Calculation of the (Pre-) Pro Rata under EU VAT Law - empcom.gov.in

Mandy Gabriël and Herman van Kesteren
Calculation of the (Pre-) Pro Rata under
EU VAT Law
Where taxable persons use inputs for taxed
and exempt purposes, they have to attribute
the costs of the inputs to both categories of
transactions, commonly on the basis of a “pro
rata” calculation. In this article, the authors
analyse the ECJ’s decision in Securenta, in which
the ECJ seems to have presented a new scenario,
i.e. the method for determining the rate of
deduction in respect of inputs used by taxable
persons for the purposes of carrying out both
economic and non-economic activities, which
the authors label as “pre-pro rata”. The article
is followed by several comments made by Paul
Lasok to the authors’ conference paper.
1. Introduction
Under Art. 9 of the VAT Directive, 1 any person who,
independently, carries out in any place any economic activity
qualifies as a taxable person, whatever the purpose
or results of that activity. The taxable person’s economic
activities can be fully taxed or fully exempt, or specific
activities may be taxed whereas others are exempt. However,
the activities of taxable persons are not limited to
economic activities. Taxable persons can also carry out
non-economic activities, i.e. activities that are outside the
scope of (EU) VAT.
Establishing the nature of the outgoing transactions is
necessary for the purpose of determining whether and,
if so, to what extent, taxable persons can deduct VAT
charged to them on the purchase of goods and services. 2
In principle, taxable persons are entitled to deduct that
VAT in so far as they use the goods and services for the
purposes of carrying out taxed transactions. 3 Where
they use the inputs for both taxed and exempt purposes,
taxable persons have to attribute the costs of the inputs
to both categories of transactions, either by directly attributing
the inputs to specific output transactions or
by attributing them to their total economic activities by
reference to turnover derived from the two categories of
transactions. In the latter case, the deductible proportion
is commonly based on a “pro rata” calculation.
It follows from case law of the Court of Justice of the
European Union (ECJ) that, contrary to a literal interpretation
of Art. 174 of the VAT Directive, only income
(“turnover”) derived from economic activities can be
taken into account for the purposes of calculation of the
pro rata. This view of the ECJ has given rise to several
questions, which should be, but have not yet fully been,
answered by the ECJ. In respect of non-economic activities,
the pro rata mechanism is not completely sidelined:
332
European Union
Mandy Gabriël
and Herman van Kesteren*
where the taxable person’s economic activities benefit
from non-economic activities and the costs of the inputs
relating to the non-economic activities can be linked to
the totality of economic activities, the pro rata calculation
still applies. 4
One of the unanswered questions results from the ECJ’s
judgment in Securenta. 5 On that occasion, the ECJ seems
to have presented a new scenario – “new” in the sense
that it is not expressly covered by the currently existing
provisions of the VAT Directive, i.e. the method for determining
the rate of deduction in respect of inputs used
by taxable persons for the purposes of carrying out both
economic and non-economic activities. According to the
ECJ, it is up to the Member States to establish to that end
appropriate methods and criteria, which must be consistent
with the principles underlying the common system of
VAT. It is clear from the ECJ’s judgment in Securenta that
that method for apportioning input VAT must be applied
before application of the existing pro rata. It can therefore
be labelled as “pre-pro rata”.
In order to correctly calculate the pre-pro rata, more
guidelines or rules are required and also the ECJ’s judgment
in SKF6 may affect the new rules. Previously, the
ECJ tended to treat sales of shares by holding companies
as non-economic activities. 7 However, in its judgment in
SKF, the ECJ held (on the basis of the “extension theory”)
that the disposal of shares in a subsidiary by a holding
company that is involved in the management of that
subsidiary can constitute an economic activity, which is
exempt from VAT. This fairly surprising view may also
have an important impact on the pre-pro rata and pro
rata fractions.
* Mandy M. Gabriël is an Indirect Taxes Consultant for PricewaterhouseCoopers
Eindhoven and a PhD researcher at Maastricht University.
