Can Regional Taxes Violate EU VAT Rules? ECJ Case C‑712/19 Ruling in Novo Banco Explained

In 2021, the European Court of Justice (ECJ) announced its judgment in the case between the Novo Banco, a credit institution with its registered office in Portugal and with a branch in Spain, and the Government of the Autonomous Community of Andalusia.

The case revolves around whether the IDECA tax, a direct tax specific to the Autonomous Community of Andalusia, is compatible with the EU VAT Directive.

Background of the Case 

In 2012, Novo Banco was subject to several tax assessments concerning IDECA. After receiving tax assessment notices, Novo Banco appealed against them before the Andalusia Superior Treasury Board and High Court of Justice, respectively, where both instances denied appeals. The rejection of appeals resulted in a legal proceeding before the Supreme Court of Spain (Supreme Court).

Novo Banco claimed that the IDECA tax violates the key EU Treaty on the Functioning of the European Union (EU Treaty) provisions by discriminating against banks not based in Andalusia. 

More specifically, the bank argued that the tax’s structure, especially the deductions favoring institutions located in that region, such as a general EUR 200,000 deduction, contributes to unjustified unequal treatment of similar institutions depending on their location. The bank further added that similar institutions from other EU countries are especially vulnerable to these disadvantageous measures. 

Furthermore, Novo Banco claimed that the IDECA tax is basically an indirect tax since it effectively taxes deposit-taking activity, which is exempt under the EU VAT Directive. 

From that stance, the Supreme Court doubted whether the IDECA is compatible with the VAT Directive, which exempts deposit-related financial transactions from VAT and restricts introducing new indirect taxes similar to VAT by nature. Therefore, the Supreme Court addressed the ECJ with a request for a preliminary ruling.

Main Questions from Request For Ruling

The Supreme Court asked the ECJ whether IDECA’s system of deductions, primarily those favoring credit institutions based in Andalusia, violates EU laws on freedom of establishment, freedom to provide services, and the free movement of capital under the EU Treaty.

In addition, the Supreme Court questioned whether the IDECA, despite being officially defined as a direct tax, should be treated as an indirect tax instead. If the answer to this question is positive, then it asks whether the IDECA is compatible with the EU VAT Directive, especially Articles 401 and 135(1)(d), which prohibit VAT-like taxes on activities that are already exempt from VAT, such as deposit-taking transactions.

Applicable EU VAT Directive Article

The Supreme Court's questions indicate that the first question is directly related to the interpretation of the EU Treaty. However, the second question refers to provisions from the EU VAT Directive, more specifically Articles 135(1)(d) and 401.

Under Article 135(1)(d), EU countries must exempt transactions from VAT relating to negotiation, concerning deposit and current accounts, payments, transfers, debts, cheques, and other negotiable instruments. 

Article 401 states that the EU VAT Directive does not prevent EU countries from keeping or implementing other types of taxes, such as those on insurance, gambling, excise goods, or stamp duties, as long as these taxes are not considered turnover taxes like VAT. Nevertheless, imposing and collecting such taxes must not create cross-border trade barriers or require customs-like formalities at internal EU borders.

Spain National VAT Rules

Due to the nature of this particular case, the ECJ did not examine the provisions of the Spanish VAT Law. Instead, it focused on the provisions of Law 11/2010 on fiscal measures concerning the reduction of the public deficit and sustainability of the Autonomous Community of Andalusia. This law established the IDECA tax. 

The ECJ focused on Article 6, which defines the nature and purpose of the tax, what is a chargeable event, who are taxable persons subject to IDECA, what is a taxable base, how the tax is calculated, and what is the chargeable period.

Additionally, the ECJ noted that when the Spanish Government introduced a national tax on bank deposits on January 1, 2013, the Andalusian government decided to suspend its own deposit tax, IDECA, as long as the national tax covered the same activity.

Importance of the Case for Taxable Persons

The Novo Banco case is primarily essential for taxable persons operating in the finance industry, particularly those operating across the EU, because it clarifies how national or regional taxes must align with fundamental EU principles and VAT rules. 

Additionally, the case illuminates situations where taxes officially labeled as direct at the national level may, in practice, fall within the scope of EU VAT law if they effectively tax economic activities similar to those already regulated under the VAT Directive.

Therefore, taxable persons operating cross-border, not only in the financial sector, may use the conclusion from this case to determine if other nationally implemented taxes breach the EU VAT Directive, and, thus, protect their rights.

