Retirement Funds and VAT

Transcription

1 Joep Swinkels* Retirement Funds and VAT This article describes some VAT aspects of institutions established for occupational retirement provision, or retirement funds. The author briefly examines their European background, the views on their VAT status, various aspects of the tax regime applicable to services rendered to them from abroad, and their entitlement to deduct input tax. 1. Introduction This article describes some VAT aspects of institutions established for occupational retirement provision, or retirement funds. It briefly examines their European background, the views on their VAT status, various aspects of the tax regime applicable to services rendered to them from abroad, and their entitlement to deduct input tax. Since, by the time the article is published, the European Sixth Directive will have been replaced by a new Directive, references to the provisions of the Sixth Directive are occasionally supplemented with reference to the provisions of the new VAT Directive, Directive 2006/ European Aspects of Retirement Funds In their Directive of 3 June ( the Retirement Funds Directive ), the European Parliament and the Council laid down further rules on the activities and supervision of retirement funds. By setting the prudent person rule as the underlying principle for capital investment and making it possible for institutions to operate across borders, the Directive is a first step on the way to an internal market for occupational retirement provision, organized on a European scale. The prudential rules laid down in this Directive are intended both to guarantee a high degree of security for future pensioners through the imposition of stringent supervisory standards, and to clear the way for the efficient management of occupational pension schemes. The Retirement Funds Directive contains rules as regards: conditions of operation of retirement funds; supervision and reporting of the institutions assets, liabilities and financial position, and their investment policy; information to the members and beneficiaries of the target level of the retirement benefits, arrangements relating to the transfer of pension rights, etc; other measures for the protection of future pensioners, such as the requirement that retirement funds must limit their activities to retirement-related operations and activities arising therefrom and, where an insurance company manages a retirement scheme or the retirement fund is sponsored by an undertaking, the assets and liabilities of the fund are ring-fenced; size of the funds assets, which must be sufficient to ensure that the funds are able to meet their financial commitments in the future; investment rules, which must be based on the prudent person principle, and rules on the management and safekeeping of the funds investment portfolio; and rules and procedures relating to cross-border activities of retirement funds. In summary, the Retirement Funds Directive, inter alia, creates the European retirement fund and provides for rules and procedures under which such funds operate, enabling European enterprises to have a single company retirement fund for all their European subsidiaries. However, due to huge differences between the Member States in income tax treatment of retirement benefits and retirement funds, such European retirement funds do not yet exist in practice. 3. VAT Status of Retirement Funds The question of whether or not retirement funds are taxable persons for VAT purposes is of importance not only for the purposes of determining their entitlement to deduct input tax, but also for determining the VAT regime applicable to services rendered to them by service providers established abroad. Where those services qualify as intangible services within the meaning of Art. 9(2)(e) of the Sixth Directive, they are deemed to be rendered at the place where the customer is established. However, as regards customers established in the European Union, that place-of-supply rule only applies where the customer qualifies as a taxable person. 3 Where, in respect of cross-border intangible services, the place of supply shifts to the place where the customer is established, the latter must account for VAT on the value of the received services under the reverse charge mechanism, which implies that the services are subject to the tax regime (VAT rate, possible exemptions) in the cus- * Tax advisor for KPMG Meijburg Amsterdam and freelance publicist. 1. Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax, OJ L 347 of 11 December Directive 2003/41/EC of the European Parliament and of the Council of 3 June 2003 on the activities and supervision of institutions for occupational retirement provision, OJ L 235 of 23 September In respect of intangible services, the place of supply also shifts to the customer s Member State where the service provider is established outside the European Union and the customer s Member State has availed itself of the optional effective use and enjoyment override under Art. 9(3)(b) of the Sixth Directive. Under the latter circumstances, the reverse charge mechanism generally does not apply, which means that the service provider must be registered in the customer s Member State. INTERNATIONAL VAT MONITOR JANUARY/FEBRUARY