Herman W.M. van Kesteren is an Indirect Taxes Partner at
PricewaterhouseCoopers Amsterdam, a professor of indirect taxation
at Tilburg University and a judge in ’s-Hertogenbosch and The Hague.
1. Council Directive 2006/112/EC of 28 November 2006 on the common
system of value added tax, OJ L 347 of 11 December 2006.
2. Hereafter referred to as “input VAT”.
3. Art. 168 of the VAT Directive.
4. ECJ judgments of 27 September 2001 in Cibo Participations SA v. Directeur
régional des impôts du Nord-Pas-de-Calais, Case C-16/00, [2001] ECR
I-6663; and of 26 May 2005 in Kretztechnik AG v. Finanzamt Linz, Case
C-465/03, [2005] ECR I-4357.
5. ECJ judgment of 13 March 2008 in Securenta Göttinger Immobilienanlagen
und Vermögensmanagement AG v. Finanzamt Göttingen, Case C-437/06,
[2008] ECR I-1597, Para. 34.
6. ECJ judgment of 29 October 2009 in Skatteverket v. AB SKF, Case C-29/08,
[2009] ECR I-10413.
7. At least, in so far as the activities are not comparable to those of a commercial,
professional share dealer. See also ECJ judgment of 14 November
2000 in Floridienne SA and Berginvest SA v. Belgian State, Case C-142/99,
[2000] ECR I-9567, Para. 28.
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2. Right to Deduct Input Tax
In order to safeguard the neutrality of the VAT system,
the VAT Directive contains a set of rules on the right
to deduct input VAT. This deduction system is aimed
at entirely relieving taxable persons of the VAT paid or
payable in the framework of all their economic activities,
provided that these activities are subject to VAT. 8 The
right to deduct may not in principle be limited and must
be exercised immediately in respect of all VAT charged
on transactions relating to inputs. 9
The transactions of taxable persons are rarely fully taxed
or fully exempt – their output is frequently a combination
of taxed and exempt transactions – and the purposes
for which taxable persons make specific investments and
purchase other inputs may vary widely. Specific inputs
may be directly attributable to taxed transactions and others
only to exempt transactions. For the purposes of direct
attribution, the inputs must have a direct and immediate
link with a subsequent taxable transaction; the ultimate
aim pursued by the taxable person by carrying out that
transaction is irrelevant. 10
Where particular inputs are directly attributable to particular
output transactions, the entitlement to deduct the
related VAT is based on Art. 168 of the VAT Directive.
Where the acquired goods and services are used for both
taxed and exempt transactions, the inputs do not necessarily
have to be attributed to individual output transactions.
If the costs of the inputs are part of the general overhead
costs and are, as such, components of the prices of
the output transactions, the related VAT can be deducted
on the basis of the pro rata. 11
Thus far, there are obviously three options: the inputs can
be attributed to the taxable person’s taxed transactions, to
its exempt transactions or to its economic business activities
as a whole. In the latter case, a proportional division
into deductible and non-deductible input tax is required.
This is where the rules governing “partial deduction”
come into play. 12 These rules, however, only apply with
regard to economic activities. 13
3. Partial Deduction in Respect of Economic
Activities
3.1. The pro rata mechanism
The rules on partial or proportional deduction of VAT
laid down by the VAT Directive prevent the costs of
the inputs having to be attributed to individual output
transactions. Where taxable persons purchase goods or
services for the benefit of their overall business activities,
the related costs are “general costs” or “overheads”.
On the basis of the VAT Directive, the deductible proportion
of the VAT on a taxable person’s overheads is
to be determined by applying a single fraction based on
turnover proportions. Member States may deviate from
this rule and authorize or require taxable persons to determine
multiple proportions, such as proportions relating
to separate parts of their businesses. They may also
authorize or require taxable persons to determine the
Calculation of the (Pre-) Pro Rata under EU VAT Law
rate of deduction of input VAT on the basis of actual use
of the inputs. 14
The numerator of the turnover (“pro rata”) fraction15 consists
of turnover derived from taxed transactions, and the
denominator of total turnover (derived from taxed and
exempt transactions).
