Taxation and Customs Union

VAT deductions

What is a right to deduct?

A right to deduct means a taxable person’s right to claim from the tax authorities the VAT paid upon acquired goods and services.

VAT is deducted by subtracting the deductible amount from the VAT payable in the regular VAT return submitted to the tax authorities.

Which VAT can be deducted?

VAT due or paid on the following transactions can be deducted:

Which activities give rise to deduct?

Only VAT due on goods or services used for the following activities can be deducted:

Can VAT be deducted fully or partly?

VAT used for activities giving rise to the VAT deduction may be deducted fully.

VAT used for activities not giving rise for deduction may not be deducted.

Proportional deduction applies in cases where direct attribution of expenditure either to a supply where there is no right of deduction or to a taxed supply where there is a right of deduction (e.g. in respect of overheads) is not possible.

Restrictions on deduction apply on certain types of expenditure.

When does the right to deduct arise?
The right to deduct arises when the deductible tax becomes chargeable (Article 167 VAT Directive).

For when VAT becomes chargeable, see Chargeable event and chargeability. The basic rule is that VAT becomes chargeable:

  • when the supply of goods or services is made;
  • for intra-EU acquisition on issue of the invoice;
  • for importation of goods, when the goods are imported.

Special rule applies for cash-accounting scheme [link].

Why does it matter when the right arises?
The time when the right to deduct arises determines in which VAT return period the business may claim to deduct the input VAT. This may often be before payment of the VAT has actually been made.

Domestic supplies of goods and services and transactions treated as such

Type of transaction on which VAT is deducted Conditions to deduct
Domestic supply of goods and services
Article 168(a) VAT Directive

VAT is due or paid on the domestic purchase;

VAT arises in the same EU country;

Purchased goods and services are used for the activities giving rise to deduction.

Transactions treated as a supply of goods and services
Article 168(b) VAT Directive

VAT is due or paid on the transactions treated as a supply of goods and services in that EU country under Article 18(a) and 27 VAT Directive:

  • Self-supply of goods for business use;
  • Self-supply of services for business use; [link]

VAT arises in the same EU country;

Goods and services are used for the activities giving rise to deduction.

Intra-EU acquisition of goods and transactions treated as such

Type of transaction on which VAT is deducted

Conditions to deduct

Intra-EU acquisition of goods
Article 168(c) VAT Directive

VAT is due on intra-EU acquisition of goods;

VAT arises in the EU country of the acquisition of goods;

Acquired goods are used for the activities giving rise to deduction.

Transactions treated as EU- acquisitions
Article 168(d) VAT Directive

VAT is due on a deemed intra-EU acquisition of goods:

  • Article 21 transactions [link]
  • Article 22 transactions[link];

VAT arises in the EU country of the acquisition of goods;

Acquired goods are used for the activities giving rise to deduction.

Importation of goods

Type of transaction on which VAT is deducted Conditions to deduct
Importation of goods
Article 168(e) VAT Directive

VAT is due or paid on importation of goods;

VAT arises in the EU country of importation of goods;

Imported goods are used for the activities giving rise to deduction.

Taxed transactions of the taxable person

Type of transaction giving rise to deduct Conditions for deduction to arise
Taxed transactions of the taxable person
Article 168 VAT Directive

Goods and services are used for the taxed transactions of the taxable person in the same EU country.

Certain transactions carried out abroad

Type of transaction giving rise to deduct Conditions for deduction to arise
Certain transactions carried out abroad
Article 169(a) VAT Directive

Transactions are related with any economic activity of the taxable person:

  • carried out abroad in any other country than the deductible VAT is due or paid;
  • those transactions are used for the activities giving rise to deduction if they were carried out domestically (i.e. in the EU country where deductible VAT is due or paid).

Transactions exempt with the right to deduct

Type of transaction giving rise to deduct

Conditions for deduction to arise

Certain exempt transactions such as:

  • Intra-EU supplies of goods;
  • Intra-EU supplies of goods to and from the Azores and Madeira and transport of goods between them;
  • Services related to the importation of goods where the taxable amount includes the value of those services;
  • Export of goods;
  • International transport services, including transport between the islands of the Azores and Madeira and between them and the mainland;
  • Certain supplies to international bodies etc. treated as exports
  • The supply of gold to central banks;
  • Supplies of goods to or within customs warehouses, tax warehouses, free zones or free warehouses etc. and related services,
  • Supplies of goods for retail in tax-free shops, sale on board etc
  • Supplies of goods under temporary importation arrangements or the internal EU transit procedure and related services,
  • Certain intra-EU acquisitions of goods intended for export.

