Facts

In March 2018, RHTB – an Austrian company – entered into a works contract for the construction of a drywall. However, after the works had commenced, the client informed RHTB that it no longer required its services and terminated the contract.

RHTB brought an action for unjustified termination before the court and sought compensation of the contractually agreed amounts from the client. After confirming the obligation to pay the termination fees, the question before the court remained whether VAT should be applied to these amounts.

Finally, the Austrian High Court referred this question to the Court of Justice. The main question in the proceedings was whether the amount owed by a client to a contractor, even where the work has not been (fully) executed due to an action of the customer, is to be regarded as a remuneration for a supply of services and is therefore subject to VAT.

Conclusion

In its judgment, the Court of Justice confirmed that these termination fees fell within the scope of the VAT directive and were therefore subject to VAT.

The Court of Justice reached this conclusion by reiterating the principles established in prior case law including ECJ Vodafone. In order to qualify as remuneration for a supply of service for consideration, there must be a direct link between the service supplied by the contractor to the recipient and the consideration actually received. It is important to highlight that this direct link remains unaffected if the recipient of the supply does not exercise its right to use the service supplied before terminating the contract, resulting in termination fees.

Applying these principles to the present case, the court concluded that there was indeed a direct link between the termination fee and the (non-)completed construction services. Consequently, the termination fee owed by the breaching party was subject to VAT.

New episode

Following the cases like Meo, Vodafone and Unicredit Leasing, the RHTB-case completes the series by providing further guidance, including the VAT treatment of predetermined sums in the context of an open-ended contract, and clarifying the scope of the Eugénie-les-Bains case, which was the only case so far not to apply VAT to compensation received by a hotel for cancelling a reservation.

Impact on businesses

The impact of the above case should not be underestimated for daily interactions between businesses facing an early termination of their contracts. On this point contract law does not always align with VAT. Since this ECJ case law may apply to termination fees in any commercial contract, businesses should consider to review their contracts to determine whether the foreseen contractual compensations are subject to VAT.

For ongoing litigation, parties should also assess if their contractual claims fall within the scope of the VAT directive. Given the material consequences of incorrect VAT treatment, it is crucial to promptly evaluate the potential implications.

Belgian VAT administrative practice

It is expected that this case will impact the ongoing review of the existing Belgian administrative commentaries which still includes some older administrative decisions such as E.T. 18762 regarding the termination of a works contract.

We will keep you informed of further developments. Should you have any questions, please contact a member of our Indirect Tax team or your trusted Loyens & Loeff adviser.