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VAT Deduction Rule Changes for Holding Companies
The Polish Ministry of Finance is planning to introduce new regulations which will significantly change VAT deduction rules for holding companies. One of the proposed changes concerns the introduction of the so called ‘pre-pro-rata’. Taxand Germany, Taxand Poland & Taxand UK explore these new regulations and the effect they could have on multinationals in Member State jurisdictions.
Activities of holding companies that are currently taxed, exempted and out of scope of VAT – current regulations
Currently, holding companies in the EU are using the pro-rata method (indirect allocation based on turnover) for the purposes of VAT deduction (or in some cases, the method of direct allocation). Pre-pro-rata specifies the amount of VAT deduction for purchases connected with activities taxed with VAT and which remain outside the scope of VAT. For many holding companies, the pro-rata ratio is relatively high and therefore allows for the deduction of the substantial amount of input VAT from so called ‘mixed purchases’ - purchases connected both with activities taxed with VAT, (eg management services for subsidiaries), and exempted from VAT (eg loans for subsidiaries).
Present rules do not require the inclusion of activities beyond the scope of VAT (such as dividends, in the case of holding companies) when calculating the pro-rata. Therefore, the current VAT deduction rules are favourable for holding companies as they allow the deduction of input VAT with the pro-rata ratio that does not include the purchases remaining beyond scope of VAT. Moreover, where the holding company does not perform activities exempted from VAT, it is entitled to deduct the whole input VAT amount (both for purchases directly and indirectly connected with taxable activities eg lease of office space).
Pre-pro-rata – new regulations and their impact on holding companies
The regulations proposed by the Ministry of Finance involve the introduction of the so called ‘pre-pro-rata’ to the Polish VAT Act. Pre-pro-rata would specify the percentage of input VAT for purchases which should be allocated to activities subject to VAT and which remain beyond the scope of VAT. The main idea behind the proposed changes is to limit the current right to deduct input VAT connected with purchases which fall outside the scope of VAT for holding companies.
Lack of closed list for activities remaining beyond the scope of VAT – risk for taxpayers
Given the fact that proposed changes do not contain a closed list of activities remaining out of the scope of VAT, it will be difficult for the taxpayers to determine which activities should be considered for the purposes of the pre-pro-rata. Such a conclusion stems from the fact that this list is virtually unlimited and it does not refer only to the activities explicitly specified in VAT, as remaining out of the scope of VAT, but also to all other business activities performed by taxpayers which are of economic value, for example:
- Contractual penalties
- Sale of receivables
- Creation of provisions
- Receipt of interest from banks
- Value of the taxpayers own work etc
Without a closed list of activities which remain beyond the scope of VAT, taxpayers will never be certain whether they have taken into account all activities remaining out of the scope of VAT, while calculating the pre-pro-rata ratio.
Important – holding companies may choose a method of calculation for the pre-pro-rata
The Polish Ministry of Finance does not plan to introduce regulations specifying the method of calculation of the pre-pro-rata. According to the Ministry, such calculations should take into account “the specific nature of the activities” performed by each taxpayer. Such wording may be dangerous for taxpayers as it leaves freedom of interpretation for the tax authorities.
On the other hand, this wording may also provide taxpayers with a certain degree of protection, as they will be entitled to create their own method of calculation of pre-pro-rata which will have to be authorised by the tax authorities. Therefore, taxpayers will be bound to use the method agreed with the tax authorities. The opportunity to discuss the method of calculation of the pre-pro-rata with the tax authorities, and subsequent authorisation of such method, will allow taxpayers to minimise the risk connected with the lack of a closed list of activities which remain outside of the scope of VAT.
The Polish example is not the only one – other Member States have introduced, or are to introduce, similar provisions. As the subject is not clearly regulated by the EU Directive, the approach of particular Member States could be different. However, all countries will definitely see an impact on the level of VAT deduction.
The United Kingdom tax authorities for instance have just updated their guidance on VAT recovery by holding companies, indicating they will pay closer attention to identifying costs that relate to shareholding activity and therefore where VAT recovery may need to be blocked.
The German Federal Tax Court (BFH) has referred to the CJEU questions regarding VAT groups and input VAT deduction by a management holding company. The references are pending at the ECJ. In particular the dispute questions the deduction of input VAT by holding companies in connection with the purchase of shares in its subsidiaries. Generally, the BFH has rejected a full input VAT deduction. The incoming purchases would at least – if not primarily – also serve the purchase and the keeping of the shares (out of scope of VAT).
However, the BFH questions whether such a proceeding would violate the principles of the ECJ’s decision Cibo Participations (C-16/00) which states that there is no direct and immediate link between the supplies purchased by a holding company with respect to the acquisition of shares in a subsidiary, and any output transaction or transactions in respect of which VAT is deductible.
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For multinationals based in Poland it is important to note all binding tax rulings to ensure compliance. For taxpayers it will result in additional work and a reduction of the amount of input VAT that could be deducted. Taking into account that only a few weeks may remain between the enactment of the changes to the VAT Act and their implementation, taxpayers do not have much time to prepare themselves.
For multinationals in all Member States it should be emphasised that as the result of planned changes all current methods of input VAT deduction on mixed purchases will have to be verified and modified accordingly, dependent on the state rules where the company operates. Multinationals should consider which model of calculation should be established by the company to maximise the amount of input VAT that could be claimed and prepare the proper documentation of evidence for the relevant tax authority.
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