3.2. Turnover to be taken into account
Member States may include subsidies other than subsidies
directly linked to the price of goods or services in
the denominator of the pro rata fraction, 16 and they must
exclude from the pro rata fraction turnover derived from,
inter alia, supplies of used capital goods and incidental
transactions involving real estate and financial services. 17
The denominator of the pro rata fraction does not include
dividends because “... the receipt of dividends is
not consideration for any economic activity... – and does
not fall within the scope of VAT”. 18 Also, interest must
be excluded from the pro rata fraction, if the granting of
loans does not constitute an economic activity19 and does
not constitute the direct, permanent and necessary extension
of a taxable activity – under those circumstances,
the interest is categorically excluded from the pro rata,
not on the ground that it is an “incidental” (financial)
transaction. 20
As the ECJ decided in Kretztechnik, 21 the pro rata mechanism
designed for economic activities can also be applied
to costs made in the framework of non-economic
activities. Kretztechnik issued shares in order to increase
its capital for the benefit of its economic activity in general.
According to the ECJ, the costs that Kretztechnik
8. ECJ judgments of 14 February 1985 in D.A. Rompelman and E.A. Rompelman-Van
Deelen v. Minister van Financiën, Case 268/83, [1985] ECR 655,
Para. 19; of 22 February 2001 in Abbey National plc v. Commissioners of
Customs & Excise, Case C-408/98, [2001] ECR I-1361, Para. 24; and of 21
March 2000, Gabalfrisa and Others, [2000] ECR I-1577, Para. 44.
9. ECJ judgment of 6 July 1995, BP Soupergaz, C-62/93, [1995] ECR I-1883,
Para. 18; and in Gabalfrisa (see note 8).
10. ECJ judgment of 6 April 1995 in BLP Group plc v. Commissioners of Customs
& Excise, Case C-4/94 [1995] ECR I-983, Para. 19.
11. ECJ judgment of 8 February 2007 in Investrand BV v. Staatssecretaris van
Financiën, Case C-435/05, [2007] ECR I-1315, Para. 24.
12. Laid down in Arts. 173-175 of the VAT Directive.
13. Where the proportion of deductible input VAT is based on a fraction regarding
turnover, turnover resulting from non-economic activities is not
taken into account; ECJ judgments in Floridienne and Berginvest, note 7,
Para. 32; and in Cibo Participations, note 4, Paras. 39 and 44.
14. It follows from the explanatory memorandum to Art. 14(5) of the proposal
for the Sixth Directive that this discretion is conferred on Member States as
a means to avoid inequalities which “may work to the detriment or advantage
of taxable persons” (see Proposal of 20 June 1973 for a Sixth Council
Directive on the harmonization of Member States concerning turnover
taxes, COM(73) 950).
15. Art. 174 of the VAT Directive.
16. Subsidies directly linked to the price of transaction will probably be included
in the pro rata fraction because they form part of the consideration.
17. Art. 174(2) of the VAT Directive.
18. ECJ judgment of 22 June 1993 in Sofitam, Case C-333/91, [1993] ECR
I-3513, Para. 13. See also, inter alia, ECJ judgments in Cibo Participations,
note 4, Paras. 39 and 44, and in Floridienne and Berginvest, see note 7,
Para. 32.
19. ECJ judgment in Floridienne and Berginvest, see note 7, Para. 32,
20. ECJ judgment of 11 July 1996 in Régie Dauphinoise-Cabinet A. Forest Sarl
v. Ministere du Budget, Case C-306/94, [1996] ECR I-3695, Para. 22
21. ECJ judgment in Kretztechnik, see note 4.
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Mandy Gabriël and Herman van Kesteren
incurred in connection with the transaction formed part
of its overheads. Since overhead costs are a component
of the costs of the output transactions, there is a direct
and immediate link to the whole economic activity. 22 As
it exclusively carried out taxed transactions, Kretztechnik
was entitled to fully deduct the VAT incurred on services
acquired in conjunction with the issue of shares. In other
words, although proceeds 23 derived from non-economic
activities are disregarded, the deductibility of VAT on
costs made in connection with these non-economic activities
is determined by applying the pro rata mechanism
designed for economic activities.
