a) Introduction
VAT has the unique characteristic of applying to all stages of the economic circuit, however only representing a burden to those who actually consume the good/service resulting from that circuit (the so-called “final consumers”)[1].
This happens due to the application of the “principle of neutrality”, according to which VAT should not materialise in a cost for the taxable persons intervening in a supply chain, but rather in a cost for consumers[2].
Notwithstanding its relevance within the VAT system, the right to deduct VAT is subject to some limits, which I believe should be split in two different categories:
- limits related to the functioning of the tax; and
- limits aimed at mitigating tax avoidance.
In the first category, the following are identified as (sub)limits to the right to deduct VAT:
- objective limits (as per the aforementioned Article 168 of the VAT Directive, VAT may only be deducted on costs incurred to carry out output operations granting the right to input VAT recovery);
- subjective limits (only taxable persons within the meaning of Article 9 of the VAT Directive are entitled to deduct input VAT);
- formal limits (the deduction of input VAT shall be supported by a valid invoice, as established by Article 178 of the VAT Directive) and finally;
- temporal limits (as per Article 179 of the VAT Directive, the deduction shall, in principle, be undertaken within the same tax period in which the tax became chargeable).
The second category of limits consist of domestic provisions adopted by EU member-states, listing categories of expenses for which related input VAT is a priori not deductible (regardless of the objective, subjective, formal and temporal limits mentioned above).
The below analysis will focus on this second category of limits given that they have given rise to extensive litigation in Portugal.
b) Limits aimed at mitigating tax avoidance
Almost all EU member-states have currently in force domestic provisions restricting the right to recover input VAT aimed at mitigating tax avoidance[3]. These find their grounds in Article 176 of the VAT Directive[4], which reads as follows:
“The Council, acting unanimously on a proposal from the Commission, shall determine the expenditure in respect of which VAT shall not be deductible. VAT shall in no circumstances be deductible in respect of expenditure which is not strictly business expenditure, such as that on luxuries, amusements or entertainment.
Pending the entry into force of the provisions referred to in the first paragraph, Member States may retain all the exclusions provided for under their national laws at 1 January 1979 or, in the case of the Member States which acceded to the Community after that date, on the date of their accession”.
This provision grants the Council of the EU the competence to list the costs on which input VAT may not a priori be recovered. The aim is to ensure that there is no tax deduction on costs that are (or may be) easily diverted to private consumption.
Until now, the Council has not been able to reach an agreement on the list of expenses in respect to which VAT may not be deductible. Therefore, the first paragraph of this provision is of limited relevance, but the second paragraph – in bold – is of greater relevance.
Such paragraph establishes the so-called “standstill clause”, which determines that in the absence of a list published by the Council – which, as of today, is the case -, EU member-states may apply their domestic provisions on exclusions from the right to deduct VAT, provided that such domestic provisions were in force as at 1 January 1979 (date of entry into force of the Sixth Directive) or as at the date they joined the EU.
Due to its unclarity, this paragraph has been the subject of several case-law reaching the ECJ, which has provided some guidance on how this clause should be interpreted, as follows[5]:
- member-states part of the EU as at 1 January 1979 – date of the entry into force of the standstill clause (and of the Sixth VAT Directive) – may apply the exclusions to the right to recover input VAT foreseen in their domestic legislation as at that date[6];
- member states joining the EU after 1 January 1979 may apply the exclusions to the right to recover input VAT foreseen in their domestic legislation, provided that such provisions were in force in the date the member-states at hand started to be bound to the European VAT system[7];
- in all cases, further amendments introduced by member-states to their domestic provisions shall only receive protection of the standstill clause if they reduce the scope of the exclusions / restrictions. If that is not the case, these domestic provisions will no longer be covered by the standstill clause.[8]
C) The Portuguese experience
Before Portugal joined the EU (at the time called European Economic Community), no VAT was imposed therein[9]. Interestingly, the levy of this tax was one of the conditions for Portugal to be accepted by the EU.
The initial version of the Portuguese VAT Code entered into force in 1 January 1986 – the date Portugal (and Spain) officially joined the EU – and listed the expenses for which input VAT could not be deducted[10]. Although the Portuguese VAT Code entered into force on the previously mentioned date, Portugal only became bound to the EU VAT system in the 1 January 1989, as a 4-year transitory period for the entry into force of the Sixth VAT Directive was agreed.
In short, the following categories of expenses were listed: i) expenses related to the purchase / use of motor vehicles for “tourism vehicles”[11], ii) fuel expenses (with the exception of diesel, which could be recovered in 50%), iii) transportation expenses, iv) hotels, food & beverage, tobacco and reception expenses and v) luxury expenses.
