While the VAT deduction mechanism ensures the neutrality of the system by allowing most businesses to recover VAT invoiced to them by their own suppliers (i.e. input VAT), it can also cause many difficulties for these businesses. The main reason for this is that VAT paid on purchases that are attributable to non-business use or to VAT exempt supplies is, in principle, not deductible. Consequently, the calculation of deductible VAT, in practice, has become so complex for most taxable persons today that it represents not only a real additional workload for them but also results in almost inexhaustible discussions with the tax authorities in the event of an audit.
Let's take the classic case of an ordinary VAT taxable person who buys a smartphone for both professional and private use (i.e. mixed-use). As this is a mixed-use good, the VAT taxable person will only be able to deduct the portion of VAT charged on the purchase of the smartphone that is attributable to its professional use. It is therefore required to establish the private and professional proportions of the smartphone’s use based on factual circumstances. In theory, for example, these proportions could be established on the basis of the number of minutes spent on the telephone for private and for professional purposes. In practice, however, such an exercise is unrealistic in light of the human and economic resources it would require.
The above described issue is similar in the case of VAT exempt supplies without the right to deduct input VAT, such as financial services, insurance services or medical services. For example, when the VAT taxable person is a bank that supplies credit services (i.e. exempt services) as well as provides financial advice to individuals (i.e. taxable services), it needs to determine how to attribute the input VAT incurred on its purchases that are used for both its VAT exempt and taxable services. For instance, when the bank acquires a new office building, it will need to determine the portion of VAT (incurred in relation to the acquisition) which is deductible for VAT purposes. This is often difficult to determine based on the actual use of the office building and another method of calculation may be the use of revenue proportions generated by the different services of the bank, which, in essence, change every year.
As the above examples show, the calculation of the deductible portion of input VAT is often tedious and time-consuming, or even impractical. Additionally, the proliferation of VAT rules that we have witnessed for years is also at the root of many errors committed by bona fide taxable persons and the disputes that arise from them. At the same time, as the facts on the basis of which taxable persons calculate the amount of deductible VAT are difficult to control in many cases – if not impossible - some taxable persons may be tempted to exaggerate these facts to their advantage. In view of this, VAT auditors may be particularly vigilant in the deduction of such input VAT.
For all the above reasons, the Belgian tax authorities have started work on simplifying the rules of VAT deductibility by introducing a series of flat rates which approximate the proportion of business use of certain mixed-use goods (e.g. company cars, smartphones, computers, etc.) and related services (e.g. telephone subscriptions, repair costs, etc.). While the application of these flat rates is optional, most taxable persons apply them for good reasons. These flat rates reduce the human and economic means necessary to calculate the amount of deductible VAT, but, above all, they also provide VAT taxable persons the assurance that their declaration will not be challenged by an auditor who would discuss the factual elements used to establish the deductible amount. Moreover, it reduces errors made in good faith due to the complexity of the calculation or the VAT legislation.
While Belgium is still in the early stages of this simplification, some countries are going much further in their quest to simplify the rules of establishing the amount of deductible VAT. For example, the Republic of Singapore now imposes on banking institutions (i.e. taxable persons that provide exempt financial services as well as taxable services) a fixed and compulsory percentage of deduction. Such simplifications do not exist in European Union legislation, but the European Commission commissioned a study in 2019 on the VAT treatment of financial services which may possibly lead to a reconsideration of the VAT deduction rules in the coming years.
In the light of the above, we are in favor of considering new approaches that simplify the rules on VAT deductibility. So, what do you think? If you run a business, such simplification could reduce your administrative burden. However, would you be in favor of these rules if you also consider that you may not be able to deduct all input VAT which would be deductible under the current more complex rules? And, when this non-deductible portion of the VAT is incorporated as costs in the price of goods and services, and consequently result in an increase of the purchase prices, would you as a customer maintain the same opinion?
Shouldn't the European Union and the Belgian tax authorities follow the example of certain simplifications that have proven their advantage elsewhere in the world? Indeed, while the Belgian tax authorities’ staff shrinks year by year and the national and European courts are clogged up with disputes resulting in particular from the complexity of our VAT system, it seems necessary to simplify the rules on VAT deductibility as much as possible in order to reduce the risks of error and fraud, and prevent potential disputes. Finally, although these simplifications may run counter to the principle of VAT neutrality, would it not be advantageous, both for the administration and for taxable persons, to create new lump-sum payments or even to refuse to deduct VAT on certain categories of goods which require too many resources for their calculation and control? Let's bet that this will be the case in the near future, and why not by 2025?
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Author: Sebastian Kirsch, Director
The VAT system in Belgium was introduced in 1971, which will be 50 years ago in January 2021. On this memorable anniversary, KPMG Tax & Legal Belgium and Wolters Kluwer jointly publish a series of articles that reflect on the current VAT system in the context of our changing business and social environments. In each article, KPMG tax experts address a specific aspect of VAT and related challenges of the system and offer predictions on future evolutions by 2025.