3.3. Pro rata after SKF
On the basis of previous case law, the acquisition, holding,
issue and sale of shares by holding companies were
believed to be non-economic activities (at least, if those
activities were not carried out by share dealers). It follows
from the ECJ’s judgments in, inter alia, Kretztechnik
and Investrand, 24 that the VAT on costs relating to these
“non-economic activities” may still be deductible, if it can
be demonstrated that they relate to the taxable person’s
overall economic activities and qualify as “general costs”.
In SKF, 25 the ECJ held that the sale of shares in subsidiaries
can constitute an economic activity. In line with
the “extension theory”, the sale of shares by a “managing
holding”, carrying out economic activities, 26 can be seen
as an economic activity. However, the ECJ added that this
economic activity is exempt. 27 The question remains of
how this decision will affect the deductibility of VAT on
costs relating to the sale of shares. Bearing Kretztechnik in
mind, deductibility can be optimized by stating that the
costs relate to the taxable person’s overall business activities.
The ECJ allowed for such an approach in its decision
in SKF. 28 However, since, according to the ECJ, the sale
of the shares formed the direct, permanent and necessary
extension of SKF’s economic activities, it seems rather
difficult to argue that the (exempt) sale of shares can be
excluded from the pro rata fraction. 29 An economic activity
can hardly be classified as “incidental” for the purposes
of calculating the pro rata fraction, if it constitutes the
direct, permanent and necessary extension of the taxable
person’s business. 30 The calculation of the deductibility of
the input tax remains much easier if the costs of the inputs
can be directly and immediately linked to the disposal of
the shares, thus influencing the selling price of the shares:
in that case, the input tax will not be deductible at all. 31
The remuneration for the disposal of shares made by
managing holding companies was initially (at least in
the Netherlands) treated as income derived from a noneconomic
activity. However, following SKF, it has to be
treated as income derived from an economic activity.
Whether a pro rata mechanism is needed in order to establish
the deductibility of VAT on costs relating to the
disposal depends on the possibility of attributing the inputs
to the overall economic activities or to the disposal
itself.
334
4. Partial Reduction in Respect of Economic and
Non-Economic Activities
4.1. Pre-pro rata mechanism
It is clear that the pro rata mechanism can only be used
in respect of economic activities. The VAT Directive does
not provide for a mechanism to establish a deductible
proportion where the taxable person’s output consists of
both economic and non-economic activities. The latter
was the case in Securenta. 32 According to the case file, 33
Securenta carried out three types of activities: non-economic
activities, exempt economic activities and taxed
economic activities. In order to acquire the capital necessary
for its activities, Securenta issued shares and formed
atypical silent partnerships. It was in dispute how the
right to deduct VAT incurred on expenditure relating to
the acquisition of capital must be determined.
Unlike in Kretztechnik, the ECJ could not simply apply
the pro rata rules because Securenta’s transactions did
not solely consist of economic activities. On the basis of
the observations of the referring national court, the ECJ
found that the expenditure connected with the acquisition
of capital was not solely attributable to Securenta’s
economic activities. It concluded that the VAT on that
expenditure was deductible only to the extent that the
expenditure was connected to the latter activities, which
gives rise to the question of how the VAT must be apportioned
to the economic and non-economic activities.
4.2. Determination of the pre-pro rata
According to the ECJ in Securenta, Member States must
ensure that the calculation of the proportion of economic
to non-economic activities (the pre-pro rata) objectively
reflects the part of the input expenditure actually to be attributed
to the respective two types of activities. Member
States have some discretion in determining the methods
and criteria for apportioning input VAT between
22. Id, Para. 25.
23. Since the term “turnover” is less appropriate in relation to proceeds derived
from specific non-economic activities, in particular the issue of shares, we
exclusively use that legal term in the context of calculation of the pro rata.
