4.5.2.6 Economic and commercial reality: possible exceptions to the main rule that ‘free elements’ are actually free

The concept of ‘commercial and economic reality’ is implicitly used by the CJEU in the Serebryannay vek-case,1 where parties had agreed that a supply would be made ‘for free’ but where, effectively, this transpired not to be the case. There was a legal relationship between the provider of the services and the recipient pursuant to which there was reciprocal performance, the remuneration received by the provider of the service constituting the value actually given in return for the service supplied to the recipient. In the circumstances of that case, a contract was concluded whereby the lessee of apartments did not have to pay rent to the lessor (the owners) during the term of the contracts. By contrast, the lessee undertook to carry out in its own name, at its expense and according to its own assessment, fitting-out and assembly work in order to complete the apartments and put them into service for the purposes of use, inter alia the purchase and provision of floors, furniture, decoration and bathroom installations. It was envisaged that, at the end of those contracts, the lessor (the owners) would recover the apartments concerned with the fixtures to be found there. The CJEU decided that this arrangement fell within the category of a supply of services for consideration.2

The above ruling makes clear that ‘commercial and economic reality’ should be used for determining the VAT treatment of transactions, even in situations where the (underlying) contractual agreements suggest a different outcome, where the ‘legally agreed reality’ (i.e. ‘not having to pay rent’) differs from the economic and commercial reality of a transaction (i.e. ‘paying rent in kind’).

Something similar happened in the Volkswagen case.3 In this case, Volkswagen made two separate supplies of services (lease of a vehicle and financing that vehicle). It had incurred costs that it had used for performing both services, but under UK legislation, it was only allowed to include those costs in one of the services (the financing services). The UK Tax Authorities therefore argued that these costs should only be (directly and fully) allocated to those transactions (which were VAT exempt, disallowing deduction of VAT on those costs). Even though the fact pattern is very different, the reasoning used by the CJEU to come to the decision that the costs should be allocated to both services because the costs were “in fact incurred, at least to a certain extent, for the purpose of” performing the non-exempt transactions. ‘In fact’ means ‘based on the relevant, objective facts’, which is equivalent to the concept of ‘economic and commercial reality’ as applied in this research. This means that actual factual reality trumps legal, deemed, realities or legally agreed realities where these deviate from factual reality (unless the legal, deemed reality is based on EU VAT rules). I have not been able to find CJEU case law where the court explicitly applied ‘economic and commercial reality’ to decide that an element to a composite supply that was advertised as free, was actually supplied for consideration. I have discussed the Marks & Spencer case, where a UK court decided that an element to a composite supply that was advertised as ‘free’ was considered to be supplied for consideration, and explicitly based its decision on economic and commercial reality, in Section 2.6.1.6. I have not come across any literature on this specific issue.

I will now examine a number of situations involving multiple-element-transactions where one of the elements is advertised as ‘free’, to determine whether ‘commercial and economic reality’ dictates that (part of the consideration) is actually also paid for this ‘free’ element. For this purpose, it should be kept in mind that the ‘main’ EU VAT rule is that each supply or element to a composite supply should be regarded individually, and that it should be established whether one or more of the elements to a composite supply is/are made free of charge. After these steps, the consideration paid for the composite supply should be allocated to and divided between the elements that are made for consideration.