8.3 Direct and immediate link with a free transaction?

Sometimes lotteries are organised for free. No payment is charged for the lottery tickets, for example as a promotional scheme. The question then arises whether the VAT incurred on the cost of the goods and services that will be distributed to the prize winners can be deducted by the business that organises the lottery.

Firs it has to be established whether the free lottery can qualify as an economic activity. In the Sveda-case, the CJEU has ruled that free activities that should regarded as a means of attracting (potential) customers with a view to providing them with goods and services qualifies as an economic activity.1 Implicitly, the CJEU said the same in the Kuwait Petroleum-case,2 because otherwise the VAT consequences of giving away goods for free at a petrol station would have had to be different. Articles 16 and 26 of the EU VAT Directive aim to tax certain transactions that are not performed for consideration, which can only be done if these transactions are economic activities. This means that activities that are performed for no consideration, but that are performed for business purposes, are considered economic activities from an EU VAT perspective.

Second, it has to be established whether the free lottery can qualify as a VAT exempt activity. After all, in this case, the supply of services carried out free of charge by a taxable person (i.e. organising the lottery) is not treated as a supply for consideration because it is not performed for purposes other than those of his business.3 However, CJEU case law exists on the question whether free of charge supplies can also be treated as VAT exempt supplies, but only with regard to the making available of immovable property, and only where this was done for private use, i.e. in cases where EU VAT rules treated these supplies as if they were made for consideration.4 In one of those cases, the CJEU decided that the private use, by the staff of a taxable person which is a legal person, of part of a building constructed or owned by virtue of a right in rem in immovable property, held by that taxable person, cannot be treated as the letting of immovable property for EU VAT purposes. The CJEU came to this conclusion not because VAT exemptions do not apply to transactions that are performed free of charge, but because ‘letting of immovable property’ is an EU concept that requires certain features, i.e. that rent is paid and that there is an agreement on the duration of the right of enjoyment, the right of occupation of the dwelling, or the exclusion of third parties.5 In absence of these features, the use of immovable property cannot qualify as (VAT exempt) lease. Lottery is not an EU VAT concept, because the application of the exemption is subject to the conditions and limitations laid down by each Member State.6 This, in my view, implies that these free of charge lottery services can, under certain circumstances, be treated as VAT exempt supplies (and treated as if they were made for consideration). In those cases, the VAT incurred on the goods and services distributed to the lottery winners cannot be deducted, under the same rationale as I described earlier.

However, if the free of charge lottery is not organised for purposes other than those of the business of the lottery organiser, then the lottery activities should not be treated as a (VAT exempt) supply of services for consideration.7 Can it, in that case, still be possible to consider the costs of the goods and services that are (to be) distributed to the lottery winners to be directly and immediately linked to the lottery activities? In my view, this is not the case.

Recent CJEU case law, such as Iberdrola,8 C&D Foods9 and VW Financial Services,10 demonstrates two relevant things in this respect. First, that for costs to be allocated to certain output or taxed transactions, these costs do not have to actually be included in the price charged for those transactions. In the VW Financial Services case, the CJEU held that “… in so far as (…) general costs were in fact incurred (…) for the purpose of the supply of (…) taxed transactions, those costs are, as such, components of the price of those transactions”.11 From the Iberdrola case and the C&D Foods cases, it is clear that if costs were made for the purpose of being able to perform taxed activities, even where these costs are not in themselves directly related to any specific output, the VAT on those costs should still be deductible. In C&D Foods, a holding company incurred costs in relation to the sale of shares by its subsidiary of its sub-subsidiary. This means that these costs did not directly relate to any output or transaction as performed by the business incurring the costs itself, because the shares were sold by its subsidiary, which was a different taxable person. From this case it is clear that VAT on such costs should be deductible if the direct and exclusive reason for incurring the costs is the taxable economic activity of the business, or the direct, permanent and necessary extension of that economic activity.12 These cases make clear that the purpose for incurring costs is decisive in determining to which activities these costs should be allocated. If there are no taxable activities to allocate the costs to, they should be considered ‘general costs’ if they were incurred for business purposes. In those case, the ‘exclusive reason’ for incurring the costs is not relevant.

The expenditure made in relation to the supply of free VAT exempt transactions will, as a general rule, never be part of the cost components of those VAT exempt transactions. Therefore, the costs can only have a direct and immediate link with the whole economic activity of the taxable person organising the free lottery, because the direct and exclusive reason for incurring the costs is the taxable economic activity of the business, or the direct, permanent and necessary extension of the economic activity.13

A Dutch case exists about a business whose main business activities consisted of producing and distributing washing and cleaning products. This business organised a free prize competition to stimulate sales of its products. The Dutch Supreme Court ruled that the VAT on the costs of the products that were distributed to the prize winner cannot be deducted, because they are used for ‘transactions as referred to’ in the relevant provision containing the VAT exempt transaction.14 The Dutch Supreme Court states that this is in line with the EU VAT system. I disagree. As mentioned, under the case law of the CJEU, there can only be a direct and immediate link between expenditure and a transaction if the expenditure is part of the cost components of the transaction, which cannot be the case for free transactions. Also, the CJEU has (implicitly) rejected the argument that VAT cannot be deducted on a free transaction if the supplier would not have been able to deduct the VAT on the costs of the various services acquired in order to carry out that transaction if the transaction had been an ordinary VAT exempt transaction (performed for consideration).15 In the Abbey National I-case, the CJEU considered it immaterial what the VAT treatment of the transaction would have been ‘under normal circumstances’. From this, it follows that the goods and services acquired by the organiser of a free lottery do not have a direct and immediate link with the free lottery activities. This means that the VAT incurred on the costs of these goods and services can be deducted as VAT on ‘general costs’ or ‘overhead costs’, following the general VAT deduction right of the business.16 The UK Tax Authorities apply this view, allowing deduction of the VAT incurred on the purchase of the prizes.17

In my view, deduction of VAT on these costs is also in line with the economic and commercial reality of such transactions, where businesses that normally perform fully taxed transactions incur costs on promotional activities. The fact that an exemption would have applied if the business would have sold lottery tickets should not affect this, as I explained in this Section.