2 tomer s Member State. Where the place of supply does not shift to the customer s Member State, the intangible services are subject to the tax regime applicable in the service provider s Member State or non-eu country Provision of retirement benefits Basically, retirement funds are life insurance companies. Against receipt of a premium, they undertake to pay periodic benefits to the beneficiaries from the time the latter reach a certain age until, as a general rule, their time of death (or the time of death of any other beneficiary). As regards their insurance activities, just like regular life insurance companies, retirement funds are undoubtedly taxable persons for VAT purposes Investment activities In order to meet their future payment liabilities, retirement funds invest the premiums received from their members and beneficiaries in immovable property and shares, bonds and other securities, or they grant loans to third parties. As regards those investment activities, the VAT status of retirement funds is less clear Investment in immovable property In so far as they invest in immovable property which they exploit by means of letting it to third parties on a commercial basis, retirement funds are taxable persons by definition because, under Art. 4(2) of the Sixth Directive, 4 the exploitation of tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis qualifies as an economic activity Granting of loans In principle, the granting of loans qualifies as an economic activity. However, the question of whether or not such a transaction is an economic activity in practice depends on the circumstances under which the loans are granted. For example, in Floridienne/Berginvest, 5 the ECJ declared that, where a holding company merely reinvests dividends received from its subsidiaries by granting loans to those subsidiaries, that activity in no way constitutes an economic activity. On the other hand, as regards the loans granted by EDM 6 (see ), the ECJ did not attach any importance to the source of the funds but, for the purpose of concluding that the granting of loan was an economic activity, only emphasized the point that the transaction constituted the direct, continuous, and necessary extension of EDM s taxable activity, and that it was carried out for commercial purposes characterized by, in particular, the wish to maximize returns from capital invested. In summary, in respect of loans granted out of a person s own funds, that person may not qualify as a taxable person for VAT purposes. In that respect, the lender s activities are different from those of, for example, banks. Banks, inter alia, use deposits and savings made by their clients for the purpose of granting loans to other clients. 7 In the latter circumstances, the granting of loans undoubtedly qualifies as an economic activity and the lender is a taxable person for VAT purposes. In that context, it should be noted that, regardless of the purposes for which they use the funds, banks remain obliged to repay the deposits made by the public, whenever the depositors wish to withdraw their funds from the bank s account. In the meantime, the banks are free to invest or use those funds at their discretion and keep the proceeds. In the grey area between, on the one hand, holding companies granting loans to their subsidiaries out of their own funds (in respect of which they do not act as taxable persons) and, on the other hand, banks granting loans with funds temporarily put at their disposal by the public (in respect of which they undoubtedly act as taxable persons) was Régie Dauphinoise. Régie was involved principally in the management of property, which consisted partly of managing let property as agent of the owners and partly of acting as manager of condominiums. As such, it received advances from the co-owners and lessees for whom it managed the properties. With the agreement of its clients, Régie invested those sums for its own account with financial institutions. Although it remained under obligation to repay, Régie became the owner of the sums advanced with effect from their payment into its account and was entitled to retain the interest on the placements, which amounted to some 14% of its total annual receipts. In that regard, the ECJ considered that the constant renewal of Régie s treasury placements ensured that the balance in its bank accounts was relatively stable. Its placements with financial institutions were therefore to be regarded as services supplied to those institutions, consisting of the loan of money for a fixed period, duly remunerated by the payment of interest. Since interest does not arise simply from ownership of the asset, but is the consideration for placing capital at the disposition of a third party and, in the case of Régie, receipt of the interest constituted the direct, permanent and necessary extension of its taxable activity, Régie was acting as a taxable person in making such investments. As regards the granting of loans, the position of retirement funds is in one respect more comparable to that of holding companies than that of banks and Régie Dauphinoise, because, just like holding companies, retirement funds are not under the obligation to repay, to their members and beneficiaries, premiums received in the framework of the retirement schemes. If a beneficiary were to die on the day he reaches the age on which 4. Art. 9(2) of Directive 2006/ ECJ judgment of 14 November 2000 in Floridienne SA, Berginvest SA v. Belgian State, Case C-142/99, [2000] ECR I ECJ judgment of 29 April 2004 in Empresa de Desenvolvimento Mineiro SGPS SA (EDM), formerly Empresa de Desenvolvimento Mineiro SA (EDM) v. Fazenda Pública, Case C-77/01, [2004] ECR I Disregarding the fact that certain categories of banks are able to create money, i.e. they are authorized to grant loans to a higher amount than the amounts received from the public as savings. 8 INTERNATIONAL VAT MONITOR JANUARY/FEBRUARY 2007

