2.6.5 The economic and commercial reality of a transaction as a reference point

Consideration of economic and commercial realities is a fundamental criterion for the application of the common system of VAT.1 This means that if businesses agree specific contractual terms, even though these contractual terms constitute a factor to be taken into consideration, they are not decisive for the purposes of determining the VAT consequences of the agreed transaction. They may in particular be disregarded if it becomes apparent that they do not reflect economic and commercial reality.2

I will use economic and commercial reality to determine whether the existing VAT rules, as applied to promotional activities and transactions involving vouchers, lead to the ‘desired result’ based on the underlying fundamental principles of VAT. This means that I use the notion of economic reality to establish the actual, objective nature of a supply, in order to test whether the VAT treatment of a promotional activity or voucher transaction is in line with the VAT treatment under preferred or desired law, based on the relevant fundamental principles of EU VAT. I will also apply ‘economic reality’ as a means to establish whether a transaction is performed the way that taxable persons normally or usually run their businesses, in order to see whether the VAT treatment of the particular transaction is similar to the VAT treatment of similar transaction that are normally or usually performed by businesses.

For example, I will discuss businesses that pay money (as a cash-back) to the purchaser of one of their products at the end of the production and distribution chain, where this end customer did not purchase the product directly from the business granting the cash-back. The CJEU allows the business that pays this cash-back to lower his taxable amount for the original supply of the relevant product, even though that supply was not made to the person that receives the cash-back. Lowering that taxable amount is based on the relevant EU VAT provisions regarding discounts.3 From a contractual perspective, it seems only possible to provide a discount in relation to a supply that was made at an earlier stage. What I mean by that is that in my view, a business can only grant a discount on a consideration that he has charged himself, and under the current EU VAT rules, a consideration is something that the business has received in return for his (own) supply.

Treating the cash-back as a discount does, in my view, not fit the current EU VAT rule framework. However, it is economic and commercial reality that the business that grants the discount does so in the furtherance of his business, and for the purpose of promoting the sale of his own products. Therefore, economic and commercial reality dictate that the business should ‘bear’ or ‘enjoy’ the VAT consequences of this payment. Under the principle of neutrality, in the sense that similar transactions should be treated the same, this business should in my view be allowed to deduct the VAT that is included in the payment (provided that the payment of the cash-back represents a VAT inclusive amount). I advocate that in these situations, where a business pays for part of a supply made to another party but where the payment is made purely for business purposes, this business should be allowed VAT deduction for his part of the payment. I call this the system of ‘joint payment, shared deduction’. It is not based on any existing EU VAT legislation. It is, however, based on economic and commercial reality and these realities require (and justify) deduction, albeit under appropriate or desired law.