The Court of Justice of the EU (CJEU) in the Bulgarian case of Iberdrola has provided reassurance to those concerned by the earlier Advocate General (AG) Opinion that cast doubt on the ability of taxpayers to recover input tax in respect of expenditure on assets which do not belong to that taxpayer.
The particular issue here was whether the input tax incurred by the taxpayer on renovating public infrastructure assets as part of a wider property development was deductible by the taxpayer in circumstances where the public authority did not pay for the works and used the assets for its own provision of public services.
Background
Iberdrola owned land on which it planned to construct a holiday village and lease it on a taxable basis. In order to connect the new village to the existing municipal waste-water pump station so that waste water could be collected, the pump station had to be extensively renovated. Iberdrola therefore undertook to carry out the repair of this public authority infrastructure at its own expense.
The holiday village could not be used for its intended purpose until the renovation was carried out and, although not entirely clear, it also appears that the public authority's permission for the development was conditional on Iberdrola carrying out the renovation free of charge.
The question was whether Iberdrola was entitled to deduct input tax on the renovation costs on the basis that there was a link to its taxable economic activity of granting leases of holiday accommodation, even though it made renovation supplies free of charge to the public authority, which used the infrastructure to conduct its waste-water disposal activities.
Causal link between necessary costs and taxable activity
According to the AG, the acknowledged causal link between the renovation costs and Iberdrola's taxable activity was not a "direct and immediate" link such as to allow the input tax to be deducted because it was the public authority and not Iberdrola that would be "using" the renovated pump station.
This caused concern that investors or developers in the analogous situation of providing infrastructure or improvement works under a section 106 Town and Country Planning Act agreement, or similar, could have been unable to deduct related input tax in the absence of a fee charged to the public authority for the services.
In the UK, HMRC has historically accepted that input tax on costs incurred in connection with such planning obligations is recoverable on the basis that these costs are attributable to supplies of land and buildings on the development in respect of which planning approval was given; any change to this position would have disrupted the financial modelling of many transactions.
Reassuringly, however, the CJEU considered that the input tax on the pump station renovation costs was deductible by Iberdrola.
It took the view that, because the reconstruction was essential for completing the holiday village project and, in the absence of the renovation, Iberdrola would not have been able to carry out its economic activity, the "direct and immediate link" required for input VAT recovery did exist. The fact that the municipality also benefited from the services could not justify denying Iberdrola the right to deduct.
The CJEU did note that the services must not go beyond what is necessary for the taxpayer's purposes, but it is clear that this would not be a cliff-edge test. If the services provided did go beyond what was necessary, the direct and immediate link would be partially broken and a right to deduct would only be recognised to the extent of the input VAT levied on the objectively necessary part of the incurred costs.
Structuring s.106 arrangements
We would not expect any change in the UK VAT recovery position of developers incurring costs on public assets or infrastructure following the CJEU's decision in this case.
However, as noted in our July Newsletter, it may still be beneficial from a capital allowance perspective to structure arrangements under section 106 agreements to involve payment of a fee by the person owning the asset on which the expenditure is incurred e.g. a local authority (who could be put in funds, if necessary, by means of a capital contribution). This would enable the taxpayer to claim contribution allowances and, assuming that the owner of the asset is using the asset directly for its taxable business, it would normally be able to recover the input VAT on this fee.
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