Tax alert 39 – VAT treatment applicable to the amounts charged by an economic operator in the event of early cancelation of services agreements providing a minimum contracting period

CJEU Decision in the case C-295 /17 MEO – Serviҫos de Comunicaҫões e Multimédia SA

On 22 November 2018, the Court of Justice of the European Union („CJEU”) issued its judgment in the case of MEO (C-295/17). The case is particularly relevant for the telecommunications, utilities and real estate (in case of companies performing rental of immovable services) sectors, but also for other economic operators concluding contracts for the provision of services for minimum contracting periods. Thus, the decision refers to the VAT treatment of the amounts received by the suppliers following the early termination of the agreement at the client’s request or due to a fault of the client default, before the expiry of the minimum contractual period.

The CJEU concluded that the above-mentioned amounts represent remuneration received by the supplier for the services rendered, being thus subject to VAT.

Facts of the case and Court Decision

MEO, a company established in Portugal, provides telecommunications services based on agreements concluded for minimum contracting periods, the payment for the respective services being received particularly as a monthly subscription. These agreements provide that, if there is an early termination of the agreement, upon the client’s request of due to a fault of the client, MEO can request a compensation corresponding to the value of the telecommunications services for the period up to the fulfillment of the minimum contracting period.

Following the early termination of the services agreement, MEO disables the services provided based on the agreement and issues an invoice to the customer, mentioning that the operation is „not subject to VAT”, invoice which includes the amounts corresponding to the remaining subscription fees due. MEO was of the view that the amounts due further to the early termination of the agreements represent a penalty / compensation which is outside the VAT scope.

The CJEU considered that the direct link between the service provided to the beneficiary and the amount received by the supplier cannot be affected by the fact that the client does not use the services provided by the supplier. In addition, the CJEU found it relevant that MEO actually obtained, in principle, the same revenues as in a situation where the client would not have cancelled the agreement before the expiry of the minimum contracting period.

As regards the qualification of a certain contractual clause as a ‘penalty clause’, from a legal perspective, the CJEU was of the view that this is not a determinant aspect in establishing the VAT treatment, an analysis of the economic reality of the transactions performed between the supplier and the client. Also, a client who enjoyed the supply of services for the entire minimum contracting period should not benefit from a VAT treatment which is different from the case of a client who terminates the agreement prior to the respective period.

Taking into account the fact that the services to be rendered to the client and the amount to be invoiced to the latter are determined at the time when the services agreement is concluded, the CJEU considered that the amount due for non-compliance with the minimum contracting period represents the value of the services rendered by the supplier, representing thus a remuneration which can be clearly identified.

The CJEU also noted that it is not relevant for the purpose of establishing the VAT treatment of these amounts whether they are provided in the agreement in order to discourage the early termination of the agreements by clients or to cover the prejudice brought by the services supplier by its client. Moreover, it is not relevant that the invoiced amount is due under the penalty clause based on national law.

Therefore, the amounts received by MEO following the early termination of the agreement should be treated as remuneration received by the supplier in relation to a supply of services performed for consideration, being thus subject to VAT.

The impact of the decision

In taking its decision the Court considered it was important, first of all, to determine the economic reality of the transactions, without seeing as determinant factors the purpose envisaged by the supplier or the related legal considerations.

Following this decision, companies which cash in amounts as penalties / compensation for the early termination of agreements should analyze the computation method used to establish them and should determine if the VAT treatment applied is correct, otherwise there would be a risk of potential additional VAT liabilities as well as potential ancillary tax liabilities at their level. Particularly, the decision impacts companies providing minimum contracting periods for their services and penalties which are computed based on the value of the services related to the remaining period as compared to this minimum period, where there is a situation of early termination.

 

Author: Catalina Cambei – Manager, Indirect Tax

 

For additional information, please contact:

Alex Milcev, Partner – Head of Tax & Legal

Email: office@ro.ey.com



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