Why the Tax Authorities May Deny VAT Deductions in Transactions Between Related Companies

The Tax Agency has published the Conflict Report No. 21, which examines a common structure in corporate groups: the use of related entities to channel investments and optimize VAT taxation.

At first glance, the operation may appear valid. However, the Advisory Commission concludes that it is an artificial structure with the sole purpose of obtaining an undue tax advantage.

Below, we explain the case and, above all, what implications it has for your company.

If you want to see another example where the AEAT also concluded that the structure was aimed at tax savings, check our post on why a repurchase of own shares can be considered artificial.

The Case Analyzed: How VAT Was Improperly Claimed

The case revolves around two related entities:

• A company that carries out a VAT-exempt activity (an educational center).
• Another company in the same group that is the owner of the property.

The key issue lies in the works carried out on the building.

Under normal circumstances, if the company using the property (the school) had directly assumed the cost of the works, it would not have been able to deduct the VAT incurred, as its activity is exempt.

To avoid this cost, a different structure was implemented: the leasing company formally assumed the works. Since this activity is subject to VAT (leasing), the incurred VAT could be deducted.

The result was clear: the group recovered VAT that would otherwise have been a definitive cost.

I Want More Information

 

Why the Tax Authorities Consider the Operation Artificial

The AEAT does not analyze each step in isolation but considers the operation as a whole. It concludes that it does not respond to real economic logic.

Key elements leading to this conclusion include:

• The lessor assumes significant investments that benefit exclusively the lessee, without coherent consideration.
• No clear correlation exists between the cost of the works and the rental income.
• The company assuming the investments lacks sufficient material means and structure.
• Funding for the works does not come from its own income, but from internal group contributions. The rental income is insufficient to finance the works.

In other words, the structure deviates from what two independent parties would do under market conditions.

Warning Signs for the Tax Authorities: What to Check Before Acting

The Advisory Commission highlighted several elements that the AEAT considers red flags in related-party transactions:

• Contracts inconsistent with industry practice: the lessor assumed million-euro expenses that would normally be the tenant’s responsibility.
• Shell companies with no real activity: the entity taking on the works had no employees or resources, being managed through third parties or linked foundations.
• Circular or artificial financing: income did not come from the company’s operations but from external contributions or capital increases.
• Comparison with independent third parties: differences in the treatment of similar contracts with unrelated entities revealed the lack of economic logic.

These indicators are key for any company wishing to avoid problems with the AEAT.

Implications for Companies and Corporate Groups

This criterion particularly affects companies operating in structures with related entities, especially when:

• VAT-exempt activities exist.
• Significant property investments are made.
• Holding or leasing companies within the group are used.
• The goal is to optimize VAT deductions.

The AEAT’s message is clear: it is not enough for the structure to be formally valid. It must have a real and coherent economic justification.

Conclusion: Form Alone Is Not Enough Without Economic Substance

Conflict Report No. 21 reinforces a principle consistently applied by the AEAT: economic substance prevails over legal form.

This does not prevent tax planning, but it requires doing so coherently, transparently, and on a solid business basis.

In transactions between related entities, especially involving VAT, reviewing the structure before implementation is crucial to avoid significant tax adjustments.

At Adlanter, we analyze these types of operations from a tax and business perspective, helping companies make safe decisions aligned with regulations and business objectives.

Frequently Asked Questions (FAQs)

Can a company deduct VAT on works in a leased property?

It depends. If the activity is subject to VAT and not exempt, generally yes. But if the structure is used to artificially transfer costs from a non-deductible entity to a deductible one, the AEAT may challenge it.

What happens if the main activity is VAT-exempt?

In that case, the VAT incurred usually becomes a cost. Attempting to avoid it through artificial structures may lead to adjustments.

Does the Tax Authorities review transactions between group companies?

Yes. Related-party transactions are subject to close scrutiny, both for VAT and other taxes.

When is a transaction considered artificial?

When it has no real economic justification and its main purpose is to obtain a tax advantage.

Can penalties apply in these cases?

Yes. In addition to adjustments and interest, the sanctioning regime established in Article 206 bis of the LGT may apply.