3 the entitlement to receive retirement benefits begins, his heirs cannot reclaim any of the premiums the deceased has paid during his entire life. On the other hand, the granting of loans, both by retirement funds and by Régie Dauphinoise, is the direct, permanent and necessary extension of their activities as taxable persons Investment in shares and other securities Under settled case law of the European Court of Justice (ECJ), the mere acquisition and holding of shares is not an economic activity for VAT purposes. That principle not only applies to holding companies, 8 but also to entities in a similar position. According to the ECJ, as regards transactions in shares, only traders in securities and holding companies directly or indirectly involved in the management of their subsidiaries have the status of taxable persons for VAT purposes. 9 Irrespective of whether its activities were similar to those of investment trusts or retirement funds, 10 the ECJ concluded that Wellcome Trust 11 must also be regarded as confining its activities to managing an investment portfolio in the same way as a private investor, not as a taxable person for VAT purposes. In EDM, 12 the ECJ confirmed its view that the mere acquisition and holding of shares is not an economic activity and added that the same applies to the selling of shares. Consequently, although its granting of credit was an economic activity, EDM s investments in shares and investment funds did not form part of its economic activities. 13 From the recent ECJ judgment in BBL, 14 it can be derived that certain investment companies can also be taxable persons for VAT purposes in respect of their transactions in securities. However, in that respect, it was decisive that the parties involved in that case were openended investment companies ( SICAVs ) which operated in the investment market collecting funds from the public for the purpose of investing them for consideration. Traders in securities Regardless of the fact that they may be engaged in largescale transactions in securities, retirement funds can not be considered to be traders in securities. Traders in securities aim to generate income by charging a commission to the parties on whose behalf they buy and sell securities 15 and even where, in the framework of those activities, they hold shares, traders in securities consider them as a temporary trading stock, which should be sold as soon as possible, preferably, for a higher price than their purchase price. Retirement funds hold shares and other securities for other reasons. They mainly aim to achieve a return on their investments in order to secure their future, long-term liability to pay retirement benefits to their beneficiaries. In addition, they do not act on behalf of third parties Conclusion In respect of their investments, retirement funds act as taxable persons as regards the letting of immovable property. As regards the granting of loans and their investments in securities, the retirement fund s VAT status is less clear. Even though they are not directly or indirectly involved in the management of the undertakings in which they hold shares and, as regards transactions in securities, they do not act as traders in securities and they are not open-ended investment institutions, retirement funds can be considered to carry out economic activities where they purchase and sell securities because their holding of securities is directly related to their activities as a retirement fund. In my view, those investments made by retirement funds form a permanent and necessary extension of their insurance activities. Retirement funds become the owner of the premiums paid by the participant and, under national legislation, they are even com- 8. See, inter alia, ECJ judgment of 20 June 1991 in Polysar Investments Netherlands v. Inspecteur der invoerrechten en accijnzen, Case C-60/90, [1991] ECR I ECJ judgment of 20 June 1996 in Wellcome Trust Ltd. v. Commissioners of Customs and Excise, Case C-155/94, [1996] ECR I The fact that, in this context, the ECJ referred to retirement funds does not necessarily mean that retirement funds manage their investment portfolios as taxable persons. 11. Wellcome Trust initially managed all Henry Wellcome s shares in the Wellcome Foundation, which operated a pharmaceutical business and had a value of 250 million. The trustees were to use the proceeds from the shares for research into human and animal medicine and for the study of the history of medicine. In the framework of a diversification scheme, the Trust sold part of its shareholding in the Foundation and used the proceeds (200 million) for making other investments. The Trust managed its assets, and its investment activities consisted essentially of the acquisition and sale of shares and other securities with a view to maximizing the dividends and capital yields which were destined for the promotion of medical research. 12. See note EDM was a holding company in the mining sector which, after being a public undertaking, was converted into a legal entity governed by private law, in the form of a limited company. Its main purpose was: prospecting and exploring for, extracting, developing and exploiting metallic and non-metallic minerals, and the marketing thereof and of the products and by-products resulting from their processing; applied research and technological development aimed directly at productive investment, by means of joint ventures; managing company shareholdings which it owned or whose management powers had been contractually entrusted to it, for companies whose purposes included the activities referred to under the first indent; promoting investment projects and the formation of companies whose purpose was connected to the mining industry by encouraging, especially, the association of public and private interests. Until its conversion into a limited company, one of EDM s main purposes was also to assist companies in which it had a shareholding to obtain loans from credit institutions, by being able to guarantee such loans. The management of its shareholdings and scientific and technological research in the mining sector with a view to investment therein, particularly through the creation of new undertakings, were always EDM s principal activity and it only occasionally sold its shareholdings in companies, even if the proceeds of those sales attained a considerable sum. 14. ECJ judgment of 21 October 2004 in Banque Bruxelles Lambert SA (BBL) v. Belgian State, Case C-8/03, [2004] ECR I See Joep Swinkels, Special Investment Funds and VAT, International VAT Monitor 4 (2006), p. 247, Sec Stock brokers aim to generate income from the difference between selling and purchase prices, see ECJ judgment of 14 July 1998 in The First National Bank of Chicago v. Commissioners of Customs and Excise, Case C-172/96, [1998] ECR I INTERNATIONAL VAT MONITOR JANUARY/FEBRUARY