A major exception is foreseen for the expenses mentioned in i), when they concern goods that constitute the main activity of the taxpayer (e.g., the purchase and maintenance of a taxi by a taxi driver).
Over the years, a few amendments to this list were made, all reducing the scope of the applicable restrictions.
The fact that the restrictions to input VAT deduction are against the nature of this tax, together with the stage of maturity that VAT reached in Portugal led, in my opinion, to a wave of challenges by the taxpayers. Entities that incurred expenses in the context of their businesses for which VAT cannot a priori be deductible (listed in Article 21 of the Portuguese VAT Code) felt discriminated, as such expenses were necessary for them to carry out their business activities. Therefore, arguments were found to challenge the non-recoverability rule.
Some taxpayers sustained that these restrictions to the right to recover input VAT constitute “irrefutable presumptions”[12], which contradicts Article 73 of the Portuguese General Tax Law (“Lei Geral Tributária”)[13].
Process no. 298/2020-T of the Portuguese Arbitration Court[14] is one of the examples where such an argument was used: in this case, an entity incorporated as an employers’ confederation deducted input VAT[15] incurred on costs related to both the organization and the entrance in events[16]. In the context of a tax audit carried out by the Portuguese Tax Authorities, the latter concluded for the (partial) non-deduction of such input VAT amounts, as the corresponding expenses were listed in Article 21 of the Portuguese VAT Code.
Disagreeing with this outcome, the confederation presented a claim before the Arbitration Court, arguing that during the tax audit, it had not been granted the possibility to demonstrate the link between the costs at stake and the output taxable activities carried out. As per the confederation’s view, this denial contradicts Article 73 of the Portuguese General Tax Law, which foresees that presumptions in tax incidence rules should be rebuttable.
The Arbitration Court decided that Article 21 of the Portuguese VAT Code constitutes a tax incidence provision only depending on the legal subsumption of facts to such legal provision, and not a tax presumption. Consequently, the confederation was not able to recover part of the input VAT amounts incurred.
It is interesting to point out that, when requested to review comparable factual situations, other courts, such as the Central Administrative Court[17] (“Tribunal Central Administrativo Sul”) took the exact opposite view concerning the nature of Article 21 of the Portuguese VAT Code.
As an example, in process no. 1113/05.8 BELSB[18] the Central Administrative Court reviewed the right of a Swiss entity to be refunded of Portuguese VAT incurred in expenses covered by Article 21 of the VAT Code, arguing that the coherence of the VAT system and the principle of neutrality determine that the provisions in Article 21 of the VAT Code must be interpreted as rebuttable presumptions. The Court further added that, given the inadmissibility of irrebuttable presumptions in the Portuguese Tax Law (due to the aforementioned Article 73 of the General Tax Law), the provisions of Article 21 of the VAT Code must admit proof to the contrary.
Bearing in mind that the Swiss entity had, during the process, shown that the costs about which VAT was seeking refund were incurred in the context of its taxable operations, the Central Administrative Court concluded that this entity had the right to be refunded from the Portuguese VAT incurred.
Other older court decisions supporting this view, such as the Arbitration Court’s decision in process no. 338/2013-T[19] may be found.
The subject is everything but clear and the (un)harmonised case law is allowing a few taxpayers to exercise their right to recover VAT in full, whereas others – in comparable situations – are not being able to prove their point.
In my view, given both the wording and the context of Article 21 of the VAT Code, it is difficult to sustain that this provision does not include presumptions. It includes presumptions – implicit presumptions, but still presumptions. Once the presumptive nature of these provisions is established, not letting the taxpayers demonstrate a link between the costs incurred and their output operations carried out seems to contradict the already mentioned Article 73 of the General Tax Law[20].
Other taxpayers tried a different line of argumentation – invoking EU principles – to challenge the validity of the provisions restricting the right to recover VAT.
This was the case of The Navigator Company, S.A. and Navigator Pulp Figueira, S.A. which incurred costs with vehicles, hotels and representation expenses in the context of their businesses and argued that the different rules co-existing in Portugal for direct tax (Corporate Income Tax) and indirect tax (VAT) were against the EU “principle of equivalence”[21].
At the time of the facts, and differently from the Portuguese VAT Code, the Portuguese Corporate Income Tax Code foresaw the deductibility of these expenses to the taxpayers’ taxable profit.
