Classic: the Zita Modes judgment

No VAT need be charged on the transfer of a business. In 2003 the Court of Justice gave further shape to that no-supply principle in Zita Modes.

Where a business is transferred, the starting point is that each asset transferred is a separate supply of goods or services. A price would then have to be set and VAT charged for each of them. To avoid that, articles 19 and 29 of the VAT Directive provide a special rule, known as the no-supply principle. The Netherlands applies that rule and has enacted it in article 37d of the Dutch VAT Act.

The facts

Zita Modes concerned the sale of a ready-to-wear clothing business by Zita Modes Sàrl to Milady, a company operating a perfumery. The Luxembourg tax authorities argued that the sale was subject to VAT, because the buyer did not continue the transferor's activity as such.

The Luxembourg court asked the Court of Justice whether the no-supply principle requires the transferee to continue the same business activities, and whether the transferee must hold a specific licence for those activities. It also asked whether the transfer of a totality of assets always requires the whole business or part of it to be transferred.

The rule

The Court held that the concept of a transfer of a totality of assets must be construed the same way in every member state. Where a member state chooses not to charge VAT on the transfer of a business or an independent part of it, that applies to every transfer of a business capable of carrying on an autonomous economic activity. The condition is that the new owner intends to operate the business rather than immediately liquidate it. A member state may also not restrict the principle to cases where the new owner holds a specific establishment licence for the activities transferred.

What this means in practice

Where a Dutch taxable person transfers a business, or part of one, capable of carrying on an economic activity, article 37d may apply. The activity carried on after the transfer need not be the same as before.

Applying that article avoids the funding problems that arise where VAT must be charged and paid on the transfer while the buyer pays the price only later. It also saves administrative effort, because each individual supply need not be assessed separately for VAT. Another advantage: where the business carries on exempt activities, no VAT need be charged that the continuing business could not deduct.

Transfers of let buildings

Proceedings are currently under way about transfers of let buildings, where the debate is whether such transfers amount to a totality of assets and services or simply to a sale of goods or stock. The outcome will have significant implications for the property sector and for applying article 37d to such transactions.

If you plan to transfer your business, establish whether article 37d can apply. That prevents non-deductible VAT, funding problems and unnecessary administration.