4 pelled to invest them. 16 Consequently, there is a direct link between the premiums (derived from their insurance activities) and the investments. Should the return on the investments turn out to be less than expected, the retirement fund has no option but to raise the premiums. Investments made by retirement funds are not a matter of investment of temporarily superfluous liquidities. In addition, just like EDM, retirement funds make their investments for commercial purposes characterized by, in particular, the wish to maximize returns from capital invested. Support for the position that, in respect of their investments in shares and other securities, retirement funds act as taxable persons can also be derived from the ECJ judgment in Harnas & Helm, 17 in which the ECJ declared that the mere acquisition of ownership in and the holding of bonds, activities which are not subservient to any other business activity, and the receipt of income therefrom are not to be regarded as economic activities conferring on the person concerned the status of a taxable person. Conversely, where they are subservient to other business activities and in the case of retirement funds, the investments in securities are subservient to their principal insurance activities retirement funds hold their portfolio in securities as taxable persons. 4. Cross-Border Services Rendered to Retirement Funds Both in the framework of their principal insurance activities and of their investment activities, retirement funds increasingly outsource functions to third-party service providers, often established abroad. Since retirement funds are taxable persons, at least as regards their principal activities, services that qualify as intangible services within the meaning of Art. 9(2)(e) of the Sixth Directive 18 are deemed to be rendered at the place where the retirement fund is established, and the retirement fund must account for VAT on the value of the received services under the reverse charge mechanism. If they are not intangible services within the meaning of Art. 9(2)(e), the services are generally subject to the VAT regime applicable in the service provider s Member State or non-eu country under Art. 9(1) of the Directive. In this respect, three questions arise. Firstly, on the assumption that contrary to the view presented above some of their investment activities do not qualify as economic activities, i.e. that, in that respect, retirement funds cannot be treated as taxable persons, the question arises of whether or not it makes any difference for the application of the reverse charge mechanism whether the retirement fund acquires the services for the purpose of its business or its non-business activities. Secondly, the question arises of what services are intangible services within the meaning of Art. 9(2)(e) and, finally, whether or not specific services are covered by an exemption VAT status of the customer Under Art. 9(2)(e) of the Sixth Directive, intangible services rendered by non-resident service providers are deemed to be supplied at the place where the EU customer has established its business on the mere condition that the customer is a taxable person for VAT purposes. That provision does not require that the customer must have acquired the intangible services for the direct purposes of its business activities. Therefore, intangible services rendered by non-resident service providers to retirement funds must be subject to the reverse charge mechanism under all circumstances, even where the retirement fund acquires them for purposes which could possibly be considered not to be business activities, such as certain investment activities. If application of the reverse charge mechanism were not based on the clear and simple criterion that the customer is a taxable person, non-resident service providers, who are responsible for making the decision as regards the tax regime applicable to the services they render, would be brought into an impossible position. In a large number of situations, they cannot possibly determine whether or not the purposes for which the customer intends to use those services qualify as business or non-business purposes according to the criteria applicable in the customer s Member State Intangible services The category of intangible services within the meaning of Art. 9(2)(e) of the Sixth Directive is fairly broad. In so far as is relevant in the context of this article, they not only cover financial services, but also services of consultants, lawyers, accountants, and other similar services, as well as data processing and the supplying of information. As regards the management of their funds, retirement funds increasingly rely on the services rendered by professional fund managers, which may be established in another Member State or even outside the European Union. Outsourcing of fund management gives rise to the question of whether or not those services are deemed to be rendered in the retirement fund s Member State and, where the place of supply is within the European Union, whether or not they are exempt from VAT Place of supply of fund management services The category of financial services referred to in Art. 9(2)(e) of the Sixth Directive comprises a large range of services. It is generally assumed that, for the purposes of the place of supply, the concept of financial services within the meaning of Art. 9(2)(e) of the Sixth 16. In that respect, Art. 18 of the Retirement Funds Directive provides that the Member States must require the retirement funds to invest the premiums in accordance with specific rules aimed at ensuring the security, quality, liquidity and profitability of their portfolio as a whole. 17. ECJ judgment of 6 February 1997 in Harnas & Helm CV v. Staatssecretaris van Financiën, Case C-80/95, [1997] ECR I-745, Para Art. 56(1) of Directive 2006/ INTERNATIONAL VAT MONITOR JANUARY/FEBRUARY 2007

