C-98/98

1 — OJ, English Special Edition 1967, p. 14. * Original language: Italian. 2 — OJ 1977 L 145, p. 1.

I - 4179

OPINION OF MR SAGGIO — CASE C-98/98

2. In so far as the goods and services are transactions are directly linked with used for the purposes of his taxable trans- goods intended to be exported to a actions, the taxable person shall be entitled country outside the Community. to deduct from the tax which he is liable to pay:

(a) value added tax due or paid in respect of goods or services supplied or to be supplied to him by another taxable person ...; 3

5. As regards goods and services to be used by a taxable person both for transactions covered by paragraphs 2 and 3, in respect of which value added tax is deductible, and for transactions in respect of which value added tax is not deductible, only such proportion of the value added tax shall be deductible as is attributable to the former transactions'. 3. Member States shall also grant every taxable person the right to the deduction or refund of the value added tax referred to in paragraph 2 in so far as the goods and services are used for the purposes of: Article 17(5) goes on to prescribe a number of formulae for the determination of the proportional deduction, the choice of for- mula being left, however, to the Member States.

4. The United Kingdom implemented Arti- cle 17(3)(c) of the Sixth Directive by treat- ing the transactions referred to therein as zero-rated, while deeming them to be theoretically taxable, so that although the right to deduct exists no tax is actually Clifford Chance had acted for the Midland charged. in relation to the acquisition of Mercantile House Holding ('Mercantile'), a company quoted on the stock exchange, a transac- tion which the Midland had undertaken to carry out on behalf of Quadrex Holdings Inc. ('Quadrex'), a corporation registered in Delaware, USA. In the United Kingdom there are various formulae for calculating the amount of the input VAT that can be deducted in the case of taxable persons who use goods and services in order to carry out both taxable and exempt transactions. The British and Commonwealth Holding plc (hereinafter 'B & C') was also interested in the abovementioned transaction. In August 1987, B & C and Quadrex entered into an agreement under which B & C was to buy Mercantile and then sell the whole- sale broking division to Quadrex. Facts and questions referred for a prelimin- ary ruling

5. The present reference for a preliminary The agreement, however, did not have the ruling arises out of a dispute between the desired result in that, due to lack of funds, Commissioners of Customs and Excise Quadrex was not able to purchase the ('the Commissioners') and Samuel Mon- abovementioned division from B & C. In tagu & Co. Ltd (part of the Midland Bank early 1988 B & C accordingly brought group, hereinafter referred to as 'the Mid- proceedings against Quadrex for breach of land'), a London merchant bank which contract. Quadrex, in turn, sued the Mid- supplies services, some of which are taxable land. In March 1988 B & C then brought and some of which are exempt so far as an action for damages against the Midland concerns deduction of VAT in respect of for the alleged misrepresentation of a

6. The Commissioners found that only part of the legal services at issue, supplied to the Midland between 1987 and 1995, were services in respect of which VAT is deduc- The Commissioners brought an appeal on a tible, so that not all of the input tax on point of law against that decision before those services was deductible — the input the High Court of Justice, Queen's Bench tax would in fact have to be apportioned Division, submitting that, although the between the taxable supplies and the legal services were supplied to the Midland exempt supplies and only the proportion in its capacity as a taxable person, they of the tax in respect of the taxable supply were in large part connected to the defence could be deducted by the Midland. of the Midland against claims that it had incurred civil liability in damages as a result of actions attributable to it which were performed while it was making the taxable supply to Quadrex (the latter supply is one in respect of which VAT is deductible because, under the United Kingdom legis- The Midland appealed against the Com- lation, it is treated as a zero-rated taxable missioners' decision before the VAT and supply, and thus remains theoretically tax- Duties Tribunal, claiming that all the legal able; such a supply falls within the scope of services, including those relating to the Article 17(3)(c) of the Sixth Directive, since litigation, were attributable to taxable the Midland had supplied a service to services (assistance in the abovementioned Quadrex, a company whose head office is financial transaction, in particular the outwith the European Community). 5

