Cross-border contract manufacturing and the VAT treatment of production tooling in Hungary: what does the CJEU’s new ruling change?

The typical arrangement

The starting point is an established business model. The Hungarian company produces parts to the order of a partner in another member state, and after manufacturing ships them to the partner’s premises abroad. The dispatch of the parts typically qualifies as a VAT-exempt intra-Community supply of goods. The special tooling used for production, however, often does not move and stays at the place of manufacture, while its ownership passes to the partner. The question is therefore what value added tax (VAT) rate applies to the sale of this tooling that remains in place.

The stakes are not small. If the sale of the tooling is ancillary to the VAT-exempt intra-Community supply of the parts, it shares that exempt treatment. If, however, it is a separate, domestic transaction, it is subject to domestic VAT, which means different invoicing, reporting and cash-flow effects, and also raises the question of cross-border VAT refunds.

The Hungarian rule: ancillary costs

The Hungarian approach rests on Act CXXVII of 2007 on value added tax (általános forgalmi adóról szóló törvény, Áfa tv.). Among the items included in the tax base, the Act names the ancillary costs that the supplier passes on to the buyer, such as charges related to packaging, transport and insurance. Importantly, this rule also applies where the ancillary cost is passed on under a separate agreement.

The tax-authority practice known so far has in many cases treated the costs related to acquiring a production line or tooling, passed on to the buyer of the parts, as ancillary. There is even a known position that treated the sale of a production line remaining in the country as ancillary to the part supplies shipped abroad. The new judgment makes it warranted to rethink exactly this habitual reflex.

Main and ancillary supply, a single composite transaction

In VAT, separate transactions may be treated together where there is such a close link between them that they support each other’s realisation, or form a single indivisible economic transaction. In that case the dominant element, that is the main transaction, must be identified, because the ancillary elements attached to it inherit its VAT treatment. So if the main element is exempt, the ancillary elements become exempt too, regardless of whether they would be taxable on their own.

The assessment must be carried out from the perspective of the customer, that is an average consumer. The ratio of the considerations of the individual transactions to one another may also be a guide, but this is not a decisive factor. The question is always whether, for the buyer, the given element serves an independent purpose, or only helps the better use of the main transaction.

The facts of the Brose case

In the case numbered C-234/24, which became known as Brose, the Court of Justice of the European Union (CJEU) examined precisely the VAT treatment of the sale of tooling that remains in place. In the case, a company in Slovakia bought parts for the manufacture of automotive components from an undertaking in Bulgaria, which handed them over within intra-Community supplies. A company in Germany belonging to the same group ordered special tooling for the manufacture of the parts from the same Bulgarian undertaking, but the tooling stayed in Bulgaria throughout and was used exclusively to make these parts.

The tooling was later resold by the German company to the Slovak party, with an invoice containing Bulgarian VAT, while the asset still remained at the Bulgarian manufacturer. The Slovak company requested a refund of the VAT paid, but the request was refused on the grounds that the sale of the tooling was ancillary to the intra-Community supply of the parts, so a zero percent rate should have been applied to it. The case turned into a preliminary ruling procedure.

What did the Court say?

The Court approached the question in three steps. First it examined the conditions of the VAT-exempt intra-Community supply. Under the VAT Directive, namely Council Directive 2006/112/EC, an exempt intra-Community supply of goods requires that the goods actually leave the territory of the member state of supply. Since the tooling did not physically move out of Bulgaria, no intra-Community supply took place, so the related exemption cannot apply either.

Second, it considered whether transactions by two different taxable persons can form a single, ancillary relationship. According to the Court, where two supplies are made by two different taxable persons, they can only exceptionally be treated as a single transaction, namely where there is an artificial splitting of the transaction in the hands of an actual supplier who controls the two taxable persons. A mere economic link or common purpose therefore does not automatically make the supplies a single transaction.

Third, it assessed the substance of ancillarity. According to the Court, several circumstances point to an independent purpose of the tooling. Such is the case where the asset is used not for a single part but for series production, where it is made available to the manufacturer throughout the entire production cycle, and where its acquisition creates a security-type position for the buyer, for example in the event of the supplier’s insolvency. It also points to independence if the parts and the tooling are invoiced separately. These circumstances suggest that the sale of the tooling is an end in itself for the buyer, not merely an accompaniment to the supply of the parts.

The table below summarises the most important considerations.

In the end the Court ruled that EU law precludes refusing the refund of the VAT charged on the sale of the tooling to a taxable person established in another member state merely because the asset did not physically leave the supplier’s member state. An exception applies only where, in light of all the circumstances of the transactions, the sale is part of a single indivisible economic transaction, or is genuinely ancillary to the intra-Community supply of the parts.

What does this mean in practice?

The message of the judgment is clear. The range of cases in which the sale of production tooling that stays in the country can be regarded as an ancillary cost of the parts, and thus follow their VAT-exempt intra-Community treatment, narrows substantially. The earlier practice, which allowed ancillarity more generously, therefore calls for heightened caution, especially for tooling tied to series production with a long life cycle.

Because the case law is uncertain and evolving, the safe solution is for the parties to assess each arrangement carefully, examining all elements of the facts. The contractual content, the manner of invoicing, the nature of the tooling’s use and the relationship between the parties together determine whether it is an independent domestic transaction or a genuine ancillary element. Misclassification carries a later tax risk, so thinking the question through already at the time of contracting pays off.