In the context of calculation of the pre-pro rata, we use the broader term
“proceeds”.
24. ECJ judgment in Investrand, see note 11, Paras. 28 and 29.
25. ECJ judgment in SKF, see note 6.
26. In its order of 12 July 2001 in Welthgrove BV v. Staatssecretaris van Financiën,
Case C-102/00, [2001] ECR I-5679, the ECJ reiterated that the
involvement of a holding company in the management of a subsidiary only
constitutes an economic activity if it takes the form of transactions subject
to VAT.
27. Under Art. 135(1)(f) of the VAT Directive, transactions in shares are
exempt from VAT.
28. ECJ judgment in SKF, see note 6, Para. 68.
29. Id, Para. 33.
30. See ECJ judgment of 29 October 2009 in NCC Construction Danmark A/S
v. Skatteministeriet, Case C-174/08, [2009] ECR I-10567, Para. 30 et seq.
See also ECJ judgment in Régie Dauphinoise, note 20, Para. 22.
31. ECJ judgment in Régie Dauphinoise, see note 20, Para. 71.
32. ECJ judgment in Securenta, see note 5. The ECJ repeated its view in its
judgment of 12 February 2009 in Vereniging Noordelijke Land- en Tuinbouw
Organisatie (VNLTO) v. Staatssecretaris van Financiën, Case
C-515/07, [2009] ECR I-839.
33. The ECJ observed that it was apparent from the information provided by
the referring national court that certain of Securenta’s activities were to be
classified as non-economic activities.
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economic and non-economic activities. The ECJ added
that, in exercising that discretion, Member States have
the right to apply any appropriate method, without being
restricted to a single method only.
4.3. Proceeds to be taken into account
The most straightforward mechanism for attributing input
tax to economic and non-economic activities would
be based on proceeds34 (turnover) derived from those
activities, analogous to the normal pro rata fraction, i.e.:
proceeds derived from economic activities
proceeds derived from economic and non-economic activities
The question arises of how close the analogy between the
pro rata and pre-pro rata fractions may or must be.
The normal pro rata fraction must be calculated per year
and must be fixed as a percentage (rounded up to a figure
not exceeding the next whole number). It seems plausible
that the pre-pro rata fraction must fulfil the same conditions.
The question which then arises is whether it would be
appropriate for Member States to prescribe an apportionment
method based on proceeds derived from economic
and non-economic activities.
4.4. Comparison of pro rata and pre-pro rata
One of the issues in applying the pro rata by analogy concerns
the receipt of non-taxable subsidies35 by charitable
organizations as “remuneration” for activities outside the
scope of VAT. Inclusion of those subsidies in the prepro
rata would have a dramatic impact on the charities.
Where 50% of their income consists of subsidies, charities
would only be entitled to deduct half the burden of input
VAT. 36
Another issue is that specific non-economic activities,
such as transactions carried out free of charge, have no
relationship with turnover or proceeds.
For other organizations, such as holding companies and
investment vehicles, it would be inappropriate to take all
non-taxable proceeds into account for the purposes of
calculating the pre-pro rata. It is clear that also for companies
such as Kretztechnik, specific categories of nontaxable
proceeds should be disregarded in this respect.
Although the issue of new shares was a non-economic
activity, the capital acquired through this non-taxable
action did not decrease the company’s rate of deduction
(it remained 100%). In that case, the only relevant factor
for calculating the deductible proportion was the nature
of the activities for which the new funds were used.