(b) is such a person entitled to deduct 1. Is it necessary to establish a direct and all the input tax charged in respect immediate link between a particular of an input on the ground that the input obtainable by a taxable person input was utilised as a consequence acting as such and a particular transac- of making a transaction falling

I-4183

OPINION OF MR SAGGIO — CASE C-98/98

within Article 17(2) or (3), in par- Arguments of the parties which submitted ticular Article 17(3)(c)? observations

3. If the answer to 1(a) or (b) is in the 8. The parties do not dispute that there is negative: an entitlement to deduction provided that there is a direct and immediate link between the input and output transactions, as held by the Court of Justice in Case C-4/94 BLP Group. 6 (a) what is the link that has to be established; and

(b) in the case of a taxable person 9. The Midland points out that the First making both transactions in Directive, which specifies in the second respect of which VAT is deductible paragraph of Article 2 that only the and transactions in respect of amount of 'value added tax borne directly which it is not: by the various cost components' of the transaction may be deducted, remains a guide to deductibility under the subsequent directives.

10. The United Kingdom does not dispute approach was confirmed by the Court of the Midland's entitlement to deduct VAT, it Justice in Belgian State v Ghent Coal merely challenges the extent to which the Terminal. 7 tax may be deducted. It argues that in the present case the legal services supplied by Clifford Chance to the Midland are in fact associated with that company's business generally and that, since such business consists of both transactions giving rise to the right to deduct and transactions which 12. So far as concerns the second question confer no such right, under Article 17(5) of referred by the national court seeking to the Sixth Directive input VAT is deductible ascertain the nature of the aforementioned only in part, specifically in proportion to 'immediate and direct link', both the Mid- the professional services relating to the land and the Commission argue, first and business giving rise to the right to deduct. foremost, that it is for the national court to The United Kingdom cannot accept that ascertain, on a case-by-case basis, whether such legal services should be considered to such a link exists. However, both those be cost components, as provided for in parties observe that in the present case Article 2 of the First Directive, of the there is a direct and immediate link financial transactions carried out by the between the legal services obtained from Midland as a component of a transaction Clifford Chance and the financial transac- or of a general class of taxable transactions. tions effected by the Midland and that, therefore, the entire amount of the tax to which the lawyers' fees are liable is deduc- tible.

13. The Commission, however, puts for- ward a number of practical examples to illustrate cases in which the aforemen- tioned direct and immediate link is appar- ent. It cites the example of a taxable person who makes 'mixed' supplies of goods and who is sued for breach of contract (on the Finally, the Midland lists a series of facts ground that the goods were faulty) relating relating to the present case to show the to a particular taxable supply, and incurs existence of an immediate and direct link legal fees in his defence. In such circum- between the transactions at issue. Included stances, in the Commission's view, the among them, for example, is the fact that direct and immediate link would lie the statements made by the Midland direc- between the legal services obtained and tor which gave rise to the claim for the particular taxable supply, rather than damages were made in the course of his the whole of the business in general; that duties on behalf of that company and in means that the taxable person would be respect solely of the financial transaction at entitled to full deduction of the tax on the issue, and that the Midland director had legal fees by virtue of Article 17(2) of the been mandated by Quadrex to negotiate Sixth Directive. On the other hand, if a with B & C the purchase of Mercantile and manufacturer carries on a business of that those negotiations centred, in particu- making both taxable and exempt supplies lar, on the question of Quadrex's financial of goods and pays an accountant to prepare status (hence the significance of the state- the annual accounts of the business, there is ments made by the director in that connec- no direct and immediate link between the tion). It was ultimately those statements accountant's work and any particular sup- which led to the termination of the contract ply of goods. In this case, the direct and immediate link is between the accountant's work and the business as a whole, with the 10 — Case C-230/94 Enkler v Finanzamt Homburg [1996] ECR result that, since that business consists of I-4517, paragraph 26.

