© 2025 by Michael Firth KC, Gray's Inn Tax Chambers
Contact: michael.firth@taxbar.com
M3. Preparatory input tax
PREPARATORY ACTIVITIES GIVING RIGHT TO DEDUCT
- Sufficient that person truly intends to use the goods/services to carry out economic activities
"[37] It is thus sufficient that the taxable person truly intended to use the goods and/or services in question to carry out the economic activities in respect of which he or she exercised his or her right to deduction (see, inter alia, judgments of 14 February 1985, Rompelman, 268/83, EU:C:1985:74, paragraph 24; of 29 February 1996, Inzo, C‑110/94, EU:C:1996:67, paragraph 17; of 8 June 2000, Breitsohl, C‑400/98, EU:C:2000:304, paragraph 39, and of 17 October 2018, Ryanair, C‑249/17, EU:C:2018:834, paragraph 18)." (ITH Comercial C-734/19)
- Investment expenditure with intention of commencement treated as economic activity
"[45] ... the principle that VAT should be neutral as regards the tax burden on a business requires that the first investment expenditure incurred for the purposes of and with the view to commencing a business must be regarded as an economic activity and it would be contrary to that principle if such an activity did not commence until the business was actually exploited, that is to say until it began to yield taxable income. Any other interpretation of Article 4 of the directive would burden the trader with the cost of VAT in the course of his economic activity without allowing him to deduct it in accordance with Article 17, and would create an arbitrary distinction between investment expenditure incurred before actual exploitation of a business and expenditure incurred during exploitation.
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[47] It follows that a person who has the intention, confirmed by objective evidence, to commence independently an economic activity within the meaning of Article 4 of the Sixth Directive and who incurs the first investment expenditure for those purposes must be regarded as a taxable person..." (Gabalfrisa C-110/98)
- Raising funds for potential future projects treated as economic activity
"[67]...On the FTT’s findings of fact, the purchase of the SFPE units was part of an exercise raising funds for FASL’s economic activities. The underlying principle is the principle of neutrality which relieves the taxable person of the burden of VAT payable and paid in the course of all its economic activities: Rompelman, para 19; Belgian State v Ghent Coal Terminal NV, para 15; Gabalfrisa SL v Agencia Estatal de Administración Tributaria (Cases C-110/98 to C-147/98) EU:C:2000:145; [2000] ECR I-1577; [2002] STC 535, para 44.
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[70] The recognition that fund-raising costs may, where the evidence permits, be treated as general overheads of a taxable person’s business means that the taxable person must be able to provide objective evidence to support the connection between the fund-raising transaction and its proposed economic activities. The taxpayer also needs to maintain adequate banking arrangements and records to vouch the later use of the funds so raised to demonstrate its entitlement to deduct and to retain the deduction, if investigated." (HMRC v. Frank A Smart [2019] UKSC 39)
- Objective evidence of intention to commence economic activities required
"[46] Article 4 of the Sixth Directive does not, however, preclude the tax authority from requiring objective evidence in support of the declared intention to commence economic activities which will give rise to taxable transactions. In that context, it is important to state that a taxable person acquires that status definitively only if he made the declaration of intention to begin the envisaged economic activities in good faith. " (Gabalfrisa C-110/98)
"The business should provide evidence of intended taxable supplies. There may be times where a business simply asserts that it is going to make supplies in the future and seeks to recover preparatory costs." (VIT22000)
- In no way dependent on recognition by tax authority
"[38] The arising of the right to deduct the VAT paid on the first investment expenditure is thus in no way dependent upon formal recognition of the status of taxable person by the tax authority. The only effect of that recognition is that such status, once recognised, cannot, save in situations of fraud or abuse, be withdrawn from the taxpayer with retrospective effect, without infringing the principles of the protection of legitimate expectations and legal certainty." (Breitsohl C-400/98)
