Recently, the European Court of Justice ("EcJ") provided further guidance on VAT recovery and more specifically, on the direct allocation of costs and the calculation of the pro rata (C-332/14). This judgment can be very useful in practice.
Wolfgang und Dr. Wilfried Rey Grundstücksgemeinschaft GbR (“WWRG”), a German property company constructed a new building for residential (VAT exempt) and commercial (VAT taxable) purposes ("mixed use"). WWRG recovered VAT on the construction costs on the basis of a pro rata based on turnover i.e. the ratio between VAT taxable and VAT exempt turnover.
Following article 173 of the EU VAT Directive, the pro rata should in principle be established on the ratio between VAT taxable and VAT exempt turnover. The EU VAT Directive also provides for the possibility to allow taxable persons to recover VAT on the basis of the actual use made of all, or a part of, the acquired goods and services.
In the underlying case, the German tax authorities rejected the pro rata calculations of WWRG because the German VAT Act required that the pro-rata method based on the turnover could only be applied in case no other method would be feasible. In this specific situation, the German tax authorities insisted that the pro rata should be calculated based on the actual use of the building, since this would lead to a more precise result.
Furthermore, in determining this "actual use", the German tax authorities, applied a calculation method which also raised questions. In short, the German tax authorities first assessed which parts of the building were used for VAT taxable activities. The VAT on costs allocated to these parts were fully deductible. A pro rata was only used for input VAT costs which could not be allocated to a specific part of the building i.e. VAT taxable use.
The EcJ ruled that taxable persons, in order to determine the amount of input VAT they are entitled to deduct, must, in a first stage, assign the input goods and services to the various output transactions which have been carried out and for the performance of which they were intended.
In a second stage, the EU Member States have the task of applying, in respect of those goods or services, the deduction arrangement corresponding to their assignation. The deduction of input VAT based on the pro rata should however be applied so far as this input VAT does not relate to a single type of transaction.
With regard to the first stage, when the goods or services are assigned to the transactions for which they are used, the EcJ stated that it is for the referring court to determine whether, if they are used for the construction of a mixed-use building, such assignation proves in practice to be excessively complex and, therefore, difficult to carry out.
As for goods and services purchased for the use, conservation or maintenance of a mixed-use building the EcJ stated that allocating such costs to a specific output transaction, generally appears, to be easy to carry out in practice, but again it is for the referring court to verify this as regards the goods and services at issue in the main proceedings.
If the above mentioned allocation cannot be made and/or substantiated .i.e. when such assignation is difficult to carry out, the input VAT on the costs at hand is in principle deductible according to a pro rata based on the turnover. As an alternative, provided that this method guarantees a more precise determination of the deductible proportion, the input VAT on the costs at hand is deductible on the basis of floor area.