16. As may be seen from the foregoing, at the heart of the problem raised by the national court is the analysis of the mechanism for deduction laid down in the VAT system. The principle of deduction of The claim for damages brought by B & C the input tax is a fundamental element of against the Midland could not in fact be the common system of VAT: at each stage considered to be part of the taxable ser- of the process of production and market- vices, since it lacks any connection whatso- ing, the taxable person pays to the revenue ever with the latter; in the United King- authorities the tax due on its sales prior to dom's view, the link is purely coincidental. deduction of the tax paid in the preceding Moreover, that action did not concern stage by its suppliers. Once the deduction solely the deductible financial transaction mechanism is seen to operate in that way, and in any event was brought by B & C, the definition in Article 2 of the First

I - 4187

OPINION OF MR SAGGIO — CASE C-98/98

18. The Community legislature, however, 13 — Case 8/81 Becker (1982) ECR 53, paragraph 44; Opinion provided for a number of cases in which the of Advocate General Lenz in BLP, cited above, paragraph 32. 14 — For example, such a category might include the renting of property by a company which carries out both exempt transactions and taxable transactions. In such a case, the 1 1— Ghent Coal Terminal, cited above, paragraph 15. rent paid cannot be linked to just one of the two 12 — Rompelman, cited above, paragraph 19. transactions.

I -4188

MIDLAND BANK

— where expenditure is for private pur- is to say, used for both deductible and poses, even when incurred as part of non-deductible transactions). In such a the normal business of the undertaking case, deduction is to be made pursuant (see Article 17(6) of the Sixth Direc- to Article 17(5) and Article 19 of the tive); such expenditure is not deduc- Sixth Directive (and in accordance with tible. the system adopted by the United Kingdom), 15 or in the proportion agreed between the Midland and the Commissioners. It should be observed that the Midland is a company which, in general, carries out both taxable transactions and exempt transactions. 19. Now, the dispute pending before the national court concerns essentially the following issues:

I -4189

OPINION OF MR SAGGIO — CASE C-98/98

graph (a), and only indirectly to that in of the development of the case-law. It is paragraph (b). 16 therefore appropriate first of all to set out the factual and legal context in which the Court has used that expression.

Substance The context is that of the BLP case, cited several times above, in which the Court was called upon to rule on the right to deduction in respect of certain services (financial and legal advice) supplied to a company and used by it for an exempt transaction. In that case the national court The first question had asked the Court whether BLP was entitled to deduct the whole of the input tax paid in view of the fact that the purpose and the result of carrying out the exempt 22. That being said, I now move on to transaction was to offset a taxed transac- analyse the first question. By that question tion in its entirety and specifically to the national court seeks to establish whe- discharge the company's debts. ther, in order for the whole of the VAT to be deductible in circumstances such as those of the Midland (that is to say an undertaking which carries out taxable transactions and exempt transactions), there must exist a 'direct and immediate link' between the The Court answered in the negative, hold- input transaction (the legal services sup- ing that, in order to be able to apply the plied by Clifford Chance to the Midland in deduction referred to in Article 17(2) of the respect of the litigation) and the output Sixth Directive, 'the goods or services in transaction (that is, the acquisition of question must have a direct and immediate Mercantile). link with the taxable transactions, and... the ultimate aim pursued by the taxable person is irrelevant in this respect'. 17

'borne directly by the various cost compo- above), where a taxable person carries on a nents', and by Article 17(3)(c) of the Sixth business with the purpose of carrying out Directive. 18 only taxable transactions, it is not neces- sary, for the purposes of deducting the whole of the VAT, that he should prove the existence of a direct and immediate link between each and every input transaction and a particular taxable output transaction. 24. Admittedly, as the Commission points The Community legislature only requires out, the matter at issue in BLP was that the goods and services be used or be different to that in the present case, in likely to be used 'for the purposes of... which what is disputed is not whether the taxable transactions' (Article 17(2) and (3) Midland has a right to obtain deduction of of the Sixth Directive). The use of the the VAT but only the amount which may be words 'purposes' and 'transactions' in the deducted. However, even from this differ- plural denotes that in certain instances a ent point of view, it is still necessary to link with a particular taxable transaction is establish whether there is 'a direct and not necessary, a link with the undertaking's immediate link' between the input and business sufficing. output transactions, because even partial deduction of the VAT depends on that factor.