Timing of commencement of output supplies
- Need not be clear when any project will commence
"[106]...This concerned the potential time lag between the incurring of the input and the carrying on of the economic activity to which FASL said it was linked. As I have explained in para 96 above, if a taxable person is not carrying on economic activity at the time it incurs the inputs (as happened in Sveda) then the input can still be linked to the future economic activity and hence can still be deductible if the court determines on the basis of objective evidence that it is the taxable person's intention to use the input in future for carrying on taxable economic activity. The authorities that Lord Hodge cites in para 60 and in support of his proposition (vii) relate to that point. In proposition (vii) he cites Sveda where that timing point was in issue and the two cases that the CJEU cited in Sveda. Those are cases in which the CJEU made clear that even if the goods acquired are not used immediately for economic activity, the right to deduct arises even if their use in an economic activity may occur sometime later: see the passages from Sveda cited at paras 51 and 53 of Lord Hodge's judgment." (Hotel La Tour v. HMRC [2025] UKSC 46)
"[68] While it is not clear from the FTT’s findings when any of FASL’s projects will come to fruition, I am persuaded that the FTT was entitled to conclude that FASL when it incurred the costs of the purchase of the SFPE units was acting as a taxable person because it was acquiring assets in support of its current and planned economic activities, namely farming and the windfarm. On that basis FASL was entitled to an immediate right of deduction of the VAT paid on the purchase of the SFPE units and is entitled to retain that deduction or repayment so long as it uses the SFPs which it received as cost components of its economic activities. A start-up business can acquire goods and services to support its future taxable supplies and claim VAT paid on those acquisitions as input tax; so too in principle can an existing business which proposes to expand its economic activity. On the facts found, FASL does not carry out and does not propose to carry out downstream non-economic activities or exempt transactions. Therefore, no question of apportionment under article 173 of the PVD arises." (HMRC v. Frank A Smart [2019] UKSC 39)
- Not permissible to require commencement within 1 year or defer input tax deduction
"[53] The fact remains that the national legislation at issue in the main proceedings not only makes the exercise of the right to deduct VAT paid by a taxable person liable thereto before he starts regularly carrying out taxable transactions conditional upon the submission of an express request and compliance with a time-limit of one year between such a request and the actual commencement of taxable transactions, but also penalises infringement of those requirements by systematic deferment of the exercise of the right to deduct until the time at which taxable transactions actually begin to be carried out on a regular basis. Such legislation may even lead to the forfeiture of that right if those transactions do not commence or if the right to deduct is not exercised within five years from the time at which that right arises.
[54] In those circumstances, such legislation goes beyond what is necessary to attain the objectives of ensuring the correct levying and collection of the tax and preventing fraud." (Gabalfrisa C-110/98)
Types of evidence
"For example a business may seek to register and recover VAT on expenses on the basis that it intends to make management charges to an associated business. In this case the intended activity is less clear and the business should provide objective evidence of their intention. There is no exhaustive list of acceptable evidence and it will very much depend on the facts of the individual case. If there are any doubts recovery will not be allowed.
The case of Rompelman (see VIT62200) makes clear the requirement that the business should provide objective evidence of its intention to make future supplies.
