For a long time, the issue of taxation of public-law legal entities remained a taboo subject, particularly with regard to VAT.
Indeed, while some public institutions—which are clearly entrusted with a public service mission—operate as de facto extensions of the government and are exempt from VAT, many organizations that serve the government find themselves in much murkier tax waters.
And EU case law has established criteria for the application of VAT that go well beyond the legal form of these entities or the types of revenue they collect. Thus, an entity organized under private law—such as a nonprofit association—that is funded by “earmarked” payments on invoices will operate outside the scope of VAT. Conversely, a public interest group that receives VAT-exempt subsidies may in fact operate within the scope of VAT, sometimes without even realizing it.
And without asking anyone for anything.
Of course, these organizations may consult with the tax authorities as part of an advance ruling procedure, sometimes through their overseeing ministry.
However, many organizations that receive grants or other revenue from their “clients”—whether private or public—without VAT do not wish to clarify their situation for fear of having to renegotiate the budget allocations granted to them.
But what, exactly, are the criteria set forth in the relevant legislation (Article 13 of Council Directive 2006/112/EC on VAT, dated November 28, 2006, and Article 256 B of the General Tax Code) and interpreted by the vast body of EU and subsequently national case law (indeed, the CJEU leaves it to national courts to define certain concepts such as “powers of public authority” or what constitutes “distortions of competition”) to determine whether the revenue of a public body can be excluded from the scope of VAT?
An opinion of the Council of State dated April 12, 2019 (Opinion CE 12-4-2019 No. 427540 FR 31/19 inf. 7, p. 9) has fortunately come to the aid of public-law entities by clarifying several concepts, so that today the process is less fraught with risk than it was before.
You need to ask yourself the right questions in the right order—follow this guide:
- Are the organization’s activities economic activities carried out for compensation?
If the answer is no, the analysis ends there: there will be no VAT on this revenue, which is considered “outside the scope.” If, on the other hand, the answer is yes, you will need to proceed to the next step of the analysis.
Applying a traditional criterion for VAT liability to all market participants (see EU and subsequently national case law on the concept of a direct link, as established by the Apple and Pear decision (CJEU, March 8, 1988, Case 102/86, Apple and Pear Development Council: RJF 8-9/88 No. 970, ECR 1988/3 p. 1443), the question here is whether there is a direct link between the revenue collected by the organization and its activities. This link is established, in particular, when there is an exchange of reciprocal services between the provider and the recipient: a grant paid to achieve a predetermined result falls within the scope of VAT, whereas if it is paid to balance the organization’s accounts, it falls outside the scope. - Does the organization act as a non-VAT-registered entity, and therefore, is it indeed a public entity acting within the scope of public authority, which allows it to act as a non-VAT-registered entity—and thus without charging VAT?
In this regard, EU case law—covering a wide variety of organizations—has recently established an original and fairly clear line of guidance. It is necessary to analyze in detail how the entity operates to determine whether it is indeed a public entity: is it sufficiently integrated into the organization of the public administration to which it belongs? This question, which involves both factual and legal considerations, must be assessed on a case-by-case basis (see, in particular, the Saudaçor case regarding exemption from VAT: CJEU, 4th Chamber, Oct. 29, 2015, Case No. 174/14, Saudaçor – Sociedade Gestora de Recursos e Equipamentos da Saúde dos Açores SA: RJF 1/16 No. 104).
Next, it must be verified that the entity does indeed possess the prerogatives of public authority, such as the right to expropriate or the right to impose penalties. The CJEU had left the door slightly open, allowing organizations without such powers to still be considered public entities capable of operating outside the scope of VAT. In its aforementioned 2019 opinion, the Council of State clarifies how this discretion is exercised:
, to be considered outside the scope of VAT, a public body’s activity must be carried out pursuant to a legal obligation or within the framework of a monopoly, or when it falls, by its nature, within the remit of a public entity. - One final point to consider: Could the exemption of the organization’s revenue from VAT lead to distortions of competition?
Thanks to the aforementioned opinion of the Council of State, we know that this risk of distortion must now be assessed in relation to the organization’s activities, regardless of whether the organization actually faces such competition. If competition is purely hypothetical in nature (for example, in certain areas of research) or because the very low rates charged by the organization do not allow for the presence of competitors, it will be possible to conclude that the organization may not apply VAT without causing distortions of competition. Consequently, the organization’s revenue falls outside the scope of VAT.
Now that the criteria for VAT liability have been clarified, public entities would be well advised to have them reviewed by their boards—or even by the tax authorities—by presenting their situation in a precise and well-reasoned manner.
