the STA and the Tribunal Central Administrativo Sul ruled that, the fact that one of the ACE’s members momentarily has a pro rata higher than 10% shall not lead to the loss of the VAT exemption. As per both decisions, only services provided to members which do not respect such condition should fall outside the scope of the exemption[8].
Notwithstanding these decisions, the Tax Authorities did not change their position, arguing in several tax audits that the above-mentioned Circular Letter no. 30084, from 10 November 2005 was still in force.
Whilst the Higher Courts ruled against the contamination effect when a member of an ACE momentarily has a pro rata above 10%, more recently, the STA confirmed[9] that such effect should play a role in situations where one of the members is originally incorporated as a taxable person with full right to recover input VAT, i.e., services supplied by the ACE to all members shall be subject and not exempt from VAT in these cases.
These recent decisions came as a surprise, as they not only go against the Court’s past position, but also that of VAT experts[10]. Furthermore, no element from the wording of this legal provision seems to imply a necessary distinction between the VAT treatment applicable to services supplied by ACEs to their members momentarily having a pro rata above 10% and to members having a pro rata above 10% at the moment of their incorporation. Nonetheless, ACEs should not ignore these decisions when modelling their flows of services.
Still with respect to condition i), ACEs supplying services to both members and third parties have also been scrutinised by the Tax Authorities. Audits to perform VAT adjustments have been undertaken in this respect as the Tax Authorities are of the view that ACEs simultaneously supplying services to members and non-members should not benefit from this exemption. The contamination effect is also present in such situations. To the best of our knowledge, no (higher court) decision has been issued in Portugal specifically covering this issue.
The exemption has also been often denied on the basis that condition ii)[11] is not fulfilled. In such cases, the Tax Authorities deny the benefit of the exemption to more general services – such as IT, security and cleaning -, arguing that these are not specifically related to the member’s activity. This has also been the Tax Authorities’ position in one answer to a binding ruling requested by a taxpayer[12].
The above-mentioned situations exemplify the restrictive approach taken by the VAT Authorities regarding the scope of application of the VAT exemption under analysis. This restrictive approach, sometimes not in line with the case-law produced by the Higher Courts, led (and still leads) to recurrent litigation between ACEs and the Tax Authorities, creating an undesirable level of uncertainty at the level of the involved groups.
If, at a national level the situation was already challenging, in 2017 several decisions issued by the ECJ caused a revolution for ACEs incorporated within the financial and insurance sectors: as an example, in DNB Banka (C-326/15) and Aviva (C-605/15) cases, the ECJ ruled that the VAT exemption is limited to groups whose members carry out a (VAT exempt) activity in the public interest, i.e., an activity listed in the different paragraphs of Article 132 of the EU VAT Directive. As an immediate consequence, as financial and insurance activities are not listed in Article 132 – but instead in Article 135 – of such Directive, groups incorporated within these sectors may not benefit from the exemption set out for services provided by independent groups of persons to their members. The Court ruled though that these decisions should only produce effects for the future (and, therefore, past tax periods may not be re-opened by the Member-States’ Tax Authorities).
For future periods, the effects of these decisions are not immediate. Indeed, the ECJ’s case-law does not have direct application, but should definitely pressure Member-States to review their domestic laws. EU law infringement procedures may also be started by the European Commission against the Member States which do not review their domestic laws.
Unlike other Member-States[13], Portugal has not (yet) put an effort to adjust its domestic law to align it with the ECJ’s interpretation of the EU VAT Directive – 5 years have passed since these two decisions were released and no official information has been issued in this respect.
Unlike other Member-States, Portugal did not speed up the process of implementing a VAT grouping scheme and remains, therefore, one of the few countries in the EU which does not have such a scheme.
The above-mentioned ECJ case-law aligned with the inaction of the Portuguese Authorities leads to huge uncertainty for financial and insurance groups incorporated in Portugal, which, in most situations, end up opting to dismantle their ACEs and choose less competitive arrangements. The more years pass without an action, the less competitive Portugal is in comparison to its EU neighbors.
Afonso Costa Gomes
novembro 2022
[1] Council Directive 2006/112/CE, of 28 November (“EU VAT Directive”).
[2] This VAT exemption is foreseen in Article 132(1)(f) of the EU VAT Directive and has been transposed to Article 9 (21) and (22) of the Portuguese VAT Code.
[3] As, in principle, the acquisition of services by the ACE – instead of by one of each member – will lead to scale gains at the level of the group.
[4] The version of Decree-Law no. 394-B/84, of 26 December.
[5] In Article 11 of the EU VAT Directive.
[6] The benefit of this regime is clear: intra-group services provided between the VAT group members are considered outside the scope of VAT and, therefore, no irrecoverable VAT costs should arise at the level of the group members in respect to intra-group transactions.
[7] “The members carry out a VAT exempt activity (i.e., the members have a VAT recovery ratio lower than 10%, as per the wording in force since 1999)”.
[8] We refer to decision issued by Supremo Tribunal Administrativo in process no. 01231/12, of 12 February 2014 and to decision issued by Tribunal Central Administrativo Sul in process no. 05774/12, of 10 July 2012, respectively.
[9] Please see in processes no. 0659/16.7BECBR, of 8 September 2021 and no. 0327/15.7BECBR, of 21 September 2022, from Supremo Tribunal Administrativo.
[10] We refer, at the EU level, to the position of the VAT Expert Group in Working Paper no. 856 and, at the national level, to the position held by Prof. Xavier de Basto in “Cadernos de Ciência e Técnica Fiscal”, of June 2007.
[11] “Services should be “directly necessary” for the members’ activities”
[12] See Ficha Doutrinária issued in process no. 4185, of 23 September 2013.
[13] Such as the cases of France, Luxembourg and Belgium.