Examples of the type of evidence that HMRC normally accepts as meeting the ‘in-business’ test are:
- Copies of invoices for expenditure you would expect a person either already in business or in the process of starting up a business to incur, for example accountancy or consultancy fees in relation to relevant business advice;
- Evidence of efforts to raise or secure finance for a business, for example letters to and from banks, finance institutions;
- Evidence of efforts to enter into contracts for either procurement of stock for resale or the for the supply of goods or services;
- A copy of a bid for a competitive tender - this should still be current;
- Details of actual or proposed advertising or marketing campaigns;
- Evidence of efforts to obtain planning permission for a business purpose - this should still be current and if the application has been refused alternative evidence may be required;
- Any other evidence demonstrating that a business is in place, or is being set up, such as letters from accountants, business plans, minutes of meetings." (VIT22000)
- HMRC acceptance of status based on preparatory acts cannot be withdrawn retroactively if events do not occur (in the absence of fraud)
" [32] The Court has ruled that, once the tax authorities have accepted, on the basis of information provided by a business, that it should be accorded the status of a taxable person, that status cannot, in principle, subsequently be withdrawn retroactively on account of the fact that certain events have or have not occurred, save in cases of fraud or abuse (judgment of 28 February 2018, Imofloresmira – Investimentos Imobiliários, C‑672/16, EU:C:2018:134, paragraph 36 and the case-law cited)." (ITH Comercial C-734/19)
PREPARING FOR ANOTHER PERSON TO COMMENCE
Preparatory acts with intention to transfer before commencement
- Right to recover to ensure neutrality
"[33] Second, it should be noted that the Court has held that, in applying the principle of neutrality of VAT, a taxable person whose sole object is to prepare the economic activity of another taxable person and who has not effected any taxable transaction may exercise a right to deduct in relation to taxable transactions carried out by the other taxable person (see, to that effect, Case C-137/02 Faxworld [2004] ECR I-5547, paragraphs 41 and 42). That interpretation of the Sixth Directive concerned a situation where the VAT which the first taxable person wished to deduct related to supplies acquired by it for the purpose of carrying out taxable transactions planned by the second taxable person." (Polski Trawertyn C-280/10)
"[41] However, in contrast to the facts of the case giving rise to the judgment in Abbey National, the taxable person in the case before the national court, namely Faxworld GbR, as a Vorgründungsgesellschaft, did not even intend to effect itself taxable operations, its sole object being to prepare the activities of the Aktiengesellschaft (limited company). None the less, the VAT which Faxworld GbR wishes to deduct relates to supplies acquired for the purpose of effecting taxable transactions, even though those transactions were only the planned transactions of Faxworld AG.
[42] In those precise circumstances, and in order to ensure the neutrality of taxation, it must be held that, where the Member State has exercised the options provided for in Articles 5(8) and 6(5) of the Sixth Directive, as a result of the fact that, according to those provisions, ‘the recipient shall be treated as the successor to the transferor’, a Vorgründungsgesellschaft, as the transferor, must be entitled to take account of the taxable transactions of the recipient, namely the Aktiengesellschaft, so as to be entitled to deduct the VAT paid on input services which have been procured for the purposes of the recipient’s taxable operations.
[43] Accordingly, the answer to the question referred by the Bundesfinanzhof must be that a partnership established for the sole purpose of founding a capital company is entitled to deduct the input tax paid on supplies of goods and services where its only output transaction in the performance of its object was to effect by formal act the transfer for consideration of the supplies obtained to that company once founded and where, because the Member State concerned has exercised the options provided for in Articles 5(8) and 6(5) of the Sixth Directive, a transfer of a totality of assets is not deemed to be a supply of goods or services." (Faxworld C-137/02)
Preparatory acts of partner in future partnership
- Partnership entitled to recover input incurred by partner on investment expenditure for partnership
"[31] Accordingly, in a situation such as that at issue in the main proceedings, in which the partners of a partnership incurred, before registration and identification of the partnership for the purposes of VAT, investments necessary for the future exploitation of immovable property by the partnership, those partners may be considered to be taxable persons for the purposes of VAT and are therefore, in principle, entitled to exercise the right to deduct input tax.
[32] Therefore, the fact that the contribution of an immovable property to a partnership by its partners is a transaction exempted from VAT and the fact that those partners do not pay VAT upon that transaction cannot have the consequence of burdening them with the cost of the VAT in the context of their economic activity without any possibility of their deducting it or of obtaining a refund (see, to that effect, Rompelman, paragraph 23).
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[35] It must therefore be held that, in so far as, under national legislation, the partners, even though they may be considered taxable persons for the purposes of VAT, are unable to rely on the taxable transactions effected by Polski Trawertyn in order to relieve the cost of the VAT on investment transactions effected for the purposes of and with the view to the activity of that partnership, the latter must, in order to ensure the neutrality of taxation, be entitled to take account of those investment transactions when deducting VAT (see, to that effect, Faxworld, paragraph 42)." (Polski Trawertyn C-280/10)
- No right to recover where partner provides client base to partnership without contributing it
"[42] The principle of fiscal neutrality does not apply therefore to a situation such as that at issue in the main proceedings, where, as is apparent from paragraphs 35 and 36 of this judgment, the provision of the client base for the use of a partnership free of charge is not a transaction falling within the scope of VAT.