The question also arises of whether the application of a
pre-pro rata would have an effect on Securenta’s rate of
deduction. Securenta’s capital was used for the purposes
of both economic and non-economic activities. It seems
irrational that a company’s rate of deduction would decrease
on account of the issue of shares, if its economic
activities are fully subject to VAT. It seems rational to ignore
proceeds derived from the issue of new shares for de-
Calculation of the (Pre-) Pro Rata under EU VAT Law
duction purposes, on the ground that, unlike Securenta’s
investment activities, the issue of shares is an incidental
(financial) transaction. For the purposes of calculating the
normal pro rata fraction, incidental financial transactions
must be excluded from the denominator. 37 It would be
consistent with that approach to also exclude incidental
non-economic financial transactions from the denominator
of the pre-pro rata fraction.
Another example of “incidental financial transactions”
that should be excluded from the pre-pro rata fraction
is the (non-taxable) disposal of shares. If, for example,
Securenta had sold its investment portfolio, this disposal
would be a non-taxable transaction because Securenta
would have acted in its capacity as a non-taxable person.
Inclusion of the proceeds of this sale in the denominator
of the new pre-pro rata fraction would not reflect economic
reality, as required by the principle of neutrality.
The above examples illustrate that a pre-pro rata fraction
based solely on income – without the possibility to
exclude proceeds derived from certain incidental transactions
– would not have the effect that input expenditures
are attributed to economic and non-economic activities
in an objective manner.
4.5. Actual-use formula
The actual-use approach laid down by Art. 173(2)(c) of
the VAT Directive – not to be calculated on an annual but
on an ad hoc basis - would be a more appropriate method
to determine the rate of deduction for individual inputs.
Application of that method would be in line with the
ECJ’s decision in Securenta that Member States must establish
methods and criteria appropriate to that aim and
consistent with the principles underlying the common
system of VAT. In that regard, the ECJ held that, where
the Directive does not contain the guidance necessary for
such precise calculations, Member States are required to
exercise their discretion having regard to the aims and
broad logic of the Directive, 38 in particular the principle of
neutrality on which the common system of VAT is based.
Accordingly, Member States must exercise their discretion
in such a way as to ensure that deduction is made
only for that part of the VAT that is proportional to the
amount relating to transactions giving rise to the right to
deduct. They must therefore ensure that the calculation
of the proportion of economic to non-economic activities
objectively reflects the part of the input expenditure
actually to be attributed to those two categories of activi-
34. For the terminology in this context, see note 23.
35. These are not subsidies which can be seen as consideration for supplies of
goods or services.
36. Which result seems to contradict the ECJ judgments of 6 October 2005
in Commission of the European Communities v. French Republic, Case
C-243/03, [2005] ECR I-8411, and in Commission of the European Communities
v. Kingdom of Spain,Case C-204/03, [2005] ECR I-8389, Para. 26,
in which the ECJ decided that Member States are not allowed to restrict the
right to deduct input tax if fully taxable persons receive subsidies.
37. Art. 174(2)(b) of the VAT Directive.
38. See, to that effect, ECJ judgment of 14 September 2006 in Hausgemeinschaft
Jörg und Stephanie Wollny v. Finanzamt Landshut, Case C-72/05,
[2006] ECR I-8297, Para. 28.
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Mandy Gabriël and Herman van Kesteren
ties. According to the ECJ, in exercising their discretion,
Member States have the right to apply, if necessary, an
investment formula or a transaction formula or any other
appropriate formula, without being restricted to only one
of those methods.
4.6. Investment formula
Application of an investment formula would be a more
appropriate method for determining the rate of deduction
of VAT on expenses relating to raising new capital by
companies. In that case, the rate of deduction depends on
the purposes for which the proceeds derived from the issue
of the shares are used. This method was advocated by
the European Commission and some Member States as
being more appropriate than the “transaction formula” 39
in the case of Securenta. The question is whether this
formula is indeed more suitable where capital is raised
through the issue of shares, as this approach is based on
the presumption that it is possible to determine to what
extent the newly acquired funds are used for economic
and non-economic activities. In practice, it will be very
difficult to determine the source of the funds used for
purchasing specific goods and services and, in addition,
those goods and services will simultaneously be used for
the two categories of activities. An apportioning method
based on actual use of inputs for the purposes of carrying
out economic and non-economic activities seems to be a
more suitable method.
