Public Sector: Reassessment of Input VAT and VAT Grouping by the Federal Ministry of Finance (BMF)

With two letters dated April 1, 2026, the German Federal Ministry of Finance (BMF) responds in particular to the German Federal Fiscal Court’s (BFH) judgment of August 29, 2024 – V R 14/24 (V R 20/22; V R 40/19) and revises its administrative view on the VAT treatment of non-economic activities in the narrower sense. Of particular relevance for municipalities and other public-law entities is the letter on input VAT deduction and deemed supplies: the most significant practical change concerns cases in which the original allocation ratio of a purchased service between non-business/sovereign and business activities subsequently shifts in favor of non-business activities (non-economic activities in the narrower sense). Previously, such a change in use had to be taxed as a deemed supply. Likewise, the permanent withdrawal of assets from the business sphere into the sovereign/public sphere was subject to taxation as a deemed supply. Going forward, such changes are generally to be handled through an adjustment pursuant to Art. 15a UStG (German VAT Act). The parallel letter on VAT grouping confirms the same fundamental approach for intra-group transactions within a VAT group.

Two letters, one common conclusion

The two letters are titled “VAT Grouping – Non-taxability of intra-group supplies in connection with non-economic activities in the narrower sense” (III C 2 - S 7105/00035/008/056) and “Input VAT deduction and deemed supply; change in the allocation between business activities and non-economic activities in the narrower sense” (III C 2 - S 7316/00022/007/023). Both letters are closely related in substance but focus on different aspects. For municipalities and other public-law entities, the letter on changes in allocation entails the more significant practical change. It clarifies that sovereign/public activities must not be treated like private use for VAT purposes. The primary trigger for this new approach is the aforementioned BFH decision of August 29, 2024. In addition, the VAT grouping letter takes into account several rulings of the European Court of Justice (ECJ) on VAT groups and the non-taxability of intra-group supplies.

Although the main practical relevance lies with municipalities and other public-law entities, these principles are not limited to the public sector. They may also be relevant beyond this area, particularly in the context of VAT groups, associations with non-commercial (ideational) activities, and potentially financial holding companies and similar structures with non-economic activities in the narrower sense. However, the letters do not introduce a fundamental change for purely non-business or private use; in such cases, the general principles on deemed supplies remain applicable.

No more deemed supply in the case of subsequent increased public-sector use

Until now, the tax authorities assumed that a subsequent increase in the share of public-sector or non-economic activities in the narrower sense required an assessment of whether a deemed supply had occurred. The BMF has now explicitly moved away from this approach. The key change therefore explicitly concerns the subsequent shift in the allocation between business activities and non-economic activities in the narrower sense. If the share of public-sector or non-economic use of an asset increases at a later stage, this is no longer to be treated as a deemed supply but rather reflected through an input VAT adjustment under Art. 15a UStG.

With this, the tax authorities are implementing a long-anticipated policy shift and aligning themselves more closely with case law and academic opinion. This is of considerable practical importance, particularly for the public sector, as public/sovereign use is no longer systematically treated in the same way as private or non-business use.

In addition, the letter provides further clarification: supplies (especially personnel services) from the business sphere to the entity’s own non-economic sphere in the narrower sense are not subject to VAT. This applies to both gratuitous and remunerated services. If non-economic use is already intended at the time the service is purchased, input VAT deduction is excluded a priori. If the service was originally intended to be used for business purposes but is later used for non-economic activities in the narrower sense, an adjustment under Art. 15a UStG must be considered instead of a deemed supply.

Why the distinction from private use is crucial

In practice, distinguishing between non-economic activities in the narrower sense and non-business use is essential. From the tax authorities’ perspective, both concepts relate to the non-business sphere. While non-business use (unternehmensfremde Nutzung) includes private use, public-sector use is regarded as a non-economic activity (nicht wirtschaftliche Tätigkeit) in the narrower sense. For non-economic activities in the narrower sense, mixed-use assets have always required an allocation, meaning that input VAT could only be deducted on a proportional basis.

