EU funding vs. VAT deduction

Lithuania: Even though a new EU funding period began, some undisclosed tax-related problems still remain, e. g. deduction of input VAT.

Even though a new European Union (EU) funding period began in 2014 (one of its priority areas is business support), some undisclosed tax-related problems still remain. One of these is deduction of input value added tax (VAT) on expenses incurred.

A purchaser’s right to deduct input VAT is one of the most important components of the VAT system and cannot be simply denied. However, practice shows that it is difficult to apply the VAT deduction principle in practice. For example, on 18 February 2014 the Supreme Administrative Court of Lithuania (Supreme Court) considered a case where the issue was whether a company registered in Lithuania (Company) can deduct input VAT from expenses incurred on a long term asset which was partly reimbursed by the EU.

Projects funded by EU funds are public use and free of charge, so that input VAT on an asset, which will not be used in the Company’s economic activity cannot be deducted. Based on this argumentation the tax authority refused to refund the Company’s input VAT.

The Supreme Court explicated the substance of economic activity and ascertained that a recreational environment even though not used directly in the Company’s economic activity can help it to attract customers – to be of indirect service to the Company’s economic activity. However, the Supreme Court noted that the long term asset would be used for non-taxable activity, i.e. public use and free of charge. Consequently the Supreme Court remained unclear whether the Company can deduct input VAT or not.

To resolve the uncertainty, the Supreme Court decided to refer to the Court of Justice of the European Union (ECJ) for a preliminary ruling, which inter alia has to decide whether the Company can recover input VAT on an asset which on the one hand will be transferred free of charge to public use but on the other hand can be recognized as an instrument for developing the Company’s economic activity.

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