Reverse charge mechanism even if only one of several service recipients is an VAT taxable person - BFH-ruling V R 7/20

In its judgement dated 10 December 2020 (V R 7/20) and published on 20 May 2021, the BFH (Germany’s Federal Finance Court) decided that the reverse charge mechanism also applies if only one of several recipients of the same service is a VAT taxable person. The challenge in this particular case was first to determine who was the actual beneficiary: two individual people or a company. The case illustrates the importance of preparing a well-structured contract.

Unclear contractual relationships

A married couple wanted to have a single-family detached house built on a plot of land in Germany. An Austrian contractor was assigned to perform the necessary timber construction work. Who the contractual partner of the Austrian contractor was - under civil law and thus also for VAT purposes as well - not immediately obvious given the circumstances. The contract named the husband as client, while the associated list of services named both spouses as the builder-owner. The building permit was issued to the husband and wife, but the property belonged solely to the husband. The husband was a VAT taxable person doing business as a sole trader, but the wife was not. The Austrian entrepreneur initially issued invoices that included the VAT to the married couple. Later, however, he cancelled these and issued amended invoices to the husband alone that omitted the VAT, citing the reverse charge mechanism.

The tax office viewed the husband as the recipient of the supply and assessed the VAT against him based on the reverse charge inputs because he was a VAT taxable person. The tax office did not grant the husband an input tax deduction because the single-family house was purely for personal use.

Both spouses were the recipients of the supply

In the first level of jurisdiction, the financial court answered the question of who actually received the supplies by declaring that both the husband and wife were the recipients. They had jointly contracted the supplies of the Austrian entrepreneur and were therefore together liable for the corresponding debt. However, the husband argued before the  federal financial court (BFH) that he and his wife had formed a partnership under civil law (GbR), and that this partnership had actually been the recipient of the supply rendered. To determine whether the reverse charge mechanism applies in this particular case, the court would first have to decide whether the GbR formed by the married couple truly constituted a GbR. The BFH pointed out that Section 705 of the German Civil Code (BGB) requires the partners in a GbR to pursue a common purpose. This was lacking in the case at hand, so that a GbR which could have been the recipient of the supply did not exist. The husband was the rightful recipient of the supply according to the underlying legal relationship.

Reverse charge mechanism is applicable in this case

Whether the wife was also a recipient of the supply is irrelevant and the BGH declined to issue a decision on this matter. The wording of Section 13b (5) Sentence 1 of the German VAT Code allows the reverse charge mechanism to be applied even if another person (in addition to the VAT taxable person) receives the supply - as long as the sole debtor of the full amount is the VAT taxable person. This interpretation not only avoids ambiguities in the interpretation of the law but also prevents persons from circumventing it. The BFH also pointed out that Art. 194 of the VAT Directive (the provision on the "determination of different tax debtors") grants the Member States regulatory discretion and is thus aligned with the argument put forth by the tax court in the first level of jurisdiction.

Recommendation: Make sure that the contract is clear and specific

The difficulties in this case were primarily due to the fact that neither the (potential) legal business relationship between the spouses, nor the contractual partner of the Austrian contractor, were clearly defined. The ECJ (European Court of Justice) had already ruled on April 21, 2005 (C-25/03) that the contractual partner receiving a supply must be a legal entity, not just a union of sorts. So, the BFH adhered to this ruling (judgement of October 6, 2005, V R 40/01). If several persons are involved on the client side, careful attention should therefore be paid to whether the formation of a company is both possible and desired. To avoid any ambiguities later as to who the recipient of the supply is for VAT purposes, it should be clearly stipulated who is to be entitled and obligated under the contract.

The fact that the reverse charge procedure is also applicable if only one of several recipients is a VAT taxable person is not clearly regulated in the VAT Directive. The BFH considers this to be part of the regulatory discretion of the Member States. Whether the ECJ takes a similar view has not yet been decided, and other Member States may take a different approach to such cases.

If one of the contracting parties is a VAT taxable person, it should be kept in mind that the reverse charge mechanism also applies pursuant to Section 13b (5) Sentence 7 of the German VAT Code (current version) if the service is not procured for entrepreneurial purposes - without an input tax deduction - as in the case of the personal home that was the object of this decision (then still Section 13b (5) Sentence 3 of the German VAT Code). It should also be noted that in accordance with the ECJ ruling of April 21, 2005 (C-25/03) and subsequent the BFH ruling of October 6, 2005 (V R 40/01), a partial input tax deduction is possible if one of the spouses uses the acquired item partially for business purposes.

Dated: May 26, 2021