Company entitled to deduct VAT on legal costs of its CEO in criminal proceedings

Costs that also benefit someone other than the company do not automatically cost you the deduction. What matters is whether the costs were incurred primarily in the interests of the business.

Deducting VAT on legal fees in criminal proceedings

A company that is a taxable person may deduct VAT to the extent that it received taxable supplies as a taxable person and uses them for its own taxable supplies. In Wolfram Becker, the Court of Justice made clear that a business incurring the cost of a lawyer in criminal proceedings against a manager cannot simply deduct the VAT: those costs also benefit someone other than the company.

Where costs also give a third party a private benefit, the question is whether the business needed to incur them. That is the case where they were incurred primarily in the company's interests. In the Dutch legal fees judgment, the Supreme Court extended that line to a company incurring the cost of a lawyer in criminal proceedings against its managing shareholder.

Where a right to deduct does exist, the further question is whether it is excluded under the Dutch decree excluding VAT deduction, because of the consumption benefit enjoyed by the third party. In the legal fees judgment the Supreme Court saw no room for the exclusion relating to staff benefits (for VAT purposes a managing shareholder is an employee) where the costs were incurred primarily in the interests of the business.

The Supreme Court

The Supreme Court recently had to rule again on a company's right to deduct VAT on legal fees for representation in criminal proceedings. The company provided asset management services. In 2013 the public prosecutor opened a criminal investigation into both the company and its director, the CEO. The CEO was employed not by the company but by the holding company that owns 40% of its shares. The legal costs of the proceedings against the CEO were invoiced to the company, which deducted the VAT.

The inspector refused the deduction on two grounds: the costs have no direct and immediate link with the company's taxable supplies, and if a right to deduct did exist it would be excluded under the decree. At the hearing before the district court the inspector withdrew the second ground.

On appeal, the Court of Appeal in Amsterdam held that the company incurred the costs to further its business. It considered it plausible that they were incurred partly to prevent the company's activities and turnover from being eroded. Although there was therefore a direct and immediate link with the business activities, the court still refused the deduction, on the basis that this was a gift to a business relation within the meaning of the decree.

The Supreme Court held that in doing so the Court of Appeal went beyond the dispute between the parties, because the inspector had expressly withdrawn that ground before the district court. The appeal court was then not free to consider of its own motion whether an exclusion from deduction applied.

The exclusion decree

The Supreme Court does not address the substantive question whether the decree applies here. Something can nevertheless be said about it. Where it is established that the company needed to incur these costs, the needs of the business come first and the CEO's private benefit is subordinate.

In the pharmacist judgment, the Supreme Court held that the exclusion for gifts to business relations did not apply to a pharmacist who paid for fitting out GP practices in the same building. What was decisive was that he incurred those costs to increase his turnover, with a view to the GPs' patients buying medicines from him.

In the recent case the company incurred the costs to prevent the erosion of its asset management activities and the turnover from them. That situation does not differ materially from the pharmacist judgment. We therefore consider that the Court of Appeal was wrong to hold that the deduction was excluded.

Why this matters in practice

Where legal costs are invoiced to a company but also benefit the CEO, the managing shareholder, another member of staff or a third party, the company may well be entitled to deduct.

In practice we regularly see inspectors adjusting or refusing that deduction too readily. The mere fact that someone other than the company enjoys a benefit does not mean the right to deduct is lost. What matters is whether the company can show that the costs were incurred primarily in the interests of the business. That the costs could also have been invoiced directly to the CEO, the director, the employee or the third party, in which case there would have been no right to deduct, does not change that.