I. The legal figure of the taxable entity for VAT purposes

The taxable entity for VAT purposes goes back to the case law of the Prussian Higher Administrative Court (preußisches Oberverwaltungsgericht) and the Finance Court of the German Reich (Reichsfinanzhofs) and was first enshrined in law in 1934. Its current form is based on Art. 11 of Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax (VAT Directive). Consequently, the national implementation of the “VAT group”, as the fiscal unity may also be called, in § 2 para. 2 no. 2 German Value Added Tax Act (Umsatzsteuergesetz – UStG) must be interpreted in conformity with EU law.
Under Art. 11 VAT Directive, each Member State may treat persons established in its territory who, although legally independent, are closely bound to each other by mutual financial, economic and organizational links, together as one taxable person. In this respect, the Member State may take the necessary measures to prevent tax evasion or avoidance through the application of this provision.
Although the individual integration characteristics must be cumulative, they must by no means be equally distinct. Whereas in the case of a partnership as a subsidiary company, the economic and organizational integration does not lead to any special features, in the opinion of the BFH and the tax authorities, the characteristic of financial integration is problematic.

1. Economic integration

Economic integration exists if the subsidiary company and the controlling company form an economic unit, i.e. the subsidiary company is to be regarded as part of the controlling company. If there are cooperations and interdependencies (for example, also between divisions of different subsidiary companies), which indicate that the subsidiary company operates according to the will of the controlling company and in an economic connection with it, this characteristic is fulfilled.

2. Organizational integration

The characteristic of organizational integration means the actual control of the subsidiary company by the controlling company with regard to the day-to-day management. This characteristic is usually fulfilled by the fact that the management of the controlling company is interlinked with the management of the subsidiary company in terms of personnel (e.g. there is identity or partial identity).

3. Financial integration

The decisive factor for the existence of the characteristic of financial integration is that the controlling company can assert its will in the subsidiary company by means of a majority resolution. If the controlling company holds more than 50 % of the shares in the subsidiary company and there is no higher qualified majority requirement for the passing of a resolution, this criterion is met.

4. Legal consequence

If the conditions are met, the subsidiary company is not an entrepreneur within the meaning of the UStG, but only a “part of the enterprise” of the controlling company and, together with the latter (and, if applicable, other subsidiary companies), is to be treated as one enterprise for VAT purposes.
In practice, this primarily leads to an administrative simplification: only the controlling company is obliged to submit VAT returns. Transactions between the controlling company and the subsidiary company(ies) constitute “non-taxable intercompany transactions” which neither trigger VAT nor entitle to input tax. With regard to the input tax deduction, which can only be claimed by the controlling company, the output sales of the entire group of controlled companies must be taken into account. As a rule, VAT balances are settled internally between the companies participating in the fiscal entity. If all companies are entitled to deduct input tax, there are no particularities. However, if a subsidiary company whose sales do not entitle it to deduct input tax is involved, an input tax apportionment (possibly on a percentage basis) must be examined at the level of the controlling company and § 15a UStG must be observed.

II. The partnership company as subsidiary company

The question of whether a partnership can be a subsidiary company for VAT purposes has not been raised for the first time by the ECJ in its ruling of 15 April 2021. The Court of Justice already ruled on 16 July 2015 in the Larentia + Minerva case (C-108/14) that the relevant provision of the VAT Directive must be interpreted in such a way that a blanket restriction of subsidiary companies to legal entities does not comply with EU law. Therefore, partnerships can already be subsidiary companies for VAT purposes according to this case law. However, according to the ECJ, a restriction in this respect is permissible if this constellation allows tax avoidance.
Subsequently, the Fifth Senate of the BFH ruled on 2 December 2015 that “a partnership may also be integrated into the company of the controlling company if, in addition to the controlling company, the partners of the partnership are only persons who are financially integrated into the company of the controlling company pursuant to § 2 para. 2 no. 2 UStG”. However, the general possibility for partnerships to be subsidiary companies was again hampered by the BFH due to the high requirements with regard to the shareholder structure or the narrow interpretation of the characteristic “persons”.
It is not surprising that the tax authorities follow the legal opinion of the Fifth Senate of the BFH in § 2.8 para. 5a German VAT Application Decree (Umsatzsteuer-Anwendungserlass – UStAE). This is justified with the argument of a lack of legal certainty, as there would be difficulties in proving the voting modalities in the partnership. This is because, unlike in the case of legal entities, the voting requirement in the partnership can also be changed orally. There is no formal requirement in this respect.