Due to this allocation requirement, changes in the original allocation ratio previously led to an asymmetry: a reduction in the business-use share was reflected through taxation of deemed supplies, whereas an increase in the business-use share did not – at least under the law – result in a subsequent entitlement to input VAT deduction. In such cases, the tax authorities applied Art. 15a UStG as an equitable measure. This led to differing tax consequences depending on whether the business-use share decreased or increased.

This inconsistency has now been eliminated by the BMF letter, as adjustments will henceforth be made exclusively under Art. 15a UStG. This is also relevant because the taxation of deemed supplies may not be subject to time limitations, whereas adjustments under Art. 15a UStG are restricted to a defined adjustment period. Furthermore, unlike deemed supply taxation, Art. 15a UStG includes a de minimis threshold (cf. Art. 44 UStDV). Additionally, it is no longer necessary to distinguish between changes from VAT-exempt to taxable use (previously already covered by Art. 15a UStG) and changes from public-sector to business use (previously subject to deemed supply taxation).

The new legal framework is therefore clearly to be welcomed. In particular, the previous taxation of deemed supplies in areas such as photovoltaic systems, halls, and swimming pools is likely to be simplified as a result.

VAT Group: same principle for intra-group supplies

The VAT grouping letter published on the same day specifically addresses the BFH judgment of August 29, 2024 – V R 14/24 (V R 20/22; V R 40/19) and aligns with prior case law of the European Court of Justice (ECJ) on VAT groups. This concerns a different area of regulation, but confirms the same basic principle: intra-group transactions between a parent company and its subsidiaries remain non-taxable even if the purchased service is used for non-economic activities in the narrower sense. The BMF clarifies that in such cases no deemed supply is triggered either. A different treatment applies only where services are ultimately used for non-business purposes, such as private needs outside the scope of public-sector functions. In this respect, the tax authorities now consistently distinguish between public/sovereign use and private use.

What needs to be reviewed now

For municipalities, special-purpose associations, municipal enterprises, and other public-law entities, this results in a concrete need for action. The focus is particularly on mixed-use assets – such as buildings, vehicles, technical equipment, and other assets – where the usage ratios have changed within the adjustment period of five or ten years, especially in cases where public-sector use has increased over time. Attention should also be paid to transactions between the business and public-sector spheres, including the provision of personnel. In particular, the BMF clarifies that the provision of staff from a commercial operation to the entity’s own public-sector sphere does not constitute a deemed supply.

The new guidelines apply to all pending cases. At the same time, both letters provide for transitional provisions. With regard to the letter on change of use, no objection will be raised if the previous administrative approach is consistently applied for tax periods prior to January 1, 2027. A similar non-objection provision applies to the letter on VAT groups until December 31, 2026.

Therefore, a structured review is recommended. In particular, it should be examined in which cases an adjustment under Art. 15a UStG – taking into account the de-minimis thresholds under Art. 44 UStDV – is more favorable or at least more appropriate than the previously assumed taxation of deemed supplies. The reverse scenario should also be considered: if business use increases at a later stage, an input VAT adjustment (i.e., additional input VAT deduction) may also be appropriate for reasons of equity.

Conclusion

With two interrelated letters dated April 1, 2026, the BMF primarily responds to the aforementioned BFH judgment of August 29, 2024 and redefines the VAT treatment of non-economic activities in the narrower sense. The practical core lies in the letter on changes in use: where the share of non-economic activity in a mixed-use asset increases at a later stage, this is no longer to be treated as a deemed supply but exclusively through Art. 15a UStG. At the same time, the tax authorities are aligning more closely with case law and academic opinion. The letter on VAT groups confirms the same fundamental approach for intra-group supplies. For the public sector, this provides greater consistency and conceptual clarity, but also creates an increased need for review in open cases.