The proceeds-based and investment formulas will certainly
not be a solution for all cases in which input tax
must be apportioned between economic and non-economic
activities. For example, where charitable organizations
receive non-taxable subsidies and use those funds
for purchasing goods and services used for both their
economic and non-economic activities, the best method
for apportioning the input tax is probably one which is
based on the extent to which the goods and services are
used by the charitable organization for its economic and
non-economic activities. If the charity uses the goods and
services to the extent of only 10% for its non-taxable activities,
whereas the subsidy amounts to 50% of its total
income, a rate of deduction of 90% seems more appropriate
in terms of tax neutrality.
4.7. Other unsolved issues
As regards apportioning input VAT to economic and
non-economic activities, much is still unclear and it can
only be hoped that the European legislator will provide
more clarity in this respect. In this context, determining
the initial rate of deduction in a particular situation
is not the only concern. It should also be clear what the
consequences are of a subsequent change in the use of the
goods and services. The use of inputs may change immediately
following initial deduction of the related VAT, or
one or several years later. In other words, the question is
whether the initial deductions must be adjusted and, if so,
whether a distinction must be made between goods and
services or between capital and current expenditures. The
relationship between the normal pro rata and pre-pro rata
336
mechanisms should also be clear, especially if they are to
each have their own adjustment mechanisms.
Under the ECJ’s judgment in Armbrecht, the application
of the existing adjustment rules must be limited to that
part of the assets assigned to the business, 40 which means
that initial input tax deductions cannot be adjusted if the
use of the goods shifts between taxable and non-taxable
purposes.
Under the new Art. 168a of the VAT Directive, which
came into effect on 1 January 2011, 41 the principles of
the existing arrangements for adjusting initial input tax
deduction in respect of immovable business assets that
are used for both business and private (non-business)
purposes also apply to the annual deemed supply that
is aimed at correcting initial full deduction on account
of private use of the assets. That provision is at least a
good start. The new legal arrangements to be included in
the VAT Directive for initial deduction and subsequent
adjustments of VAT relating to inputs used for both economic
and non-economic purposes should however not
only apply to goods but also to services, and they should
clearly indicate the relationship between private and nonbusiness
use of business assets. 42
5. Summary and Conclusions
Taxable persons are entitled to deduct input VAT to the
extent they use the related goods and services for the purposes
of carrying out taxed transactions. If the inputs are
used for both taxed and exempt transactions, the input
VAT must be apportioned, either by directly attributing
the inputs to specific outputs or by attributing them to
the taxable person’s total economic activities. In the latter
case, the deductible proportion can be established on the
basis of a “pro rata” fraction based on turnover.
In respect of non-economic activities, the pro rata mechanism
is not completely sidelined. The economic activities
of a business may even benefit from non-economic activities
being carried out. In such cases, where the costs of
inputs relating to non-economic output transactions can
be linked to the taxable person’s total economic activities,
the pro rata fraction still applies.
However, where inputs cannot be fully linked to the taxable
person’s total economic activities, the existing pro
rata mechanism cannot be used and, under Securenta,
Member States have to establish appropriate deduction
methods and criteria, consistent with the principles un-
39. The “transaction formula” presumably refers to the apportionment
method based on turnover.
40. ECJ judgment of 4 October 1995 in Dieter Armbrecht v. Finanzamt Uelzen,
Case C-291/92, [1995] ECR I-2775, Para. 32.
41. By Council Directive 2009/162/EU of 22 December 2009 amending various
provisions of Directive 2006/112/EC on the common system of value
added tax, OJ L 10/14.
42. In its judgment in VNLTO (see note 32), the ECJ decided that the selfsupply
rules laid down by Art. 26 of the VAT Directive are limited to
private and non-business use of business assets, and do not apply to the
use of those assets by a business for its non-economic activities. VNLTO’s
non-economic activities (safeguarding the interests of its members) were
still part of its business activities.
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derlying the common system of VAT. Before attributing
inputs to taxed and exempt economic transactions, taxable
persons have to attribute input tax to economic and
non-economic activities (the pre-pro rata).