III. ECJ judgment of 15 April 2021

In the judgment based on a referral by the Berlin-Brandenburg Tax Court, the ECJ now addresses the question of whether the restrictive view of the tax authorities and the Fifth Senate of the BFH with regard to the financial integration of a subsidiary company as a controlled company precludes the interpretation of Art. 11 para. 1 VAT Directive.
The case law of the Fifth Senate is contradicted by the opinion of the Eleventh Senate of the BFH, according to which § 2 para. 2 no. 2 sentence 1 UStG can be interpreted in conformity with the Directive to the effect that the term “legal entity” also includes a GmbH & Co. KG. This difference in supreme court case law made it necessary for the Tax Court in the present case to submit this question of interpretation to the ECJ for a preliminary ruling.

1. Facts relevant for the decision

The decision to refer relates to the following facts: the claimant, a GmbH (limited liability company), was a limited partner in a GmbH & Co. KG (limited partnership with a limited liability company as general partner) in addition to a GbR (company constituted under civil law) and three natural persons. The general partner was another GmbH. According to the partnership agreement of the KG (limited partnership), the claimant had six votes in the partners’ meeting, the other partners each had one vote. The KG passed its resolutions by simple majority.
It is undisputed that the KG was economically and organizationally integrated into the claimant. The claimant also assumed that the criterion of financial integration had been met as of December 2017 and that a fiscal integration within the meaning of § 2 para. 2 no. 2 UStG existed between itself and the KG. Subsequently, the KG did not file an advance VAT return for the month of December 2017, as the parties involved were of the opinion that the VAT was to be borne by the claimant as the controlling company. However, the tax office assessed an advance VAT payment to the KG for December 2017, as in its opinion a tax group did not exist due to the lack of financial integration. The reason for this was the lack of a possibility for the controlling company, as a shareholder of the KG, to intervene. The tax office referred to § 2.8 para. 5a sentence 1 UStAE. The appeal proceedings were unsuccessful. The action before the tax court led to a referral to the ECJ.

2. Decision of the European Court of Justice

The ECJ ruled that, against the background of the principles of legal certainty, fiscal neutrality and proportionality, Article 11 of the VAT Directive must be interpreted in such a way that it precludes national legislation under which the ability of a partnership to form a fiscal unity together with the controlling company is made dependent on the fact that, in addition to the controlling company, only those persons are partners in the partnership who are financially integrated into the company. In other words: according to the ECJ, the above-mentioned restrictive interpretation of the criterion of financial integration, which the administration has adopted on the basis of the case law of the Fifth Senate of the BFH, is contrary to EU law.

IV. Consequences from the ECJ decision

The ECJ has rejected the legal opinion of the Fifth Senate and thus also the opinion of the tax authorities and confirmed the opinion of the Eleventh Senate of the BFH. The legal uncertainty with regard to subsidiary companies should therefore now be eliminated. Although the tax authorities continue to be bound by the UStAE, the interpretation of the law in conformity with EU law leads to the inclusion of partnerships in the tax group, provided that the above-mentioned requirements are cumulatively met.

1. Consequences for the practice

If a tax group with a partnership as subsidiary company is desired, but has not been recognized by the tax office with reference to the UStAE, the ECJ ruling can be invoked. In order to identify the desired tax group, it should be sufficient to indicate this in the advance VAT return or in the annual VAT return. By fulfilling the above-mentioned criteria, the partnership becomes a dependent part of the company of the controlling company. A special application is not required.
However, there are risks in the reverse case that this legal consequence is not desired. This is because an unrecognized taxable entity also triggers the legal consequences of § 2 para. 2 no. 2 UStG. In this case, the entrepreneur should refer to the previous administrative practice according to the UStAE under the aspect of protection of legitimate expectations.

2. Legislative reaction

The legislator is aware of the problems in connection with the taxable entity for VAT purposes. For this reason, the “Paket für Bürokratieerleichterungen (Package for Reducing Bureaucracy)” adopted by the German government on 13 April 2021 provides, among other things, that in the future a taxable entity for VAT purposes can only be established upon application and through a corresponding confirmation regarding the fulfillment of the legal requirements of the tax authorities.
This package of measures does not specify what these regulations should look like in the future and, in particular, what effects a confirmation once issued will have. The coalition agreement 2021-2025 contains no statement on this. Further legal developments therefore remain to be seen.

V. Conclusion

The ECJ’s decision is to be welcomed, as it promotes the harmonization of VAT through the uniform application of the VAT Directive and eliminates the legal uncertainty that previously existed with regard to the requirements for financial integration in the case of a subsidiary company. In individual cases, companies in the legal form of a partnership should examine whether a fiscal unity exists according to the above criteria and what consequences, opportunities and risks arise from this.