5 Directive is directly linked to the exemption for financial services under Art. 13(B)(d) of the Directive. 19 Although services consisting of the management of shares and other securities (investment portfolios) have been excluded from the exemption for transactions in shares and other securities laid down by Art. 13(B)(d)(5) of the Sixth Directive, 20 in view of the fact that the management of special investment funds is exempt from VAT under Art. 13(B)(d)(6) of the Directive, 21 it seems safe to assume that management of investment funds also qualifies as a financial service within the meaning of Art. 9(2)(e) of the Sixth Directive. In BBL, 22 the ECJ has more or less confirmed that view by stating that open-ended investment companies are taxable persons, so that the services referred to in Art. 9(2)(e) 23 rendered to them were subject to VAT in the investment company s Member State. Determination of the place of supply becomes less straightforward where the service provider renders a more comprehensive package of services, which not only consists of management but also includes custody services. Since custody services ( safekeeping ) have been excluded, not only from the exemption under Art. 13(B)(d)(5), but also from that under Art. 13(B)(d)(6), 24 it is highly doubtful that custody services can be treated as financial services within the meaning of Art. 9(2)(e). On the other hand, from the fact that safekeeping has explicitly been excluded from the scope of the exemption for financial services, it could be derived that, by its nature, that service is a financial service. Where a package of services consists of several elements and the importance of those elements is not of such a nature as to make it possible to consider one element as the principal service and the others as ancillary services, the package must be split up for the purposes of the place of supply rules. 25 Where the package is supplied for a single price, attribution of that price to the different elements will by definition be arbitrary. It should be noted that, although the ECJ has declared that such a split-up may be necessary, it has never actually applied it in practice. On the other hand, the elements of which the package consists may be so intertwined that the package must be considered to be a complex service (single composite supply), which is subject to its own tax regime. That tax regime does not necessarily have to correspond to the most convenient 26 or obvious 27 tax regime applicable to one of the elements. It must be assumed that the package will be subject to the VAT regime that produces a rational result. However, the rationality of the result does not only depend on the nature of the service but also on the circumstances under which it is provided. 28 As regards a package consisting of management and custody services rendered to a retirement fund established in the European Union, it cannot be precluded that a tax court would find that the most rational result would be that the package is subject to the VAT regime applicable in the retirement fund s Member State. In this respect, it should be noted that the ECJ s concept of rationality generally is based on the view that services that are consumed within the European Union should bear European VAT. A different view would make it very easy for retirement funds to avoid the burden of VAT by acquiring such packages from a service provider that is, at least formally, established outside the European Union in a country with a mild VAT climate Exemption for fund management services In the case that, for VAT purposes, fund management services rendered to EU retirement funds are deemed to be rendered within the European Union, either at the place where the retirement fund is established or at the place where the EU fund manager is established, the next question is whether or not those services will actually be subject to VAT. Under Art. 13(B)(d)(6), management of special investment funds as defined by the Member States is exempt from VAT and in certain Member States, for example, Estonia, Lithuania, Luxembourg, 29 Slovak Republic and Spain, the national legislation explicitly provides that management of retirement funds is exempt from VAT Art. 135(1) of Directive 2006/ Art. 135(1)(f) of Directive 2006/ Art. 135(1)(g) of Directive 2006/ Case C-8/03, see note The services in question rendered to the open-ended investment funds included: assistance in the management of the fund s assets; provision to those responsible for the day-to-day management of the fund of all documentation, information and advice they might deem necessary in order to carry out their duties; and assistance to the fund in the acquisition, subscription, transfer and disposal of shares, bonds and all other negotiable securities and in relation to currency or treasury operations. 