[43] Moreover, as the Court has already held, the principle of fiscal neutrality is not a rule of primary law but a principle of interpretation, to be applied concurrently with the principle on which it is a limitation (Case C‑44/11 Deutsche Bank [2012] ECR, paragraph 45). It does not therefore allow the scope of the deduction from output VAT to be extended in the face of an unambiguous provision of the Sixth Directive. As regards the case which gave rise to Polski Trawertyn, it was clear that the application of the national legislation at issue did not allow either the future partners of the partnership to be created or that partnership to rely successfully on the principle of neutrality.
[44] Third, it is important to note that the facts of the dispute in Polski Trawertyn are also different in other respects from the situation at issue in the main proceedings. Thus, in this case, the new partnership had already been created when Mr Malburg acquired the client base and, unlike the situation at issue in Polski Trawertyn, there was no contribution of capital goods, in this case, the client base, to the capital assets of that partnership. Finally, it is not the newly formed partnership which has requested the right to deduct input VAT paid by a partner in the course of acts preparatory to the partnership’s activity.
[45] Therefore, the reasoning underlying the interpretation adopted by the Court in Polski Trawertyn cannot be applied to a situation such as that at issue in the main proceedings." (Malburg C-204/13)
OUTPUT SUPPLIES NEVER COMMENCE
Inputs already fully consumed at time of intention ceasing
- Initial right to deduct is not lost
"[43] The Court has also repeatedly held that the right of deduction, once it has arisen, is retained even if, subsequently, the intended economic activity was not carried out and, therefore, did not give rise to taxable transactions ... or if, by reason of circumstances beyond its control, the taxable person was unable to use the goods or services which gave rise to the deduction in the context of taxable transactions ... " (Vittamed C-293/21)
"[41] In the absence of fraud or abuse, and subject to adjustments which may be made in accordance with the conditions laid down in Article 20 of the Sixth Directive, the principle of VAT neutrality requires, as indicated in paragraph 36 of this judgment, that the right to deduct, once it has arisen, be retained even where the tax authority is aware, from the time the first tax assessment is made, that the economic activity envisaged, which was to give rise to taxable transactions, will not be taken up." (Breitsohl C-400/98)
- Not for tax authority to assess the soundness of reasons for abandoning planned activity
" As regards circumstances beyond the taxable person’s control, the Court’s case-law makes plain that it is not for the tax authorities to assess the soundness of the taxable person’s reasons for abandoning the economic activity initially planned, since the common system of VAT ensures neutrality of taxation of all economic activities, whatever their purpose or results, provided that they are themselves subject in principle to VAT (see, inter alia, judgments of 14 February 1985, Rompelman, 268/83, EU:C:1985:74, paragraph 19, and of 17 October 2018, Ryanair, C‑249/17, EU:C:2018:834, paragraph 23)." (ITH Comercial C-734/19)
- Deciding to liquidate in view of the results of profitability study
"[22]... Entitlement to deduct is retained, even if it is subsequently decided, in view of the results of a profitability study, not to move to the operational phase but to put the company into liquidation, with the result that the economic activity envisaged does not give rise to taxed transactions (INZO, paragraph 20)." (Fini C-32/03)
- As long as intention was genuine at the time
"[37] It is thus sufficient that the taxable person truly intended to use the goods and/or services in question to carry out the economic activities in respect of which he or she exercised his or her right to deduction (see, inter alia, judgments of 14 February 1985, Rompelman, 268/83, EU:C:1985:74, paragraph 24; of 29 February 1996, Inzo, C‑110/94, EU:C:1996:67, paragraph 17; of 8 June 2000, Breitsohl, C‑400/98, EU:C:2000:304, paragraph 39, and of 17 October 2018, Ryanair, C‑249/17, EU:C:2018:834, paragraph 18).
