The European Court of Justice has decided that partnerships can be considered closely bound to a VAT group by a financial link even if some partners of that partnership are not themselves linked to the VAT group. According to the court, a partnership is linked to the VAT group as soon as the head of the VAT group, with its statutory right to vote, can dominate the partnership. On the other hand, according to the opinion of the V. Senate of the Highest German Tax Court and of the German Ministry of Finance, a partnership can only be considered a controlled company in a VAT group if all shareholders are financially integrated into the controlling company.
The EU VAT directive provides member states with an option to regard several legally independent taxable persons as a single taxable person for VAT purposes (VAT group) if these persons are closely bound to one another by financial, economic and organizational links. The German legislator historically has been rather restrictive when adopting the VAT grouping rules. By the very letter of the law, only legal entities can be considered members of a VAT group. In Larentia + Minerva (C-108/14), the ECJ decided that this narrow application of the VAT grouping conflicts with the basic principle of equal treatment of all legal forms of organization under the harmonized European VAT law. The EU VAT directive provides that all legally independent taxable persons can be regarded as a member of a VAT group as long as they perform a taxable activity. A partnership can be a taxable person, so there is no reason to exclude partnerships from VAT groups. One of the chambers of the German Federal Tax Court interpreted this judgment to mean that partnerships can be included in a VAT group only if its partners are financially linked to the head of a VAT group. This basically means that a partnership could only be part of a VAT group if its partners are ultimately legal entities held by the head of the VAT group. The court considered that partnerships often require unanimous decisions under corporate law or the partners can amend voting rights based on oral agreements, which makes it impossible to have stable financial links to the head of a VAT group.
In its new judgment, the ECJ has disagreed with this restrictive interpretation of its earlier decision and held the view that a partnership can be financially linked as soon as one of the partners has a majority of the statutory voting rights. In particular, the court rejected the argument that the possibility to easily amend the statutory voting right would create a risk of tax fraud when this risk is merely theoretical and has not been substantiated by the authorities in a court hearing. The court thus argued that the objective of preventing tax avoidance does not constitute justification for the restrictive German regulation on VAT groups, since this would require a number of objective indications of abusive practice and not just a theoretical danger. In our view, this is an interesting point, which may also become relevant in other constellations where formal requirements may not be in line with an actual need to combat VAT fraud.
The German tax authorities will need to accept that partnerships have financial links and, therefore, can be considered closely bound to a VAT group in more cases going forward. At present, tax payers can rely on the VAT guidelines published by the authorities or choose to adhere to the principles set out in the case law (i.e., when the German fiscal court publishes its follow up decision to the ECJ ruling). Going forward, we expect that the authorities will change their VAT guidelines. At that point, businesses should be aware that the VAT grouping is mandatory, so a qualifying partnership would instantly be included in a VAT group with no further action or application (even if this is not desired). Of course, there might be a possibility to keep a partnership out of a VAT group in some cases when the statutory voting rights can be amended in a way that would not financially link the partnership to the head of the VAT group.
It is worth mentioning that there are currently additional ECJ referrals (C-141/20 and C-269/20) that are still pending, which are also of central importance for VAT grouping in Germany. In these referral cases, the ECJ has to decide who is liable for tax in the VAT group: the controlling company or the group as the new taxpayer. If it turns out to be the group, such a result would not be in line with the current German practice, and it might be associated with considerable tax losses for the German tax authorities. Company groups could take the position that there is simply no tax debtor under the past and current VAT grouping rules. However, a judgment that is fully against the position of the German tax authorities does not appear to be likely. In any event, the referrals show that there is an urgent need to question and amend or fully revise the VAT grouping rules in Germany.
Independent from that, the German legislature should consider the ECJ judgment as an opportunity and revise the legal requirements for VAT grouping — ideally by introducing a new application procedure involving the tax administration. The ECJ has indicated in the above judgment that it may be a better solution to make the VAT group optional and subject to permission upon request of the taxpayer under certain conditions. Such a procedure would indeed avoid cases of unrecognized VAT groups and of incorrectly assumed VAT groups as well as related extensive reversal procedures.