Calculating the pre-pro rata solely on the basis of turnover
or proceeds – without the possibility to exclude certain
incidental transactions – would not objectively reflect
the use of the inputs for economic and non-economic activities.
Application of an investment formula would be a
more appropriate method for apportioning VAT relating
to the issue of shares. However, the investment formula
is also not ideal, for example in the case of charities that
receive non-taxable subsidies. Moreover, it is difficult to
apply that formula in practice. Ad hoc apportionment of
European Union
Calculation of the (Pre-) Pro Rata under EU VAT Law
input VAT on the basis of actual use of individual goods
and services would be the preferred option for determining
the rate of deduction of VAT relating to individual
inputs.
The existing rules for adjusting initial input tax deductions
only apply to changes in the use of business goods
for taxed and exempt purposes. From 1 January 2011, the
principles underlying the existing adjustment rules also
apply to goods that are used for both business and private
(non-business) purposes. The rules to be introduced
for the purposes of determining the rate of deduction in
respect of inputs used for economic and non-economic
purposes must be more comprehensive and include services
as well.
The Right To Deduct for Partially Exempt
Bodies
1. Introduction
The question of the right of bodies engaged in making
both taxed and exempt supplies (“partially exempt bodies”)
to deduct input tax is a sub-topic of the more general
question of input tax deduction. Theoretically, in relation
to partially exempt bodies, the only question to be
considered is the methodology to be used to calculate the
deductible input tax. However, that question conceals a
number of other questions that need to be considered and
that take us back to the more general question of input
tax deduction, primarily: what are we trying to achieve
by input tax deduction and what kind of expenditure is
in principle deductible?
The starting point for a consideration of those questions
(which do not call for a definitive exposition in the present
context) is inevitably to be found in the model of VAT
that one is using and, for practitioners, in how the policy
questions arising from that model have been resolved in
practice by the legislature.
For example, the EU model of VAT is based on transaction
chains and provides that input tax is deductible in
so far as inputs are used for taxed transactions.
That model was adopted because the EU VAT system was
designed for the specific purpose of resolving problems in
the application of turnover taxes to transnational transactions
(or transaction chains) within the European Union
(i.e. transactions or transaction chains involving more
than one tax jurisdiction). Accordingly, the EU VAT system
is based on considerations that are not relevant to
a tax that is intended to operate only within a single tax
jurisdiction, albeit that the EU system applies the same
approach to input tax deduction relating to national
transactions.
Paul Lasok*
An important consequence of the EU model is the need to
allocate inputs to the correct transaction chain (or to that
transaction chain to the correct extent) so that, in the case
of the problematic transaction chains (the transnational
ones), the correct tax treatment is given in the correct tax
jurisdiction.
An additional feature of the EU model – the one that is
of concern here – is the presence, in the model, of transactions
that are exempt from VAT. Such transactions
are not taxed but, in the EU model, do not permit the
deduction of input tax. The transaction chain, for VAT
purposes, therefore ends where there is an exempt transaction.
Thus, in the case of a partially exempt trader, the ability
to deduct input tax arises, in the context of the EU model,
only to the extent that inputs can be included in a transaction
chain producing a taxed output.
A further complication arises from the phenomenon of
the so-called non-economic activity, i.e. the use of inputs
for a purpose that does not amount to the making of a
taxed or an exempt transaction. Of course, that complication
may apply to all traders, not just those who are partially
exempt. Although a consideration of non-economic
activities is not strictly relevant to what is considered here,
a brief word should, perhaps, be made about that topic.
The general category of non-economic activities comprises
a range of diverse situations that, for VAT purposes,
cannot be assumed to produce the same tax consequences.
At the risk of overgeneralization, some forms of
non-economic use, properly understood, involve internal
* Paul Lasok QC FIIT MA (Cambridge), LLM (Exeter University), PhD
(Exeter), Head of Chambers, Monckton Chambers, England.
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