Being confronted with this argument by the first time, and assuming that no ECJ decisions are known in this particular concern, the Arbitration Court stayed the proceedings and requested the ECJ’s preliminary ruling on the conformity of the domestic provisions with the principle of equivalence set out by the EU law.
In Navigator Company case (C-459/21), the ECJ clarified that the principle of equivalence is procedural and may therefore not apply to material situations – i.e., the right to recover input VAT. Based on this argument, the ECJ concluded that the principle of equivalence does not disallow domestic legislation of a member-state – such as Article 21 of the Portuguese VAT Code – foreseeing the non-deductibility of specific costs, even when such costs are deductible for Corporate Income Tax purposes.
Since no other arguments were presented by the entities before the Arbitration Court, this Court decided in line with the ECJ’s preliminary ruling and, as such, denied The Navigator Company, S.A. and Navigator Pulp Figueira, S.A’s right to recover the VAT incurred on the expenses at stake (please refer to CAAD’s decision in process no. 513/2020-T[22]).
Finally, it has also been argued by some entities that, as Portugal did not impose VAT before joining the EU, Article 21 of the Portuguese VAT Code contradicts the standstill clause foreseen in Article 176 (2) of the VAT Directive.
This was the position of Super Bock Bebidas, S.A. – a beer manufacturing company – which, in the context of its activity, incurred costs in meals, accommodation, car rentals, tolls and fuel.
This entity’s position was that, considering that the standstill clause expressly refers to the date of the state’s accession to the EU as the relevant moment to determine if domestic provisions restricting the right to recover input VAT were in force, and Portugal did not impose VAT before such date, no such provisions could have been in force in this country.
Being required to review the conformity of the aforementioned Article 21 of the Portuguese VAT Code with the standstill clause, the Arbitration Court decided to stay the proceedings and request – again – the ECJ’s preliminary ruling on the conformity of the domestic provision with the EU clause.
The ECJ ruled that the standstill clause applies to the restrictions to input VAT recovery foreseen in the Portuguese domestic law and, as a consequence, Portugal has the right to exclude these specific expenses from the right to recover VAT (even if linked with the taxable activities performed by the taxpayers)[23].
In my view, the Court is not clear on which date should be considered the relevant date to ascertain the applicability of the standstill clause: 1 January 1986 (date of Portugal’s accession to the EU) or 1 January 1989 (date the Sixth VAT Directive entered into force in Portugal)? However, as in its decision the ECJ refers to its previous decisions regarding other member-states mentioning the date the Sixth VAT Directive started to bind them as the relevant date, I understand that the same reasoning was applied in this case. This reasoning justifies the Court’s conclusions.
Despite the aforementioned decision – dated 17 September 2020 -, a few months ago the Arbitration Court concluded for the non-applicability of the standstill clause to Article 21 of the Portuguese VAT Code (please refer to CAAD’s process no. 607/2022-T).
In this process, a car manufacturing company incurring VAT on the purchase of transport services for the benefit of its employees[24] claimed its right to recover such tax, arguing that it was able to link such expenses with its taxable output activities.
In this regard, when reviewing the applicability of the standstill clause, the Court surprisingly opted to refer to the ECJ’s decision previously issued in Maritza case (process C-124/12), a case where Bulgaria’s domestic provisions – and not the Portuguese ones – had been reviewed…
In that case, the ECJ had been required to review the validity of Bulgaria’s domestic VAT law provisions restricting the right of taxpayers to recover input VAT, taking into account that on the date of its accession to the EU, Bulgaria opted to amend its VAT law previously in force, introducing further restrictions to the right to recover VAT in respect to some categories of expenses[25].
Given this fact pattern, the ECJ had ruled that “[…] the ‘standstill’ clause, provided for in the second paragraph of Article 176 of Directive 2006/112, is not intended to allow a new Member State to amend its domestic legislation on its accession to the European Union in a way which diverts that legislation from the objectives of that directive”, concluding that “[…] Article 176 of Directive 2006/112 is to be interpreted as precluding a Member State, on its accession to the European Union, from introducing a limitation on the right to a deduction under a national legislative provision […] when such an exclusion was not provided for in the national legislation in force until the date of that accession”.
By applying the conclusions reached by the ECJ in the aforementioned case to the process under review, the Arbitration Court decided by the Portuguese car manufacturer’s right to recover input VAT.
In my view, the Arbitration Court incurred a critical mistake when comparing both cases: if in Maritza the ECJ had concluded that, by excluding from the right to recover VAT expenses that until the date of such country’s entry into the EU were recoverable, Bulgaria’s domestic VAT law did not comply with the standstill clause, one may not arrive to same conclusion in the case of Portugal.