I -4191

OPINION OF MR SAGGIO — CASE C-98/98

cular importance, as the United Kingdom (the Midland in this case) making both observes, where the intention is to apply transactions in respect of which VAT is the general principle of deduction of the deductible and transactions in respect of whole of the VAT to circumstances, such as which it is not, is entitled to deduct all the those described by the national court, in input tax charged (in the present case, tax which the taxable person carries out tax- charged on Clifford Chance's fees) in able and/or exempt transactions and/or respect of an input (the service supplied receives services or goods which may be by those chambers in defending the claim used both for exempt transactions and for against the Midland) on the ground that the taxable transactions. In such a case, where input was utilised as a consequence of there is no immediate and direct link making a transaction falling within Arti- between the services and goods and the cles 17(2) or (3), in particular Arti- taxable transactions, the right to deduct is cle 17(3)(c). restricted proportionately or is precluded where the output transaction is an exempt transaction.

I -4192

MIDLAND BANK

national court to determine the specific Article 17 of the Sixth Directive. 23 The use approach to adopt in the case of a taxable of the two adjectives 'direct' and 'immedi- person who, as in the present case, seeks to ate' cannot but refer to a particularly close deduct all the VAT paid on legal services of link between the taxable transactions (in which he made use not only in carrying out the present case, the financial transaction) a deductible transaction but also in defend- carried out by a taxable person (in this ing himself in court in litigation arising out case, the Midland) and the goods or of that transaction. services supplied by another taxable person (in the present case, Clifford Chance).

23 — The Court has held, specifically (in paragraphs 18 and 19 So far as concerns the wording, I would of that judgment) that 'paragraph 2 of Article 17 of the Sixth Directive must be interpreted in the light of mention first that the expression 'direct and paragraph 5 of that article. Paragraph 5 lavs down the immediate link' 2 2 was chosen by the rules applicable to the right to deduct VAT where the VAT relates to goods or services used by the taxable person Court, in the oft-cited BLP case, as a key "both for transactions covered by paragraphs 2 and 3, in respectof which value added tax is deductible, and for to the interpretation of the terms used in transactions in respect of which value added tax is not deductible". The use in that provision of the words "for transactions" shows that to give the right to deduct under paragraph 2, the goods or services in question must have a direct and immediate link with the taxable transactions, 22 — In the French language version of the judgment in BLP, and that the ultimate aim pursued by the taxable person is cited above: 'lien direct et immédiat'. irrelevant in this respect'.

