8.2 A direct and immediate link

According to the fundamental principle which underlies the VAT system, VAT applies to each transaction by way of production or distribution after deduction of the VAT directly borne by the various cost components.1 It follows from that principle, as well as from the rule that, in order to give rise to the right to deduct, the goods or services acquired must have a direct and immediate link with the taxable transactions, that the right to deduct the VAT borne by those goods or services presupposes that the expenditure incurred in acquiring them is part of the cost components of the taxable transactions. That expenditure must therefore form part of the costs of the output transactions which use the goods and services acquired.2 Beelen refers to this rule as ‘the rule of on-charged costs’.3 The CJEU has since clarified that costs do not have to actually be included in the price of specific taxed output for the VAT on those costs to be deductible.4

If costs of goods or services are not directly and immediately linked to taxed output in the above sense, those costs can still form part of a taxable person's overheads. As such, these costs are considered cost components of the economic activity of the business as a whole. The costs of these goods and services have a direct and immediate link with the whole economic activity of that taxable person.5 The VAT on such costs can be deducted according to the ‘general’ VAT recovery right of the business.

In some sectors, such as insurance and games of chance, goods and services can be purchased that will be used for the provision of the business’ actual business activities, but that can be perceived as being provided free of (additional) charge. For example, if a person takes out car insurance that will ensure that the car is repaired at no extra charge when it is broken, that person will (periodically) pay an insurance premium. From a VAT perspective, the essentials of an insurance transaction are that the insurer undertakes, in return for prior payment of a premium, to provide the insured, in the event of materialisation of the risk covered, with the service agreed when the contract was concluded.6 In my view, this means that the insured does not pay for the service (or goods) that he will receive, for example as restitution or part of a repair under the insurance agreement, but for the right to receive these in the event of materialisation of the risk covered. The premiums are, therefore, not (partial) prepayments for the agreed services or goods that may have to be provided to him when the insured risk materializes, but for the service of being covered/insured against the effect of the materialisation of the covered risk. The insurance company provide insurance services, it does not (as a general rule) sell goods or other services.

The same applies to organisers of games of chance, such as lotteries. A lottery is the distribution of prizes by chance where the persons taking part make a payment or consideration in return for obtaining their chance of a prize.7 Organisers of lotteries don’t sell goods or services (other than lottery services). However, they do distribute prizes, which can be goods and/or services, to the winners. The payments received for issuing the lottery tickets are, however, not consideration for the supply or distribution of those prizes.

Insurance services and gambling services such as lotteries are VAT exempt.8 This means that no VAT is charged on the insurance premiums or the payments for the lottery tickets, and the insurance company or the lottery organiser, as a main rule, cannot deduct the VAT on the costs that are directly related to these activities.9 This means that the VAT incurred by insurance companies and lottery organisers on the cost of the goods and services that will be distributed as a result of the materialisation of the insured risk will, as a general rule, not be deductible. A direct and immediate link exists between these goods and services and the insurance transactions or the lottery activities, because the expenditure for these goods and services will, as a general rule, be part of the cost components of those VAT exempt transactions or have a direct and immediate link with the whole economic activity of that taxable person.