Differently from Bulgaria, Portugal did not impose VAT before joining the EU and benefitted from a 4-year transitional period between the date the Portuguese VAT Code entered into force (1 January 1986) and the date the Sixth VAT Directive started to apply to it (1 January 1989).
These facts were relevant for the ECJ to conclude, in Super Bock Bebidas, S.A. case, that the expenses foreseen in Article 21 of the Portuguese VAT Code were covered by the standstill clause.
It is my – and others’ – understanding that, since on the date the standstill clause started to produce effects in Portugal – i.e., 1 January 1989 – Portugal had domestic provisions excluding specific expenses from the right to recover VAT, which had entered in force 4 years before, these domestic provisions are covered by the standstill clause. This is the conclusion reached by the ECJ in Super Bock Bebidas, S.A.[26] case, that was completely ignored by the Arbitration Court in process no. 607/2022-T.
Most likely the Portuguese Tax Authorities will appeal from this decision.
d) Final remarks
Different arguments have been used by VAT taxable persons to challenge the rules restricting the right to recover VAT incurred on the expenses listed in Article 21 of the Portuguese VAT Code.
Although all the arguments have their merits, challenges based on (potentially) EU law violations by Article 21 of the Portuguese VAT Code have not succeeded. This may be because both the scope of application of the standstill clause and the content of the principle of equivalence have already been reviewed by the ECJ in several decisions. In the particular case of the standstill clause, the above-mentioned Super Bock Bebidas,.S.A case is quite clear in mentioning that the Portuguese VAT provisions are covered by such clause (the decision is probably less clear in detailing the reasoning adopted).
On the other hand, arguments based on the relationship between Article 21 of the Portuguese VAT Code and Article 73 of the General Tax Law should be further explored as, so far, the Arbitration Court has not been able to convincingly conclude that the list of expenses included in such a provision do not constitute presumptions. Also, one should expect taxpayers to try to take advantage from the contradictory case-law already published in this regard. Thus, further litigation is definitely expected.
Afonso Costa Gomes
January 2024
[1] This aim is mentioned on the second and third paragraphs of Article 1 of Council Directive 2006/112/EC, of 28 November (hereinafter referred to “VAT Directive”): “On each transaction, VAT, calculated on the price of the goods or services at the rate applicable to such goods or services, shall be chargeable after deduction of the amount of VAT borne directly by the various cost components” and ”The common system of VAT shall be applied up to and including the retail trade stage”.
[2] In practice, this principle is applicable through the deduction mechanism, according to which each taxable person intervening in a supply chain may deduct, from the VAT amounts to be charged on their sales (output VAT), VAT incurred on the expenses (input VAT). This mechanism is foreseen in Article 168 of the VAT Directive, and its relevance has been further explained by the European Court of Justice (“ECJ”). See inter alia the ECJ’s ruling in Grupa Lotos S.A. case (C-225/18):
- “[…] the right of deduction provided for in Article 168(a) of the VAT Directive is an integral part of the VAT scheme and in principle may not be limited. The right to deduct must be exercised immediately in respect of all the VAT charged on transactions relating to inputs […]”;
- “the deduction system is intended to relieve the trader entirely of the burden of the VAT payable or paid in the course of all his economic activities. The common system of VAT consequently ensures neutrality of taxation of all economic activities, whatever their purpose or results, provided that they are themselves subject in principle to VAT […]”;
- “It follows from this that, in so far as the taxable person, acting as such at the time when he acquires goods or receives services, uses those goods or services for the purposes of his taxed transactions, he is entitled to deduct the VAT paid or payable in respect of those goods or services […]”
[3] Please refer to the review carried out by Carlos Baptista Lobo and Daniel S. de Bobos-Radu in “Restrições do Direito à Dedução do IVA & Direito Constitucional Europeu” (Cadernos do IVA, 2020), where the Authors provide us with a comparative analysis of the different restrictions to the input VAT recovery right in force within the EU. As per the Authors, Portugal and Greece are amongst the member-states with more strict rules in this concern (i.e., imposing more and more strict limitations to the right to recover input VAT), whereas Germany, Slovakia and Luxembourg do not have, in their domestic laws, expenses which VAT is a priori not recoverable.
[4] The predecessors of the VAT Directive, namely Directive 77/388/EEC of 17 May 1977 (“the Sixth VAT Directive”) also had similar provisions on this subject.
