Background
In March 2018, RHTB (service provider) and Parkring (client) entered into a construction contract for a project valued at €5,377,399.69, including €896,233.28 in VAT. In June 2018, shortly after the work began, Parkring informed RHTB that the project could no longer proceed, citing reasons beyond RHTB's control.
On December 19, 2018, RHTB demanded payment of the agreed amount, reduced by the costs saved due to the contract's termination, amounting to €1,540,820.10, including VAT. Parkring disputed this claim, asserting that RHTB was entitled only to payment for work already performed.
The case proceeded through legal channels:
- First instance: The court ruled in favor of RHTB, finding that Parkring had wrongfully terminated the contract. The amount for unperformed work was deemed VAT taxable.
- Appeal: This ruling was overturned. The appellate court held that no VAT was due on the amount for unperformed work since no actual exchange of services had occurred.
The Austrian Supreme Court referred a preliminary question to the CJEU on the VAT treatment of such payments.
Preliminary question
The central issue was whether the amount payable by the client after unilateral contract termination, where the contractor was willing to complete the work and the termination was attributable to the client, should be considered remuneration for a service under the VAT Directive. In other words, is this amount subject to VAT?
Court's ruling
The CJEU determined that such payments are indeed subject to VAT, based on the following considerations:
1. The right to the service suffices:
The mere right to use a service qualifies as a taxable transaction, regardless of whether the customer exercises this right. Once the service provider enables the customer to access the service, a taxable supply arises.
2. Direct link between service and payment:
There is a clear direct link between the service provided by the contractor and the payment received. This link remains intact even if the client opts not to use the full service. The payment is therefore not considered compensation but rather remuneration for a provided service.
3. Commenced work is decisive:
RHTB had already begun the project and was ready to complete it. The fact that Parkring terminated the contract for reasons not attributable to RHTB does not break the direct link between the performed service and the payment received.
4. Economic and commercial reality:
VAT law emphasizes economic and commercial reality. The amount payable reflects not only the contractually agreed compensation for the service, reduced by any savings, but also ensures minimum remuneration for the contractor.
5. Reference to previous case law:
The Court referred to rulings such as Vodafone Portugal (C-43/19) and MEO (C-295/17), which held that termination fees could be subject to VAT. The payment in the RHTB case is viewed as consideration for the agreed service, consistent with the principles from these earlier cases.
6. Not compensation for damages:
The Court distinguished this case from Société thermale d’Eugénie-les-Bains (C-277/05), where cancellation of a hotel reservation was deemed compensation exempt from VAT. In the RHTB case, an identifiable service had already been partially performed, and the payment is therefore considered remuneration for the services rendered.
Commentary
In practice, the VAT treatment of termination fees often sparks debate. The Court clarified that payments for the unilateral termination of a service contract—where the service provider was ready to deliver the full service and had already started work—are subject to VAT.
This ruling aligns with a broader trend where payments are more readily classified as taxable. However, it is somewhat regrettable that the Court did not take the opportunity to clearly distinguish between earlier cases such as Vodafone Portugal and Société thermale d’Eugénie-les-Bains. It remains important that, in cases not considered as compensation for damages (and therefore subject to VAT), the recipient must have derived some benefit from the terminated contract.
In Belgium, Article 1794 of the Civil Code permits a client to unilaterally terminate a construction contract, provided the contractor is compensated for incurred costs, work performed, and lost profits. According to Belgian administrative commentary, such compensation is not subject to VAT as long as it exclusively relates to lost profits for unperformed work. On the other hand, the Société thermale d’Eugénie-les-Bains judgment is also effectively applied in Belgian practice (Parliamentary Question No. 72 from Mr. Van der Maelen, dated November 8, 2007). Thus, not all termination fees in Belgian practice fall within the scope of VAT.
However, it is noticeable that tax audits increasingly focus on termination fees. For cases that closely mirror the circumstances of the now numerous European rulings, it is advisable to reassess whether the classification as compensation for damages still holds.