I - 4193

OPINION OF MR SAGGIO — CASE C-98/98

30. The Court has held that whether there is a 'direct and immediate link', a matter for the national court, must be determined on the basis of an objective criterion, 25 that is to say without taking account of the ultimate aim or the results of the economic activities of the taxable person seeking to deduct VAT, provided, of course, that those activities are themselves subject to VAT. 2 6 That approach not only ensures 'that all economic activities... are taxed in a wholly neutral way', 30 it also serves to safeguard the principle of legal certainty. It 'is con- trary to the principle of legal certainty for the rights and obligations of taxable per- Let me give a specific example. Company sons to depend on facts, circumstances or A, which provides services for both deduc- events which occurred after the tax author- tible and non-deductible transactions, is ity made a finding in respect of those rights entitled to deduct all the VAT in respect of and obligations'. 31 y services which it has received in its turn from company B, so long as the latter services are objectively linked to the deduc- 27 — In Rompelman, the Court held that the economic activities referred to in Article 4(1) of the Sixth Directive may tible transactions. To that end, that require- consist in several consecutive transactions and that pre- paratory acts, such as the acquisition of assets and therefore the purchase of immovable property, which form part of those transactions must themselves be treated as constituting economic activity (paragraph 22). 24 — Any other solution might appear to run counter to the 28 — The Court has ruled, for example, in Enkler that one of the principles laid down by the Court, in particular in Ghent factors 'on the basis of which the tax authorities must Coal Terminal, cited above. In that judgment, the Court consider whether a taxable person has acquired goods for held that the right to deduct remains where, by reason of the purposes of his economic activities is the nature of the circumstances beyond his control, the taxable person has goods concerned' (paragraph 26). See also Case C-110/94 never made use of those goods or services for the purpose INZO [1996] ECR I-857, paragraph 21. of carrying out taxable transactions. 29 — See, to that effect, Ghent Coal Terminal, paragraphs 20, 25 — See BLP, paragraphs 24 and 26, and Rompelman, 21 and 22. paragraph 19. 26 — In line with the case-law of the Court. See, most recently, 30 — See Ghent Coal Terminal, paragraph 15. Ghent Coal Terminal, cited above, paragraph 15. 31 — INZO, cited above.

33. Finally, so far as concerns Question 31. That having been said, I am of the 2(a), by which the national court seeks to opinion that, in circumstances such as those ascertain whether the test for determining set out by the national court, there is the amount of the deductible input tax is always a 'direct and immediate link' any different as between Article 17(2), (3) between a taxable transaction and the and (5) of the Sixth Directive, the reply supply of certain goods or services when- depends on the formula chosen by the ever, in the light of an objective assessment Member State in question to determine the (which it is for the national court to carry proportion of the deductible tax, pursuant out), the goods or services are used by the to Article 17(5). In the case of the United taxable person to carry out one or more Kingdom, according to its observations, the taxable transactions. Such a link exists, in formula chosen reflects that provided for in particular, in accordance with the second Article 17(2) and (3). In that case, then, the paragraph of Article 2 of the First Direc- test to be adopted will be the same. tive, if the amount of the tax paid in respect of the supply of a good or for the provision of a service was borne directly by the various cost components of the taxable transaction. The mere fact that a service (such as legal defence) was supplied as a consequence of a deductible transaction is not sufficient, however, for the purposes of deducting the whole of the VAT paid by a The third question taxable person (such as the Midland) in respect of the supply of that service. More- over, the link must be identifiable according to objective criteria; that generally means that the link should reflect the normal 34. In view of the answers given to the two relationship between the two supplies, so preceding questions, the third question that the second should follow the first not does not call for an answer. I therefore in a mechanical way, but according to the put forward an answer to it only by way of normal and regular order of causal chains. an alternative.

(2) Article 17(2) and (3) of the Sixth Directive must be interpreted as meaning that, in order for all the VAT paid in respect of a service by a taxable person, who carries out both transactions in respect of which VAT is deductible and

I - 4196

MIDLAND BANK

transactions in respect of which it is not, to be deductible, the mere fact that that service was utilised also as a consequence of making a transaction falling within the scope of Article 17(2) or Article 17(3), in particular Arti- cle 17(3)(c), of the Sixth Directive is not sufficient.

Entitlement to deduct VAT does arise, however, whenever, in the light of an objective assessment (which it is for the national court to carry out), a service is utilised by the taxable person, according to the normal and regular order of causal chains, to carry out one or more taxable transactions falling within the scope of the abovementioned articles. Such a link exists, in particular, in accordance with the second paragraph of Article 2 of the First Directive, if the amount of the tax paid in respect of the supply of a service was borne directly by the various cost components of the taxable transaction.

In order to establish whether the test for determining the amount of input tax that is deductible is any different as between Article 17(2), (3) and (5), it must first be established what formula has been adopted by the Member State concerned for the determination of the proportional deduction of the VAT, within the meaning of Article 17(5) of the Sixth Directive.