Whether and under what conditions the damages tax paid to a company is very controversial and depends on the individual case. We provide an overview and explain which principles must be observed in the VATability of damages payment.

1. damages in VAT law

1.1. Definition of damages

The concept of damages is foreign to the VAT Act. It is regulated and defined solely in civil law. Damage therefore means any involuntary loss of assets. The compensation is therefore the payment which compensates for this involuntary loss.

1.2. No provision for damages

The question of whether the provision of damages leads to a sales taxable exchange of services is neither regulated by national nor European VAT law. Rather, general rules and principles of VAT law are decisive.

The assessment of damages for the purposes of sales tax is carried out primarily on the basis of § 1 (1) no. 1 sentence 1 UStG. According to this, VAT is subject to all deliveries and other services provided by a domestic entrepreneur against payment within the framework of his company.

The examination of entrepreneurial status does not cause problems specifically adapted to the property of damages. This is different when checking the existence of a delivery or other service. There are some problems here. Can damages constitute a VAT delivery or other service?

2. The damages as a performance

2.1. Definition of performance in VAT law

The term value added tax is not in accordance with the understanding of civil law services. Under civil law, every act, toleration or omission constitutes an achievement. For VAT purposes, on the other hand, a service is only provided if the supplier confers a consumable advantage on the recipient. An advantage is consumable if it enables immediate final consumption or can be included as a cost factor in a consumable product. In addition, a performance requires that the provision of benefits is based on a willingness of the entrepreneur to perform. He must give the benefit to the recipient consciously and voluntarily. Excluded from sales taxation are therefore such advantages that the recipient receives without or even against the will of the entrepreneur.

2.2 Consumable advantage

The mere obtaining of money does not constitute a consumable advantage. Money is used to procure items and other services that can be consumed. Therefore, it is a means that enables consumption, but cannot be consumed itself.

From a sales tax perspective, the question therefore arises as to whether the creditor has been granted a consumable advantage if the performance owed is absent. Such a case can occur in the event of impossibility of a service according to § 275 BGB. Impossibility exists if the object of the contract has been irreparably destroyed and no replacement can be procured. Then, as a rule, in accordance with § 326 paragraph 1 BGB, the obligation of the recipient to pay compensation also ceases. However, if the impossibility occurs at a time when the creditor was in default of acceptance, the obligation to pay in return according to § 326 (2) sentence 1 Alternative 2 BGB remains.

First of all, the power receiver does not yet receive a consumable advantage in the absence of power over the service to be provided. However, in the event of a delay in acceptance, the entrepreneur has done everything necessary in turn to bring about the performance success, so that the customer only has to accept the service. Then the power receiver gains control over the power. However, this also provides a consumable advantage. This leads to the assumption of a sales tax benefit, despite the fact that the performance success has practically failed.

2.3 Will to Achieve

2.3.1. Willingness to pay damages for damage to property

The willingness to perform in cases of damage caused, for example, in the form of property damage, is problematic. Then it must be considered whether the acceptance of the damage constitutes a sales tax benefit in the form of a toleration or omission, which could be made the subject of another service according to § 3 paragraph 9 UStG.

The occurrence of the damaging event is not intended by the damaged company. A sales tax benefit is therefore not present in these cases even if the harmful party obtains a consumable advantage through the harmful act. If the damaged party has to pay a rate of money to compensate for the damage, this payment is therefore not subject to VAT.

Conversely, however, it follows that the acceptance of damage to an object belonging to the company can exceptionally be regarded as a VAT benefit if the entrepreneur has deliberately consented to the damage being caused. If the recipient pays the entrepreneur a fee for this toleration of the damage and thereby obtains a consumable advantage, there is a sales taxable exchange of services. For this, it is sufficient that a contractually agreed project necessarily leads to the occurrence of damage to the legal interests of the company. In such cases, it is in principle a contractually agreed remuneration rather than damages.

Such a situation relevant for sales tax purposes is present, for example, if the entrepreneur allows the recipient to create a work on his property and also consents, against payment of compensation, to the incurring of certain damages incurred in the construction of the work.

2.3.2. Willingness to perform in the case of property deprivation

If the damaged person takes away from the company an object owned by it with the intention of enriching himself, he regularly commits theft according to § 242 StGB. This constitutes a liability for damages under the law of tort.

Undoubtedly, the damager receives a consumable advantage through the unlawful obtaining and use of the object. In addition, the illegality of the action does not preclude taxability according to § 40 AO. However, the damager gets the thing without or against the will of the owner. Therefore, there is a lack of willingness to perform and therefore a sales tax performance.

2.3.3. Case from European case law on willingness to perform

Just last year, the European Court of Justice (ECJ) ruled that there is a sales tax benefit for the withdrawal of electrical energy. The principle of neutrality prohibits distinguishing between illicit and permitted transactions. It is intended to burden the final consumption of goods or services provided that those goods or services have been supplied or supplied under the VAT scheme within the framework of taxable transactions. This applies even if the recipient obtains the advantage himself and thus without the will of the entrepreneur. The special feature in this case, however, was that the network operator had to supply Storm generally by legal obligation to anyone who did not conclude a contract with a commercial provider. In this respect, the operator can therefore be assumed to have a general will to supply electricity to any consumer who fulfils this condition.

