It excludes liability to VAT on the pay of employees bound to their employer by a legal relationship (employment contract).

On the other hand, a business may deduct VAT when goods or services supplied by another taxable person have been used for the purposes of its taxable transactions.

Finally, as a general rule, the procedure for deduction requires an invoice to be produced.

Decrees adopted in 1968 and 1997 allow businesses in the Netherlands to deduct a percentage of an allowance paid to an employee who uses a car belonging to him in connection with his employer's business. That allowance does not formally form part of his pay for the purposes of Netherlands tax legislation. The percentage of the allowance that is deductible from the amounts of VAT to be paid by the business is equivalent to a weighted average of VAT which is considered to reflect the costs linked to the employee's use of his vehicle (acquisition, fuel, maintenance and repair costs).

The Commission took the view that that legislation does not comply with the Sixth VAT Directive and asked the Court of Justice to declare that the Netherlands has not complied with Community law (failure to fulfil obligations).

The Court of Justice recalled first of all that the Member States do not have any discretion as regards the extent of the right to deduct: the right applies only in respect of VAT paid on goods and services supplied to one taxable person by another taxable person.

An employee acting for his employer cannot have the status of taxable person, even where he uses his own vehicle for the purposes of the business.

Furthermore, the mere fact that an employee uses his vehicle in connection with his employer's business does not correspond to a supply of the vehicle or of the fuel used to the employer, who alone is accountable for VAT. The employer reimburses in some way his employee for depreciation of the vehicle and fuel costs.

The Court also stressed that there was no invoice, an essential formal requirement for making a deduction. It added that, in the absence of a supply between taxable persons, invoicing would not, in any event, have enabled the Netherlands legislation to become compatible with the relevant Community provisions. It also pointed out that the detailed rules for implementing the deduction mechanism which is provided for in the present case by the Netherlands legislation are flat-rate and imprecise in nature.

The Court stated finally that the objective of fiscal neutrality is doubtless not fully attained in such circumstances, since the business is not permitted to deduct the VAT element contained in the allowance paid to the employee although that item of expenditure has been incurred for the purposes of the employer's economic activity.

The Court pointed out, however, that it is for the Community legislature to establish detailed rules for the application of any right to deduct, and that no such right exists in circumstances of this kind as Community law now stands.
                                            

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