Article 169(b) VAT Directive

Only domestic VAT exempt transactions listed in Article 169(b) VAT Directiveare eligible.

Certain exempt financial transactions

Type of transaction giving rise to deduct

Conditions for deduction to arise

Certain exempt transactions such as:

  • insurance and reinsurance transactions,
  • negotiations and granting of credit and its management by the person who granted it;
  • dealings in credit guarantees and their management by the person who granted the credit;
  • transactions concerning deposit and current accounts and other negotiable instruments, excluding debt collection;
  • transactions concerning currency;
  • transactions in shares, interests and other securities, excluding management and safekeeping and excluding documents establishing title to goods, and rights in rem.

Points (a) to (f) of Article 132(1) VAT Directive

Only VAT exempt transactions listed in Article 169(c) VAT Directive are eligible and only when one of the two conditions are met:

  • the customer is established outside the EU or
  • the transactions relate directly to goods to be exported out of the EU.

Deductions for cross-border supplies of new means of transport

Type of transaction on which VAT is deducted Conditions to deduct
Deductions for cross-border supplies of new means of transport
Article 172 VAT Directive

Any person who makes occasional supplies of new means of transport to other EU country.

Only a fraction of paid VAT can be deducted.
The right to deduct arises, and may only be exercised, at the time the new means of transport is supplied.

Proportional deduction

When does proportional deduction apply?
Proportional deduction of input VAT applies whenever a taxable person (business) carries out both transactions in respect of which VAT is deductible (taxed supplies) and those in respect of which it is not (most exempt supplies, for example).

The basic rule
Only so much of the VAT incurred by a business on goods and services used both for transactions qualifying for VAT deduction and for transactions not qualifying for VAT deduction may be deducted as can be attributed to transactions qualifying for a VAT deduction.

How is the attribution done?
Article 173(2)VAT Directive prescribes a number of methods that may be used, but leaves the choice of method to each EU country.
The methods can be classified as (1) sectoral attribution; (2) direct attribution or (3) global attribution.

Method Description
Sectoral attribution

EU country may:

authorise the business to determine a proportion for each sector of its business, if it already keeps separate books of account for each sector or
require the business to keep separate books of account for each sector of its business and to determine a proportion for each sector.

Direct attribution

EU country may authorise or require the business to deduct or not to deduct on the basis of the actual use to which all or part of the goods or services are put in respect of a specific transaction.

Global attribution

EU country may authorise or require the business to base the deduction on the use to which all goods and services are put in respect of all its transactions.

EU countries are not required to choose one method to the exclusion of the others.

Under all three methods, where the amount of non-deductible VAT turns out to be very small compared to the deductible amount, EU countries may choose to allow it to be equated to nil and hence allow full deduction.

How is the deductible proportion calculated?
The deductible proportion is calculated as a fraction, of which:

  • the numerator is the total VAT-exclusive annual turnover attributable to transactions qualifying for VAT deduction and
  • the denominator is the total VAT-exclusive annual turnover attributable to both transactions qualifying for VAT deduction and transactions not qualifying for VAT deduction.

EU countries may choose whether or not to require subsidies (other than those directly linked to the price of supply) to be included in the denominator.

There are amounts that must be excluded from the calculation. These are amounts of turnover attributable to:

  • supplies of capital goods used by the business for business purposes (however, in EU countries where no adjustment is made for capital goods (see Deductions: adjustment for capital goods), disposals of capital goods may be included in the calculation);
  • incidental transactions with immovable property and incidental financial transactions; and
  • incidental exempt financial transactions, listed in points (b) to (g) of Article 135(1) of VAT Directive.

How often is the deductible proportion calculated?
As the rules imply, the deductible proportion is calculated once a year. A provisional proportion, based on the previous year’s transactions may be used initially, and an adjustment is then made when the final proportion is known in the following year.

Where there are no or insufficient transactions in the previous year on which to base the provisional proportion, the business can use its own forecasts to estimate it, with the approval of the national tax authorities.

