The European VAT is an indirect tax system, it is designed to tax private consumption of goods and services. In short the system works as follows: Company A supplies goods or services to company B and charges company B with the applicable VAT. Company B pays the agreed price for the supplies and the VAT charged to company A. Company A reports and remits the VAT it charged to the tax authorities, and company B in its turn can deduct the VAT it has been charged with. Normally VAT does not trigger an additional cost for companies in the supply chain. This is different however, if company B would use the acquired goods or services for purposes that do not provide the right to deduct input VAT, as with the provision of goods for free. Due to the lack of remuneration, providing goods or the use of goods (i.e. lease) for free, can be regarded as a so called non-economical activity. Should company B acquire or manufacture goods that are subsequently provided for free, company B could be denied the right to deduct the input VAT it incurred and is thus confronted with an additional cost which has a subsequent impact on the margin of company B1.

The VAT issues around the provision of goods for free is of particular importance for manufacturers of medical devices who often sell their products and services in package deals. Such packages can include free product samples or free use of certain equipment and/or services (which can only be used together with the products that are actually sold and paid for). This set-up often triggers discussions with VAT authorities on the question whether or not input VAT can be recovered. Recently Advocate General Kokott ("AG") of the European Court of Justice ("ECJ") concluded in the Sveda case (C-126/14)) that the provision of free products should not restrict the right to deduct input VAT, provided that it facilitates and relates to VAT taxable sales. Please note, the ECJ still has to provide its ruling.

Sveda, a Lithuanian company, commissioned the construction of a Baltic mythological recreational discovery path. Sveda provided access for free. Visitors can buy food, drinks, souvenirs and other items in shops and restaurants operated by Sveda along the discovery path.

Sveda deducted the input VAT on the costs it incurred on the refurbishment of the discovery path. The Lithuanian tax authorities challenged this refund stating that the costs were connected to non-economic activities and therefore input VAT could not be recovered.. Non-economic activities are not relevant for VAT purposes; only VAT on costs in relation to economic activities can be recovered.

AG’s conclusion

AG Kokott held that it should be examined whether the refurbishment costs of the path had a direct and immediate link with Sveda’s VAT taxable supplies in its shops and restaurants. Free access was offered so that visitors would buy products in these shops and restaurants. From an economic perspective, this constituted a direct and immediate link between the refurbishment costs and the VAT taxable supplies. The AG referred to the example of offering free parking space in order to attract customers to a store. AG Kokott concluded that Sveda was thus entitled to deduct the input VAT.

Practical implications

The conclusion of the AG in the Sveda case provides tax payers with an additional argument to claim deduction of VAT on products that are provided for free. Should the ECJ follow the conclusion of the AG, then it is clear that the right to deduct input VAT may not be restricted provided that the free products facilitate and/or are related to VAT taxable supplies.

Please note, however, that some EU countries apply specific restrictions on the right to deduct input VAT. These restrictions are based on a so called "stand still clause" and may deviate from the EU VAT Directive and the VAT rulings of the ECJ.

The provision of goods for free, or the use of goods for free, therefore remains an activity which could in principle trigger additional VAT costs and it is therefore recommend to suppliers to assess their supplies for free and obtain a clear overview of the VAT consequences of such arrangements.