Deductibility of VAT: What is the Pro rata Rule and how does it affect businesses?
One of the most controversial aspects of the Value Added Tax (VAT) Law is the deductibility of input VAT.
Companies often encounter difficulties in determining the correct way to deduct input VAT when they simultaneously carry out transactions that give rise to a right to deduct, i.e. transactions that are subject to and not exempt from VAT, and transactions that do not give rise to a right to deduct, i.e. transactions that are both subject to and exempt from VAT.
This can be the clear example of a company dedicated to the leasing of real estate, specifically the leasing of warehouses or commercial premises (a transaction that gives rise to the right to full deduction of VAT) together with the leasing of dwellings (a transaction that does not give rise to the right to deduct VAT in any proportion).
Throughout this post, we will analyze what the Pro rata rule is, the different types of apportionments, the requirements that must be met for a company to be able to deduct input VAT and how a company can deduct input VAT when this rule applies to it.
However, before answering these questions, it is necessary to point out that for a company to know how to deduct its input VAT, it is necessary to determine the nature of the transactions it carries out, i.e. “to know if I can deduct my purchases, I must look at my sales”.
When is a company subject to the “Pro-rata Rule”?
When it simultaneously carries out transactions that give rise to the right to deduct and transactions that do not give rise to the right to deduct, as established in article 102 of the VAT Law.
This will result in the company only being able to deduct part of the VAT it bears, specifically for the part of the operations that do give rise to the right to deduct.
Types of deductible proportion and criteria for its application
Article 103 of the VAT Law regulates the types of pro-rata that exist and the criteria for their application.
In particular, there are two types of apportionment:
- General Pro-rata
- Special Pro-rata
The special deductible proportion may be applied on a voluntary or compulsory basis. It will be voluntary when it is opted for in the manner and within the periods established by regulations and it will be compulsory in those cases in which the deductible input VAT quotas resulting from the application of the General Pro-rata exceed 10% of the deductible quotas that would have resulted from the application of the Special Pro-rata.
The General Pro-rata shall apply where the Special Pro-rata does not apply.
VAT deductibility requirements
As is well known, and as regulated in article 95.1 of the VAT Law, in order for a company to be able to deduct the VAT paid on its purchases of goods or services, these must be directly and exclusively related to the professional or business activity.
In this regard, the VAT regulations establish that certain goods are not considered to be directly and exclusively assigned to the activity, specifically the following:
- Goods which are normally used for both a business activity and other activities of a non-business or non-professional nature.
- Goods or services that are used simultaneously for business or professional activities and for private needs.
- Goods or rights that do not appear in the accounts or record books.
- Goods and rights acquired by the entrepreneur, and which do not form part of his business or professional assets.
- Assets intended to be used for the satisfaction of the personal or private needs of entrepreneurs or professionals, their family members, or their dependants.
In the case of passenger cars and their trailers, mopeds and motorbikes, the legislator presumes that the percentage of use for the development of the business or professional activity will be 50%.
Finally, it should be remembered that, according to article 96 of the Law, certain goods or services cannot be deducted in any proportion, such as jewellery, alcohol, tobacco, goods, or services intended for customer services, among others.
How is the Pro-rata Rule calculated?
First, it is necessary to identify which transactions give rise to the right to deduct and which transactions do not give rise to the right to deduct, in accordance with the provisions of articles 93 and 94 of the VAT Law.
Then, for the calculation of the pro rata, the amount resulting from the division of the total amount of transactions giving rise to the right of deduction by the total amount of transactions carried out by the enterprise, i.e. transactions giving rise to the right of deduction plus transactions not giving rise to the right of deduction, must be multiplied by 100.
The result of this division is always rounded up to the nearest whole number.
As mentioned above, there are two types of pro-rata: general and special.
- The General Pro-rata consists of deducting all the input VAT payments in the percentage calculated in the manner described above,
- The Special Pro-rata is a more precise form of calculation in which the input VAT quotas of the acquisitions of goods and services are deducted according to their destination. In such a way that:
- If the good is used in an activity giving rise to a right to deduct, the input VAT shall be deducted in full.
- If the good is used in an activity which does not give rise to the right to deduct, no input VAT may be deducted.
- If the asset is used in both types of activity, the input VAT will be deducted according to the general pro-rata percentage.
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