EU countries that had different rules in place at 1 January 1979 may retain their own rules and countries joining the European Union after that date may retain the rules they had at their date of accession.

(Article 175 VAT Directive)

How precise must the deductible proportion be?
It must be fixed as a percentage and rounded up to a figure not greater than the next whole number.

Example

A business, B Co, has a VAT-exclusive turnover of EUR 70 000 from transactions qualifying for deduction and EUR 50 000 from transactions not so qualifying. It has also sold capital goods for a total of EUR 12 000*.

Its deductible proportion is:
70 000 / (70 000 + 50 000) = 58.33%
This may be rounded up to no more than 59%.
* B Co’s country excludes the value of capital goods from the calculation of the deductible proportion.

Restrictions on deduction

When can the right to deduct be restricted?
There are essentially only two global restrictions on the right of a taxable person (business) to deduct the VAT incurred on goods and services purchased or acquired.
In no circumstances may VAT be deducted in respect of expenditure that is not strictly business expenditure.

Examples of expenditure that is not strictly expenditure as quoted in Article 176 VAT Directive are expenditure on luxuries, amusements or entertainment.
With the unanimous agreement of all EU countries, a general restriction, or block, is set to be imposed on the deduction of VAT for certain specified types of expenditure.

Until such time, EU countries may retain exclusions that were in place at 1 January 1979 (or as at their date of joining the EU, if later). A number of EU countries, for example, continue to deny deduction for VAT on business entertainment.

Capital goods
EU countries may, subject to consultation of the VAT Committee, totally or partly exclude expenditure on some or all capital goods from the right to deduct, for cyclical economic reasons.

Instead of denying deductions, EU countries may instead tax goods the business manufactures itself or purchases within the EU or imports from third countries, but not more heavily than they tax the acquisition of similar goods

(Article 177 VAT Directive).

Evidence and procedures for deduction

What evidence or procedures are needed for deduction?
A taxable person (business) may only exercise his right to deduction if he satisfies certain conditions. The precise nature of the evidence or conditions depends on the nature of the transaction in respect of which the deduction is being claimed.

The deduction is claimed for VAT on: Evidence/conditions required
Supply of goods and services Business must hold a valid VAT invoice.
Transactions treated as a supply of goods or services

Rules are laid down by the individual EU country.

Intra-EU acquisitions of goods

Business must hold a valid VAT invoice and provide the information required in its VAT return.

However, EU countries may choose to override this rule and allow businesses to make the deduction even where they do not hold a valid VAT invoice

Transactions treated as intra-EU acquisitions Rules are laid down by the individual EU country.
Imported goods Business must hold an import document naming it as the consignee or importer and stating the amount of VAT due or enabling that amount to be calculated.
Reverse-charge VAT Rules are laid down by the individual EU country.

(Articles 178 , 181 VAT Directive)

Regardless of the above, EU countries have the authority to allow businesses to make a deduction in cases where they have not been able to comply with the requirements above and/or with the method of making deductions. The EU country concerned will set its own detailed rules for this.

(Article 180 VAT Directive)

How and when deductions are made

The basic rule
Taxable persons (businesses) make good their right to deduct input VAT when making their VAT return for the relevant period by:

  • subtracting the input VAT for which the right of deduction has arisen in that period
  • from the total amount of VAT due by them in that period.

(Article 179 VAT Directive)

For how and when to make a return, see VAT returns.

For when VAT becomes due, see Chargeable event and chargeability.

Exception for occasional transactions
EU countries may choose to require that persons whom they regard as taxable persons because they carry out occasional supplies of

  • buildings prior to their first occupation and of the land on which they stand or
  • building land

to exercise their right of deduction only when they make the supply.
(Article 179 VAT Directive)

For when a supply is made, see Chargeable event and chargeability.

What happens if deductible VAT is more than the VAT due?
If the amount of VAT a business may deduct in any period is greater than the amount of VAT due from that business in the same period, EU countries may either:

  • make a refund of the excess or
  • carry the excess forward to the next period.

They may, however, also refuse to refund or carry forward an excess if it is insignificant.
(Article 183 VAT Directive).

Adjustments of deductions

General rules

When can or must an adjustment be made?
There will be occasions when after a deduction (‘the initial deduction’) has been made, the circumstances underlying the deduction change, so that it is no longer correct. This may be because:

  • the purchase on which the VAT was payable is cancelled
  • a price reduction is subsequently obtained for a purchase
  • a transaction remains totally or partially unpaid
  • where proportional deduction applies, the final deductible proportion is calculated
  • the capital goods scheme applies.