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[39] However, and even though preventing possible tax evasion, avoidance and abuse is an objective recognised and encouraged by the VAT Directive (see, inter alia, judgment of 28 February 2018, Imofloresmira – Investimentos Imobiliários, C‑672/16, EU:C:2018:134, paragraph 51), that possibility cannot lead the tax authorities to establish, where the investment is abandoned, rules of evidence, such as the presumption of the existence of abuse or fraud, the effect of which would be to make it virtually impossible or excessively difficult for taxable persons to exercise the right to deduct VAT, which is a fundamental principle of the common system of VAT." (ITH Comercial C-734/19)
- No requirement to adjust (because no change of intention for fully consumed inputs)
"[44] It is only if the taxable person no longer intended to use the goods and services in question to carry out taxable output transactions, or used them to carry out exempt transactions, that the close and direct relationship, within the meaning of the case-law cited in paragraph 41 above, which must exist between the right to deduct input VAT and the performance of planned taxable transactions, would be broken." (ITH Comercial C-734/19)
"Unfortunately there will be times when business fail before they have actually made any supplies. The input tax recovery rules treat the intended supplies as if they were actual supplies. As long as there is a genuine intention to make supplies the VAT incurred on preparatory costs for the failed business will be recoverable subject to the normal rules.
The case of Ghent Coal (see VIT62200) is clear authority for this approach. If a business is:
- unable to fulfil its original intention to trade; and
- does not make a supply
there is no need for it to repay any input tax deducted in relation to the intended supplies." (VIT22000)
Inputs not fully consumed at time of intention ceasing
- Adjustment for input tax on goods on hand/not consumed at time of cessation of intention
"[44] It is only if the taxable person no longer intended to use the goods and services in question to carry out taxable output transactions, or used them to carry out exempt transactions, that the close and direct relationship, within the meaning of the case-law cited in paragraph 41 above, which must exist between the right to deduct input VAT and the performance of planned taxable transactions, would be broken." (ITH Comercial C-734/19)
- Deemed supply on private use or deregistration
"[70] ... As the CJEU recorded in Sveda (para 36) the taxpayer will have to repay input VAT if it does not use the input goods or services for the purposes of its economic activity. HMRC has power to charge VAT under regulation 3 of the Value Added Tax (Supply of Services) Order 1993 (SI 1993/1507), where a taxable person uses services supplied to it for its business for a purpose other than a business use, by treating that use as a supply of services in the course of its business. This may involve HMRC in more investigations than the CJEU envisaged in BLP (para 24). But this supervision of the subsequent use of the raised funds, with which the services were associated, seems to me to be an inevitable consequence of the CJEU’s interpretation of the PVD." (HMRC v. Frank A Smart [2019] UKSC 39)
"Where goods are still on hand, at the time of deregistration, output tax must be accounted on the market value.
Where a service is put to a private use, output tax must be accounted for on the cost value. You can use any fair and reasonable method to work out the cost." (VIT22000)
- No adjustment where plan changes but still involves taxable supplies
"[47] Furthermore, the Court has stated that, where, by reason of circumstances beyond its control, the taxable person did not make use of a service or goods, such as immovable property, which gave rise to a deduction in the context of taxed transactions, it is not sufficient, in order to establish the existence of a ‘change’ for the purposes of Article 185 of the VAT Directive, for that property to remain empty after the termination of the lease to which it was subject, even where it has been established that the taxable person still intends to use it for a taxed activity and undertakes the necessary steps to that end, since that would be tantamount to restricting the right of deduction through the provisions applicable to adjustments (judgment of 28 February 2018, Imofloresmira – Investimentos Imobiliários, C‑672/16, EU:C:2018:134, paragraph 47; order of 18 May 2021, Skellefteå Industrihus, C‑248/20, EU:C:2021:394, paragraph 44)." (Vittamed C-293/21)
"[46] In the light of all the foregoing considerations, the answer to parts (a) to (i) of the first question is that Articles 167, 168, 184 and 185 of the VAT Directive must be interpreted as meaning that the right to deduct input VAT on goods, in the present case immovable goods, and services acquired with a view to carrying out taxable transactions, is maintained where the investment projects initially planned have been abandoned owing to circumstances beyond the taxable person’s control, and there is no need to adjust that VAT if the taxable person still intends to use those goods for the purposes of a taxable transaction." (ITH Comercial C-734/19)