Dr Robert brederode –
As a consequence of the distinction in value-added tax (VAT) between taxable and exempt supplies, a problem arises when the use of capital assets fluctuates over time.
Contrary to the general practice for income tax, capital inputs are expensed under a VAT to ensure neutrality as regards the choice between capital and labour or investment and consumption.
That would mean that the initial use of a capital good, exempt or taxable, would determine whether and to what extent the VAT paid on the purchase of the good is recoverable.
If the initial use is for the production of exempt supplies, no VAT would be creditable, even if the same good were used for making taxable supplies at a later point during its economic life cycle.
On the flip side of the coin, if the initial use were in relation to taxable outputs, all VAT would become recoverable, regardless of later use for exempt supplies. An expensing regime for capital goods would not only encourage manipulation as regards their initial use but could also easily lead to economic distortions.
The VAT legislation of most countries contains specific rules for input VAT adjustments in the case of capital goods, basically determining the extent of tax expensing over a longer time period.
The choice would be between expensing over a time period that more or less represents the economic life cycle of a specific good, which would have the result of different expensing periods depending on the type or qualification of a good, or to set a time period for all goods, ignoring difference in life cycles.
The adjustment period is generally spread over a different number of years for moveable property (e.g. 5 years) and immovable property (e.g., 10 years), respectively.
Under EU law, initially, the amount of input VAT that can be recovered is determined at the time of purchase of a capital good. Subsequently, at the end of each year, an assessment is made as to the percentage of creditable VAT for that year.
Adjustments shall be made on the basis of the variation in deduction entitlement in subsequent years in relation to that for the year in which the goods were acquired or manufactured.
Therefore, if the percentage is different from the initial ratio, an adjustment is made on the portion of tax allocated to that year, which is one-fifth or one-tenth of the total input VAT.
This system denies significance to disparities between the initial use at the time of acquisition and actual use in later years.
It eliminates manipulation by exempt businesses that may be tempted to arrange for a short period of taxable use of a capital good, just to receive a full VAT credit on its purchase before using it for its intended exempt use (which would not allow for VAT credits).
It also does justice to businesses using capital goods for making both taxable and exempt supplies at varying degrees over time as the businesses would not lose input-VAT credits.
Although the statutory length of the adjustment period is in itself arbitrary and not an exact representation of the actual economic life of each capital good, it has the benefit of being relatively simple to administer for both businesses and taxing
From a cash flow perspective, it remains beneficial to somehow ensure that the initial use to the largest extent possible is related to the production of taxable outputs.
Dr Robert F van Brederode is of counsel to Horwath Mak Ghazali in Oman. He is a tax lawyer, practitioner and scholar with over 30 years of experience in global VAT.
He served Crowe Horwath International as the global indirect tax leader, and was the national practice leader of the US member firm.
Robert is the author of dozens of academic journal articles and 8 books. He can be reached at Robert.email@example.com.