When must an adjustment be made?
An initial deduction must be adjusted where it is higher or lower than the deduction to which the taxable person (business) is entitled (Article 184 VAT Directive).
This is particularly the case where purchases are cancelled, price reductions are obtained or there is some other change in the factors used to calculate the deduction.
However, no adjustment may be made for transactions remaining totally or partially unpaid or where goods purchased are destroyed, lost or stolen (subject to proper proof or confirmation).

Nevertheless, EU countries may choose to insist on an adjustment where:

  • transactions remain totally or partially unpaid or
  • in the case of theft.

(Article 185VAT Directive)

What is the procedure for adjustments?
Every EU country provides national rules for making adjustments (Article 186 VAT Directive).

Adjustments for capital goods

What are capital goods?
The VAT Directivedoes not contain a definition for ‘capital goods’; this is left to EU countries themselves.

However, the concept is broadly speaking equivalent to a fixed asset, the use of which is likely to extend over several years (at least five is the implication), typically, immovable property or expensive computer equipment, and is unlikely to be limited to one specific business or non-business purpose.

The legislation for the capital-goods adjustment is found in Articles 187-191VAT Directive.

What about services?
EU countries may choose to regard services having characteristics similar to those normally attributed to capital goods as if they were capital goods.

When must an adjustment be made for input VAT on capital goods?
An adjustment must be made whenever, during the ‘adjustment period’, the degree of use of the goods for the purpose of making taxable (taxed/exempt) transactions alters.

Adjustments for capital goods need not be made, therefore, when the business makes only transactions that are taxed or exempt with right of deduction or only transactions that are exempt without right of deduction or non-taxable.

It will therefore apply to businesses who make proportional deductions at any time during the adjustment period.

How long is the adjustment period?
The normal adjustment period is five years, starting with the year in which the goods are acquired or manufactured.

Alternatively, EU countries may start counting this period from the date on which the goods are first used.

In the case of immovable property, EU countries may extend this period up to a maximum of 20 years.

How often must the adjustment be made?
The adjustment is made annually during the adjustment period. However, if the degree of entitlement to the deduction (calculated as for proportional deductions generally) is the same in any year as in the first year for which the deduction is claimed, no adjustment need be made.

How is the adjustment made?
The adjustment in any one year is given by the formula:
(VAT on original acquisition/number of years in the adjustment period) x difference in entitlement percentage

Example
A business who makes both taxed and exempt transactions purchases a computer installation at a price of EUR 200 000 for his factory. The VAT on the purchase is EUR 40 000. The adjustment period is 5 years.

In Year 1, the degree of use for taxed transactions is 60%. In Year 2, it is 56%; in Year 3 it is 65%; in Year 4 60% and in Year 5, 58%.

Deductions and adjustments are as follows:
Year 1
40 000 x 60% = 24 000 original deduction
Year 2
(40 000/5) x (60% - 56%) = 320 due to national tax authorities
Year 3
(40 000/5) x (65% - 60%) = 400 deduction
Year 4
No adjustment, as the entitlement percentage (60%) is the same
Year 5
(40 000/5) x (60% - 58%) = 160 due to national tax authorities.

What happens if capital goods are sold or transferred during their adjustment period?
There is only one adjustment period. If the transferee (new business owner) acquires the goods while that period is still running, it must make the adjustment only once in respect of all the time the period still has to run. If the supply to it was taxed, the business' original deduction (initial entitlement percentage) is 100%. If the supply is exempt, it initial entitlement percentage is zero.

Choices open to individual EU countries
In applying the adjustment scheme for capital goods, EU countries may choose to:

  • adopt their own definition of capital goods
  • specify the amount of VAT to be used in the adjustment calculation
  • take measures to prevent the obtaining of an unjustified advantage
  • make administrative simplifications.

Is the capital-goods adjustment scheme compulsory?
Normally, yes.
EU country may choose not to operate it under the following conditions:

  • the practical effects of applying the scheme is negligible;
  • it takes into account overall impact of VAT and the need of administrative simplification;
  • it ensures that there is no distortion of competition as a result;
  • consults the VAT Committee in advance.