24. See ECJ judgment of 4 May 2006 in Abbey National and Inscape Investment Fund v. Commissionairs of Customs and Excise, Case C-169/ ECJ judgment of 25 February 1999 in Card Protection Plan Ltd. Commissioners of Customs and Excise, Case C-349/96, [1999] ECR I For example, in Linthorst, the ECJ ruled that the services of veterinarians could not be treated as work on goods (animals are goods) or advisory services. See ECJ judgment of 6 March 1997 in M.J.M. Linthorst, K.G.P. Pouwels en J. Scheres c.s. v. Inspecteur der Belastingdienst/Ondernemingen te Roermond, Case C-167/95, [1997] ECR I For example, in Commission v. France, the ECJ ruled that destruction of contaminated waste must not be treated as work on goods. See ECJ judgment of 25 January 2001 in Commission of the European Communities v. French Republic, Case C-429/97, [2001] ECR I For example, in Berkholz, the operation of gaming machines on board a ferry sailing between Germany and Denmark was subject to VAT at the place where the service provider had established his business (in Germany), not at the place where the activities were actually performed (predominantly outside the territory of the European Union), whilst, in RAL, the same service was subject to VAT at the place where the activities were actually performed (in the United Kingdom) and not at the place where the service provider had established its business (outside the European Union). See ECJ judgments of 4 July 1985 in Günther Berkholz v. Finanzamt Hamburg-Mitte-Altstadt, Case 168/84, [1985] ECR 2251, and 12 May 2005 in RAL (Channel Islands) Ltd, RAL Ltd, RAL Services Ltd, RAL Machines Ltd v. Commissioners of Customs and Excise, Case C-452/03, [2005] ECR I In Luxembourg, the following is exempt from VAT: management of undertakings for collective investment and retirement funds subject to the supervision of the CSSF (public body in charge of the supervision of the financial sector) and the Commissariat aux Assurances (public body in charge of the supervision of the insurance sector) as well as of securitization bodies and of SICAR (investment companies in venture capital) situated in Luxembourg. 30. It cannot be precluded that the less transparent definitions of the scope of the exemption for management of special investment funds applicable in the other Member States also include management of retirement funds. INTERNATIONAL VAT MONITOR JANUARY/FEBRUARY

6 However, from Abbey National, 31 it has become clear that the Member States discretion to define the special investment funds whose management is exempt from VAT is not unlimited. In that judgment, the ECJ has declared that the concept of management of special investment funds has its own independent meaning in Community law, the content of which the Member States may not alter. Taking into account the purpose of the exemption, which is encouragement of small private investors to invest in transferable securities, the ECJ has, in that context, also made a firm connection between the concept of special investment funds and open-ended undertakings for collective investment in transferable securities (UCITS), 32 which implies that the management of the retirement funds investment portfolio is not covered by the exemption. On the other hand, the question of whether or not the words special investment funds are capable of including closed-ended investment funds, such as Investment Trust Companies, is still pending before the ECJ. 33 Anyway, in the same judgment, the ECJ has made it clear that the concept of management does not include custody ( safekeeping ) services. 34 Consequently, custody services rendered to EU retirement funds are subject to VAT under all circumstances, unless the custodian is established outside the European Union and its services are deemed to be rendered there. 5. Retirement Funds Right To Deduct Input Tax In the course of their activities, retirement funds incur input tax, in particular where they outsource various functions to independent third-party service providers. For the purposes of deduction of input tax, the expenses can be subdivided into three major categories: expenses relating to their insurance transactions; expenses relating to their investments; and overhead expenses Insurance transactions Since insurance transactions are exempt from VAT, retirement funds are not entitled to deduct input tax in respect of their main activities. However, on the basis of Art. 17(3)(c) of the Sixth Directive 35, retirement funds are in principle entitled to deduct input tax in respect of insurance services rendered to insured established outside the European Union. It is however unlikely that large groups of private individuals resident outside the European Union will insure their retirement through EU institutions. Therefore, in practice, deduction of input tax under Art. 17(3)(c) will be limited to retirement schemes sponsored by companies that employ large numbers of persons originating from countries outside the European Union. Some retirement funds entrust various administrative functions to related or non-related third parties, which may, for example: trace persons entitled to retirement benefits; assess the biometrical risks of potential new participants; charge to, and collect from, the participants the periodic premiums; pay retirement benefits to the beneficiaries; take care of the fund s tax obligations (withholdings); make legally required reports on behalf of the retirement fund; draw up the fund s annual reports; keep the fund s financial records; keep track of the fund s beneficiaries; provide general information to the beneficiaries and financial authorities on behalf of the retirement fund; handle complaints; etc. Since those services are subject to VAT, which is generally non-deductible, outsourcing of the activities will lead a VAT burden. In practice, retirement funds apply various methods to avoid that burden. For example, they may form a VAT group of which the fund and the service provider form part. However, that option does not provide a universal solution because not all Member States allow group registration and, if they do, the Member States may have rules to exclude entities that are not entitled to full input tax deduction, from the group. In the second place, group registration requires close financial, organizational and economic links between the members of the group and, although those links have not been defined at the level of the European Union, it may safely be assumed that, in most Member States, they form an insurmountable obstacle to forming a VAT group between a retirement fund and a separate, commercial service provider. Finally, the members of VAT groups must be established in the same Member State. The fact that separate service providers must make a profit will also be an obstacle to the formation of a costsharing association 36 because one of the conditions for that arrangement is that the umbrella organization merely claims from its members exact reimbursement of their share of the joint expenses. If they cannot make a direct profit, third-party service providers quickly lose interest in rendering services to retirement funds. In the 31. ECJ judgment of 4 May 2006 in Abbey National plc and Inscape Investment Fund v. Commissioners of Customs & Excise, Case C-169/ See Council Directive 85/611/EEC of 20 December 1985 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS). 