Therefore, the decision of the ECJ is not to be understood as a departure from the requirement of willingness to perform. Rather, the ECJ has ruled in previous decisions that theft of goods does not constitute a sales tax benefit. Therefore, the assumption of a sales taxable service is based solely on the fact that the entrepreneur was obliged by law to perform.

A similar case exists when a black driver is charged an increased fare. Also then, a sales tax service of the rail service provider to the black driver should be present. The railway service provider also has the general will to transport every boarding passenger.

3. Remuneration for damages

3.1. Definition of remuneration

In addition to the existence of a service, the justification of a sales taxable exchange of services requires that this service is provided against payment. There must therefore be a direct link between the service and remuneration. This requires that there be a legal relationship between the contributor and the recipient, in the context of which mutual services are exchanged, the compensation received by the contributor forming the actual equivalent value for the service. This legal relationship can be both contractual and legal in nature.

In determining presentness, it is not the objective value, but only the subjective value of the performance which the parties attach to it. An indication that the remuneration represents the value of the service is the existence of a compensation link between the service provided and the amount paid. Even if the remuneration is not determined from the outset, it in any case represents the equivalent of the service if it serves its compensation. A further indication for determining the amount of the consideration lies in the appreciation of the service by the recipient and the appreciation of the consideration by the performing entrepreneur. Therefore, the remuneration constitutes the equivalent of the service provided if it is determined by the service and not exclusively by other factors.

3.2. Legal relationship for damages

In the case of damages, the criterion of the existence of a legal relationship does not cause any problems. Either there is a debt relationship between the parties from the outset or it is justified at the latest with the damage caused by a legal debt relationship.

3.3. Increased fee

Due to disruptions in the exchange relationship with the entrepreneur, the recipient may be obliged to pay a higher fee than originally agreed and still receive the same service. The amount represents the subjective value of the service if the parties have contractually agreed on the payment owed or if the provider has unilaterally determined it with binding effect for the recipient.

The situation is different if the amount owed is subsequently increased. If the performance does not change, the additional amount cannot be directly related to the performance. Rather, the agreed service is already fully compensated by the agreed fee. Thus, there is no sales tax on the subsequent increase.

In the previous example with the black driver, therefore, a division of the amount to be paid into a turnover-taxable and a non-taxable part must also be made. Only the amount to be provided by the recipient, which corresponds to the actual ticket price for the black journey carried out, serves to compensate for the transport service and is therefore directly related to it.

The ECJ decided a case for increased pay differently. The subject of the decision was the question of whether the increased parking fee for violations of the parking regulations is taxable. One infringement was the non-payment of the parking fee, the exceeding of the maximum parking period for parking spaces offered free of charge or the parking of the vehicle in an area not marked as a parking area. The ECJ ruled that sales tax should be paid on the entire increased parking fee. The increased parking charge is directly related to the parking placement. It covers the higher operating costs that would be caused by illegal parking.

3.4 Same remuneration for non-contractual service

3.4.1 Reduction of the fee in an amount corresponding to the reduction

The entrepreneur can also provide a service that qualitatively or quantitatively does not correspond to the ideas of the participants. Even then, the question arises as to what VAT consequences are to be linked to this. Different cases have to be differentiated.

Once the recipient can reduce the amount to be paid to the corresponding extent. This case exists, for example, if the recipient claims damages instead of the service in the form of small damages. Then the recipient keeps the owed item and only demands a compensation of the inferior value in money. The compensation thus compensates for the reduction. For this reason, not the amount originally owed is subject to VAT, but only the difference between the agreed remuneration and the damages paid.

3.4.2. disproportionate or lack of reduction of the amount

The amount owed cannot be reduced at all or only disproportionately. This case can occur, for example, at the termination of a work contract. According to § 648 sentence 1 BGB, the customer is entitled to a right of termination against the entrepreneur at any time. However, the claim of the entrepreneur on the work wage remains unaffected by the assertion of this right of termination. According to § 648 sentence 2 half sentence 1 BGB, he must only be credited for what he saves in expenses as a result of the cancellation of the contract or acquires or maliciously refrains from acquiring through other use of his labour power.

The production of the partly finished work and the acquisition of ownership of it by the customer lead to the existence of a sales tax service. The entrepreneur deliberately grants the customer a consumable advantage by acquiring ownership of the work. However, the remuneration is intended, in accordance with the will of the parties, to pay for the completely produced work. The entire remuneration cannot therefore serve to compensate for the partial service. Only the part corresponding to the value of the subwork applies this part. Only in this respect can there therefore be something in return. Sales tax therefore applies only to this part of the amount.

On the other hand, the amount exceeding the value of the service already provided serves to compensate for the damage incurred by the entrepreneur as a result of the termination and the associated early termination of the contract.

4th Conclusion

There are different cases where damages are subject to VAT. This occurs, for example, if the recipient is still obliged to provide the consideration in the event of a delay in acceptance despite the impossibility. Another case exists if the entrepreneur consents to his infringement of legal interests and demands an increased fee for it. Furthermore, the entrepreneur may be obliged by law to render to everyone. This obligation then gives rise to the assumption of a general willingness to provide services, so that a sales taxable service is present.