Analysis of the Court Findings

Under the first question, which refers to the provision from the EU Treaty, the ECJ underlined that the IDECA applies to deposits made by customers of credit institutions operating in Andalusia. Additionally, the law offers two types of deductions, general and specific, only available to institutions with a registered office or agency in Andalusia.

The ECJ noted that this practice raises the question of whether such a system unfairly discriminates against institutions from other regions or EU countries and violates EU regulations.

The IDECA general deduction includes two deductions: a EUR 200,000 deduction for banks with their registered office in Andalusia, and another based on the number of agencies in the region, ranging from EUR 5,000 to EUR 7,500 per branch, depending on the municipality size.

Therefore, the ECJ analyzed whether these deductions discriminate against credit institutions with registered offices outside Andalusia, whether they are elsewhere in Spain or other EU countries. Moreover, the ECJ wanted to determine if this violates the freedom of establishment.

The second part of the question concerns the specific deductions that apply to credits, loans, and investments aimed at projects in Andalusia, which means they are intended to direct capital flow, primarily affecting the free movement of capital. The ECJ stated that these types of deductions allow credit institutions to reduce the IDECA tax by the amounts of credits and investments in Andalusia-based projects tied to an economic sustainability strategy or socially beneficial projects.

The deduction's purpose is primarily to encourage investment in Andalusia and promote regional savings. Nevertheless, taxing deposits not used for Andalusian projects may create a disparity, potentially discouraging investments outside the region.

Regarding the second question, the one that refers to the EU VAT Directive, more precisely, whether the Spanish regional tax IDECA conflicts with the EU VAT Directive, the ECJ highlighted that Article 401 of the VAT Directive allows EU countries to introduce or maintain taxes that are not considered turnover taxes. However, there are limits to this right. When introducing these taxes, EU countries must pay attention to not introducing customs-like formalities between EU countries.

To determine whether the tax affects the movement of goods and services in a way comparable to VAT, the ECJ outlined the criteria for whether a national tax qualifies as a turnover tax and is, therefore, incompatible with the common system of VAT under Article 401 of the VAT Directive.

Even if a tax is not identical to VAT in every aspect, it may still be incompatible if it has the exact characteristics of VAT. Therefore, according to established case-law, a tax resembles VAT if it applies generally to transactions involving goods or services, is proportional to the price charged by the supplier, and is levied at each stage of production and distribution, regardless of the number of previous transactions. 

Additional criteria include deducting amounts paid in earlier stages, so that only the added value is taxed at each stage, and the final burden rests on the consumer. If a tax does not meet even one of these VAT characteristics, Article 401 does not prohibit its introduction or maintenance.

Courts Final Decision

The ECJ ruled that EU-wide rules on freedom of establishment, provided under Article 49 of the EU Treaty, do not allow a regional tax rule that gives a EUR 200,000 tax deduction only to banks with their head office in that region, since that is unfair to banks based elsewhere in the EU. However, smaller deductions based on the number of local bank branches are generally allowed, as long as they do not favor banks based in the region.

Regarding the movement of capital, provided by Article 63 of the EU Treaty, EU rules do not allow tax deductions that reward banks for investing only in that specific region, in this case Andalusia, if the goal is just to boost the local economy. 

On the other hand, the EU VAT rules, specifically Article 401 of the EU VAT Directive, do not prevent an EU country from introducing a separate tax on banks based on the amount of money their customers have deposited.

Since the IDECA is calculated using the average amount of those deposits over the year and is paid by banks, not by the customers, the tax differs from VAT in how it works and who is subject to it. Considering all the facts, such a tax is allowed under the EU rules and regulations.

Conclusion

The Novo Banco ECJ case illuminates the delicate balance between national or regional tax autonomy and fundamental EU principles. The ECJ clarified that tax benefits favoring institutions based solely on regional establishment violate the freedom of establishment guaranteed under EU law. Additionally, deductions implemented to boost regional investments can breach the principle of free movement of capital.

Nevertheless, regarding compatibility with VAT law, the ECJ underlined that as long as the tax does not have the same characteristics as VAT, the EU VAT Directive, specifically Article 401, does not prohibit the introduction of such a tax.

Source:  Case C‑712/19 - Novo Banco SA v Government of the Autonomous Community of Andalusia, Spain, EU VAT Directive