33. J.P. Morgan Fleming Claverhouse Investment Trust plc and The Association of Investment Trust Companies v. Commissioners of HM Revenue and Customs, Case C-363/ Services corresponding to the functions of a depositary, such as those set out in Arts. 7(1) and (3) and 14(1) and (3) of Directive 85/611/EEC (see note 32), are not covered by the concept of management. 35. Art. 169(c) of Directive 2006/ Under Art. 13(A)(1)(f) of the Sixth Directive (Art. 132(1)(f) of Directive 2006/112), Member States must exempt from VAT, services supplied by independent groups of persons whose activities are exempt from or are not subject to VAT, for the purpose of rendering to their members the services directly necessary for the exercise of their activity, where these groups merely claim from their members exact reimbursement of their share of the joint expenses, provided that such exemption is not likely to produce distortion of competition. 12 INTERNATIONAL VAT MONITOR JANUARY/FEBRUARY 2007

7 second place, the exemption for cost-sharing associations may produce distortion of competition, which may exclude several activities from its scope and, finally, the Member State in question may require that there are at least two members, which implies that it takes at least two retirement funds to set up such a cost-sharing association. Retirement funds could also consider funding certain expenses, which means that they provide their own staff to the service provider. By removing the labour element from the service providers charge, the retirement funds could considerably reduce the VAT burden of outsourcing the activities to a third party. 37 However, not all service providers are interested in providing services with staff employed by their customer Investment activities As regards the retirement funds investment activities, three different categories of investment must be distinguished, from a VAT perspective: exploitation of im - movable property, granting of loans and transactions in shares and other securities Exploitation of immovable property One of the categories of activities which will entitle retirement funds to deduct input VAT is the letting of office buildings and other commercial immovable property. Although the leasing and letting of commercial immovable property is in principle exempt from VAT, Member States may enable the lessor or landlord to opt for taxation. That option applies in all Member States, unless the Member State in question has categorically excluded the letting of commercial immovable property from the exemption. Where the latter exclusion applies in the retirement fund s Member State, it has the advantage that the retirement fund s right to deduct input tax is clear in respect of let immovable property located abroad. Under Art. 17(3)(a) of the Sixth Directive, taxable persons are entitled to deduct input tax in respect of transactions carried out abroad, which would have entitled them to deduct input tax if those transactions had been carried out within the territory of the country. Although it must be assumed that the amount of domestic input tax relating to the letting of immovable property abroad will not be high, the rent derived from those transactions abroad will have a positive effect on the retirement fund s pro rata. In Member States in which, in accordance with the Directive, the letting of commercial immovable property is exempt from VAT, albeit that an option for taxation is available, the retirement fund s right to deduction is less straightforward. It would, however, be fair to treat lettings abroad as being taxable where it can reasonably be assumed that, had the letting taken place in the retirement fund s Member State, it would have opted for taxation Granting of loans The granting of loans is in principle exempt from VAT but, nonetheless, it gives rise to the entitlement to deduct input tax where the loans are granted to parties established or resident outside the European Union. In view of the fact that, under the ECJ s judgment in Harnas en Helm, 38 transactions in bonds do not constitute the granting of credit, but must be treated as transactions in securities, 39 it seems tenable to take the view that only the proceeds from the sale of bonds, not current interest, must be taken into account for the purposes of the pro rata Transactions in securities In practice, retirement funds hold large quantities of shares and their portfolios are generally managed by a third-party managers, which means that retirement funds are definitely interested in a broad application of the exemption for the management of special investment funds (see ). Share dividends do not affect the investment fund s right to deduct input tax under the pro rata. Presumably, the same applies to interest received on bonds. Where securities are held by a retirement fund in its capacity as a taxable person, their sale could in principle give rise to the entitlement to deduct related input tax, provided that the customer is established outside the European Union and the sale is not an incidental financial transaction (see below). That deduction is limited to VAT on expenses directly relating to the sale of the securities, not the expenses relating to the management and safekeeping by third-party service providers of the retirement fund s portfolio. However, since shares and other securities