6.3.2.3 No recovery of VAT on costs that exceed what is objectively necessary to allow a business to carry out its taxed transactions

This is a relative ‘newcomer’ to the scene of non-deductible VAT. The concept was introduced by the CJEU in the Iberdrola-case,1 where a business took upon it the costs of restauration/refurbishment of an immovable property belonging to an unrelated third party, because it needed that property to function properly to ensure that the business could perform its own, taxed, business activities.

Without the reconstruction of that pump station (the immovable property belonging to the third party), it would have been impossible to connect the buildings which the business planned to build (and exploit for consideration) to that pump station, with the result that that reconstruction was essential for completing that project and that, consequently, in the absence of such reconstruction, the taxable person would not have been able to carry out this economic activity.

According to the CJEU, the circumstances of the case were likely to demonstrate the existence of a direct and immediate link between the reconstruction service in respect of the immovable property belonging to the third party and a taxed output transaction by the business, since it appears that the service was supplied in order to allow the latter to carry out the construction project at issue in the main proceedings. The fact that the third party also benefitted from that service could not justify the right to deduct corresponding to that service being denied to the business if the existence of such a direct and immediate link was established.2

In that regard, the CJEU considered it to be necessary to take into account the fact that the input reconstruction service at issue in the main proceedings is a component of the cost of a taxed output transaction by the business. According to the CJEU, the referring court should examine whether that service was limited to that which was necessary to ensure the connection of those buildings to the immovable property at issue in the main proceedings or whether that service went beyond that which was necessary for that purpose.3

In the first situation, it would be necessary to recognise a right to deduct the input VAT levied on all the costs incurred for the reconstruction of the pump station since those costs can be regarded as having a direct and immediate link with the general costs connected with all the economic activities of the taxable person. However, if the reconstruction works relating to that pump station exceeded the needs created solely by the buildings constructed by the taxable person, the existence of a direct and immediate link between that service and the taxed output transaction by the taxable person, consisting of the construction of those buildings, would be partially broken and a right to deduct would thus have to be recognised in respect of the taxable person only for the input VAT levied on the part of the costs incurred for the reconstruction of the pump station which was objectively necessary to allow the taxable person to carry out its taxed transactions.4

It seems that the CJEU introduced a kind of ‘necessity test’ for the deduction of VAT on costs or investments that also benefit a third party. Because the relevant CJEU case is the first in which this test is mentioned, I will assume that this (possible) infringement of the right to deduct VAT, being a fundamental principle underlying the common system of VAT, should be interpreted strictly, as should all exceptions to general VAT principles.5 Therefore, I will assume that this rule only applies to situations where costs are made for services performed to goods that are owned by a third party which also profits from these services.