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

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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. © IBFD INTERNATIONAL VAT MONITOR SEPTEMBER/OCTOBER 2011 333
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. INTERNATIONAL VAT MONITOR SEPTEMBER/OCTOBER 2011 © IBFD
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Calculation of the (Pre-) Pro Rata under EU VAT Law - empcom.gov.in

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