are frequently traded through stock markets, it will be virtually impossible for the sellers to determine in practice who the buyers are, let alone, where they are established Overhead expenses The main activities of retirement funds are insurance transactions, which are exempt from VAT but, nonetheless, give rise to the right to deduct input tax, where the fund s customers are established outside the European Union. Consequently, input tax will be deductible under the pro rata. The pro rata will also include the retirement fund s overhead expenses relating to its investment activities, at least in so far as the retirement fund carries out those activities in its capacity as a taxable person. Apart from the fact that there are valid grounds for considering that the retirement funds investments are an 37. For further details of funding, see Joep Swinkels, VAT-saving concepts and interpretations, International VAT Monitor 6 (2005), pp , Sec Case C-80/95, see note In that respect, the ECJ observed that the activity of a bondholder may be defined as a form of investment which does not extend further than straightforward asset management. The income from the bonds derives from the mere fact of holding them, which entitles the holder to payments of interest. Such interest cannot, therefore, be regarded as a return on an economic activity or transaction carried out by the bondholder, since it derives from the mere ownership of the bonds, Harnas en Helm, Case C-80/95, note 17, Para. 18. INTERNATIONAL VAT MONITOR JANUARY/FEBRUARY

8 extension of their economic activities, the ECJ is not particularly narrow-minded in granting taxable persons the right to deduct input tax in respect of activities taking place in the framework of their business, which are actually outside the scope of VAT. For example, in Kretztechnik, 40 the ECJ took the view that, although the issue by a corporate company of new shares does not constitute a transaction falling within the scope of VAT, the issuing company is nonetheless entitled to fully deduct the VAT charged on the expenses incurred in connection with that share issue, provided that all the transactions undertaken by the taxable person in the context of his economic activity constitute taxed transactions. In that respect, the ECJ observed that, by issuing new shares, a company aims to increase its assets by acquiring additional capital, whilst granting the new shareholders a right of ownership of part of the capital thus increased, which means that, from the issuing company s point of view, the aim is not to provide services. Also from the shareholder s point of view, payment of the sums necessary for the increase of capital is not a payment of consideration but an investment or an employment of capital. Since the issue of new shares is for the benefit of the company s economic activity in general, expenses relating to the issue form part of its overheads and are therefore, as such, component parts of the price of its products. Those supplies have a direct and immediate link with the whole economic activity of the taxable person. 41 For the purposes of the pro rata, however, incidental financial transactions must be excluded. In that regard, the ECJ has declared in EDM 42 that, although the scale of the income generated by the financial transactions within the scope of VAT may be an indication that those transactions should not be regarded as incidental, the fact that income derived from the financial transactions is greater than that produced by the taxable person s main activity does not suffice to preclude their classification as incidental transactions. Instead, financial transactions are to be regarded as incidental transactions in so far as they involve only very limited use of assets or services subject to VAT. Had the main activities of retirement funds been subject to VAT, which they are not, that interpretation could have led to a considerable increase of the funds pro rata. For the purposes of determining whether or not financial transactions are incidental, only the expenses directly relating to the sale of securities must be taken into account, not the expenses relating to the management and safekeeping by third-party service providers of the retirement fund s portfolio. 6. Summary As regards retirement funds, several questions in the field of VAT cannot yet be answered with absolute certainty. It is still unclear whether or not retirement funds act as taxable persons in respect of large parts of their investment activities and whether or not their VAT status affects the VAT regime applicable to intangible services rendered to them by non-resident service providers. The retirement fund s VAT status definitely affects its entitlement to recover input VAT as regards financial services rendered to customers outside the European Union. Finally, the outsourcing of activities to third-party service providers may result in a considerable VAT burden on retirement funds, in particular where the ECJ does not deviate from its course leading to the definitive view that the exemption for the management of special investment funds does not apply to closed-ended investment and retirement funds. 40. ECJ judgment of 26 May 2005 in Kretztechnik AG v. Finanzamt Linz, Case C-465/03, [2005] ECR I Similarly, in its judgments of 22 February 2001 in Abbey National plc v. Commissioners of Customs and Excise, Case C-408/98, [2001] ECR I-1361, and 29 April 2004 in Faxworld Vorgründungsgesellschaft Peter Hünninghausen und Wolfgang Klein GbR v. Finanzamt Offenbach am Main-Land, Case C-137/02, [2004] ECR I-5547, the ECJ declared that the right to deduct input tax also applies to transactions that are in principle within the scope of VAT but, on the basis of an optional, concessional arrangement (the transfer of a business as a going concern) not treated as taxable transactions. 42. Case C-77/01, see note INTERNATIONAL VAT MONITOR JANUARY/FEBRUARY 2007