Expansion of municipal roads - BFH-ruling "Mitteldeutsche Hartsteinindustrie" (XI R 26/29)

In its judgement of 16 December 2020 (XI R 26/20) in the "Mitteldeutsche Hartstein-Industrie" case, Germany’s Federal Court of Finance (Bundesfinanzhof, BFH) ruled that services performed in association with the unremunerated expansion of a public road by an entrepreneur entitle the entrepreneur to take input VAT deductions insofar as these are necessary for the company’s operation and that the benefit to the general public is, at most, incidental. A VAT-taxable free of charge supply does not exist if there is no threat of an untaxed end use. The BFH thus amends its case law, which previously denied the input VAT deduction.

Expansion of a municipal road by the plaintiff

The plaintiff had received permission from the city to operate a limestone quarry if the plaintiff agreed to expand a municipal road at its own expense so that it was suitable for the corresponding heavy traffic. The road remains available to the public after the expansion.

Previous case law and administrative opinion: no input VAT deduction permitted

In such cases, the BFH and, as a result, the tax authorities (circular letter dated June 7, 2012) did not allow any input VAT deduction on the input services, since the entrepreneur already intended to make the development or expansion available to the municipality free of charge when purchasing the input supplies. Because there was no input tax deduction, there was also no uncompensated supply to be taxed.

ECJ and BFH: Indirect relation to taxed output services is sufficient

The BFH had referred the case to the ECJ (European Court of Justice) for a preliminary ruling. Following the principles of the ECJ, the BFH decided that because the expansion work only encompassed what the plaintiff needed to operate the limestone quarry and the expansion costs were part of the cost elements of the taxed output transactions, the plaintiff was entitled to an input VAT deduction from the input services. The fact that the general public could also drive on the road free of charge did not preclude this because the upgrade work was not done for the benefit of the general public (who could also drive on the road beforehand), but to adapt it to the needs of the limestone quarry. Although in this case the input services were only indirectly related to the plaintiff’s taxed output transactions, that this suffices is clear from the ECJ case law. The BFH expressly abandons its previous case law to the contrary.

Expanding the road was not a remuneration for the municipality´s granting of the permit to operate the limestone quarry, so the expansion does not constitute a taxable supply with installation.

There was also no free of charge supply by the plaintiff because the expansion work was done to accommodate the heavy loads carried by traffic to and from the limestone quarry and the benefit to the general public was merely secondary.. There is therefore no untaxed end use of the input services, which, however, is a prerequisite for a VAT-taxable free of charge supply under a narrow interpretation in conformity with EU law.

Recommendation: Check development measures carefully for prerequisites related to the input tax deduction

Until now, the BFH and Germany’s Federal Ministry of Finance have assumed that input services for development measures serve to provide these measures to the municipality free of charge and are therefore not deductible. The ECJ and BFH are now providing new opportunities for deducting the input VAT, enabling taxpayers to directly reference these. We recommend that you carefully examine the prerequisites: According to the new case law, a measure’s benefit to the general public may be secondary at best. This raises the question of whether expansion work and the initial development measures should be treated differently. In the case at hand, the general public had always been able to drive on the road and expanding it did not provide any significant improvement. On the other hand, building a new road offers the general public something they previously did not have. However, such a view would contradict the ECJ case law in the "Sveda" case (ECJ of October  22, 2015, C-126/14), which decreed that input VAT from the construction of a recreational path was deductible if the public could use it free of charge.

Please also note that the case presented here relates to a free of charge work supply. Different rules apply with regard to the supply of services - just as they do in the case of services to the municipality for remuneration.

Dated: June 2, 2021