[5] Carlos Baptista Lobo and Daniel S. de Bobos-Radu (in chapter 6 of the above-mentioned Article) and Maria Odete Oliveira (in chapter 3.2 of “O Despacho do Tribunal de Justiça, de 17 de Setembro de 2020 no Processo c-837/19, Super Bock bebidas S.A., sobre a compatibilidade das disposições do artigo 21º do Código do IVA português com a Directiva Europeia. Alguns comentários”) have done interesting comparative analysis on the several ECJ case-law issued in this concern.
[6] Please refer to the ECJ decision in joint cases X Holding BV and Oracle Nederland BV, processes C-538/08 and C-33/09.
[7] If this date is typically the date the member state at stake joined the EU, it may not necessarily be the case. As decided by the ECJ decision in Super Bock Bebidas, S.A. case (process C-837/19), the Court confirmed that the standstill clause applies to the restrictions to input VAT recovery in force in Portugal on the date of this country’s accession to the EU (i.e., 1 January 1986), considering that, due to a transitory agreement, the Sixth VAT Directive only entered into force in Portugal in 1 January 1989.
[8] Please refer to the ECJ decision in Commission vs. France case (process C-345/99).
[9] A consumption tax, named Imposto sobre as Transacções was in force.
[10] The initial version of Article 21 of the Portuguese VAT Code may be found in here: https://diariodarepublica.pt/dr/detalhe/decreto-lei/394-b-1984-605547
[11] The term is further defined on this provision.
[12] As taxpayers are not given the right to demonstrate the (possible) link between their expenses and the output activities carried out.
[13] This provision establishes [in Portuguese]: “As presunções consagradas nas normas de incidência tributária admitem sempre prova em contrário”
[14] Which may be found in https://caad.org.pt/tributario/decisoes/decisao.php?s_processo=298%2F2020-T&s_data_ini=&s_data_fim=&s_resumo=&s_artigos=&s_texto=&id=5567
[15] According to the pro rata method.
[16] According to Article 21 of the Portuguese VAT Code, VAT incurred on costs related to the organization of events is deductible in 50%, whereas VAT incurred on costs related to the participation in events is deductible in 25%.
[17] The second instance judicial court in tax matters.
[18] Which may be found in http://www.dgsi.pt/jtca.nsf/170589492546a7fb802575c3004c6d7d/51035ff19aa33e47802587890039bbbe?OpenDocument
[19] Which may be found in https://caad.org.pt/tributario/decisoes/decisao.php?s_iva=1&s_processo=238&s_data_ini=&s_data_fim=&s_resumo=&s_artigos=&s_texto=&id=292 .
[20] Although, one must note that some literature takes the opposite view. Please see Sérgio Vasques, in “IVA, Direito à Dedução e Presunções Tributárias: a Jurisprudência do CAAD” (Cadernos do IVA, 2017) who interprets Article 73 of the General Tax Law more narrowly.
[21] This principle establishes that the procedural rules governing actions for safeguarding the rights that taxpayers derive from EU law (e.g., rights deriving from the application of the VAT Directive) must not be less favorable than those governing similar domestic actions (with this regard please see, inter alia, the ECJ’s decision in Dragos case, process C-69/14).
[22] It is worth to note that, in the meantime, the same parties presented a new complaint before the Arbitration Court, in respect to VAT incurred on costs during the year 2020 (the case mentioned above referred to the year 2018). Bearing in mind the similarity of facts and circumstances between the two cases, and considering the preliminary ruling given by the ECJ, the Arbitration Court also decided for the non-deductibility of VAT incurred by the entities on costs during the year 2020 (please refer to CAAD’s decision in process no. 476/2022-T).
[23] Please refer to the Order of the Court: “[…] Article 176 of Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax must be interpreted as not precluding legislation of a Member State which came into force after the date of accession of that Member State to the European Union, and according to which the exclusions from the right to deduct value added tax charged on expenditure relating to, in particular, accommodation, food, drink, vehicle leases, fuel and tolls, also apply where it is established that that expenditure was incurred for the purchase of goods and services used for the purposes of taxed transactions”.
[24] The company explains that, due to the remote place where it operates and lack of public transportation, it was required to contract transport services from a third-party, which transports the employees from specific meeting points in the surrounding villages to its premises.
[25] In particular those amendments denied the deduction of VAT incurred in goods and services intended to be supplied free of charge.
[26] For further details on the Super Bock Bebidas, S.A., please refer to Maria Odete Olivera’s comments in “O Despacho do Tribunal de Justiça, de 17 de Setembro de 2020 no Processo c-837/19, Super Bock bebidas S.A., sobre a compatibilidade das disposições do artigo 21º do Código do IVA português com a Directiva Europeia. Alguns comentários”.