1. Adjustment of Deductions of VAT on Capital Goods – application and recent cases Graziella Demanuele Bianco 16 th October 2015

2. Capital Goods Scheme (CGS) A mechanism for regulating deductibility over the 'VAT-life' of a capital good. CGS affects all taxable persons who make capital expenditure on tangible property particularly those who are engaged in mixed supplies, those who use assets for business and non-business purposes and those whose business context changes with a consequent variation in their VAT recovery rights. 1

3. EU VAT Directive  Articles 187 to 192 of EVD  Prescribes a 5 year ‘adjustment period’;  Extendible to 5 years from first use of the good;  Extendible to up to 20 years in the case of immovable property. 3

4. EU VAT Directive  Adjustment required in 3 instances:  Annually if there is variation in the deduction entitlement during the adjustment period when compared to the first year;  If the capital good is supplied during the adjustment period;  If a person transfers from being taxed in the normal way to a special scheme or vice versa. 3

5. EU VAT Directive  Flexibility to Member States to:  decide on the adjustment period within the parameters;  define capital goods;  include services within the definition which have characteristics similar to those attributed to capital goods;  set the amount of input tax to be adjusted;  adopt measures to ensure the adjustment does not give rise to unjustified advantage;  have administrative simplifications; and  refrain from applying the CGS if the practical effect is negligible, provided that no distortion of competition arises. 3

6. VAT Act  Item 7(1) of Tenth Schedule of VAT Act Where the input tax credit of a person (“the owner”) for any tax period during a calendar year (“the year of acquisition”) includes tax on the supply to that person or the intra- community acquisition or importation by that person of capital goods, an adjustment should be made to the input tax already allowed, if the input tax for any year during an adjustment period is allowable at a rate which is higher or lower than that already allowed in the year of acquisition.  S.L. 406.12 – Value Added Tax (Adjustments Relating to Input Tax on Capital Goods) Regulations – Effective 1 st May 2004 2

7. S.L. 406.12  Defines capital goods  A generic definition not a definition by asset type.  Excludes assets <€1,160.  Not linked to the accounting treatment.  Establishes a 5 year adjustment period for moveable goods and 20 years for immovable property from the start of the VAT period in which initial deduction is made or in which first use is made (if use is not made during the former VAT period) 2

8. S.L. 406.12  Covers certain services:  Operations related to the realisation, transformation or improvement of capital goods;  Construction contracts; but not other services having the characteristic of capital goods (e.g. services related to intangible assets such as IP or software). 2

9. ‘Triggers’ for adjustment Annual adjustments if there are: 1. Changes in use of the capital goods or change in the proportion of the initial deduction; 2. Changes in the elements used for the calculation of the deducted input tax. One-time adjustments if: 3. The capital good is used solely for private purposes; 4. The capital good is supplied when the initial deduction had been limited; 5. The capital good ceases to exist within the framework of the enterprise unless proved to be destroyed or stolen; 6. The person becomes a non-taxable person or is solely engaged in exempt without credit supplies. 9

10. One-time adjustments  In EVD, one-time adjustments are explicitly mentioned once covering the instance when capital goods are supplied.  In S.L. 406.12 one-time adjustments in favour of the taxable person are not explicitly contemplated other than when capital goods are supplied. 9

11. Recent Court cases

12. C-500/13 Gmina Międzyzdroje  The EVD together with the principle of neutrality, must be interpreted as not precluding provisions of national law, such as those at issue in the main proceedings, which, in a case where there is a change in the purpose of immovable property acquired as capital goods from an initial use in activities not conferring entitlement to deduct value added tax to a subsequent use in activities which do confer such entitlement, provide for an adjustment period of 10 years starting from the time at which the goods are first used and, therefore, do not permit a one-off adjustment during a single tax year. 9

13. To be soldTo be let Case 63/2013 ART of 30/3/2015 9 Claimed 60% of the input VAT in the first few years Plans changed after 3 years

14. To be soldTo be let Case 63/2013 ART of 30/3/2015 9 Correction letter filed claiming 100% input VAT Correction denied by VAT Dept. ART – The co. has right for additional recovery, which right is to be regulated by the terms of S.L.406.12 Appeal

15. Case 63/2013 ART of 30/3/2015  A ‘change of intentions’ case  The VAT Dept. denied the correction on the basis of a former Court of Appeal decision (Aprilia Hotel v. Commissioner, appeal no. 2/11) and expressed its view that ‘input VAT incurred in connection with an operation which falls outside the scope of VAT cannot be claimed at a later stage on the premise of “a change of intention”’  The VAT Dept. also contended that the right to deduct arises at the time when the deductible tax becomes chargeable i.e. the input VAT credit is so much of the input VAT on expenses used or intended to be used in the furtherance of the economic activity as determined in the relevant VAT period. 9

16. Case 63/2013 ART of 30/3/2015  Some arguments mentioned in the judgement:  Fiscal neutrality;  References to CGS even though the adjustment was made by means of a correction letter;  Reference to case-law. 9

17. Case 63/2013 ART of 30/3/2015 the CGS ‘is applicable in cases of adjustment of deductions, such as the case in the main proceedings, where goods the use of which is not eligible for deduction are then put to a use which is eligible’ Deduction possible when subsequent use of assets is ‘eligible’ 9  Reference to case C-184/04 Uudenkaupungin Kaupunki

18. Case 63/2013 ART of 30/3/2015 only the capacity in which a person is acting at the time when the tax becomes chargeable can determine the existence of the right to deduct Initial capacity the use to which capital goods are put merely determines the extent of the initial and subsequent deductions to which the taxable person is entitled Actual use = % of recovery 9  Reference to case C-184/04 Uudenkaupungin Kaupunki

19. Case 63/2013 ART of 30/3/2015 immediate use of the goods for taxable supplies is not a condition for CGS to apply Immediate use not required the CGS also applies necessarily where alteration of the right to deduct depends on a deliberate choice on the part of the taxpayer Exercise of options do not effect initial right 9  Reference to case C-184/04 Uudenkaupungin Kaupunki

20. Case 63/2013 ART of 30/3/2015  Other arguments mentioned in the judgement  ART cannot rely on the former Court of Appeal decision in Aprilia - In Aprilia the judge argued that the aim of the CGS is aimed to cover adjustments in the case the use of a good is no longer attributable to taxable or exempt with credit supplies or when private use of the good is made. The aim of the CGS was not for a taxable person to make a retrospective adjustment of the input tax when its economic activity changes from the provision of exempt supplies to taxable supplies. (!) 9

21. Case 63/2013 ART of 30/3/2015  Other arguments mentioned in the judgement  Aprilia Hotel was not registered for VAT at the time it incurred input VAT and was closed for refurbishment.  Not clear under which ‘trigger’ would a change in intentions fall, but in any case it would require an annual adjustment. 9

22. Practical/Technical considerations

23. Practical/technical considerations The ‘Eur 1,160’ The inclusion/exclusion of services e.g. architect/notary fees, hire of crane to lift furniture Definition of capital asset Clear in the case of yearly adjustments Not explicit in the case of one-time adjustments A VAT year does not necessarily coincide with the financial or calendar year Timing of the adjustment How is ‘use’ defined for the determination of the start of the adjustment period? The starting point of the VAT-life

24. Practical/technical complexities Claim initial input VAT on capital goods and and adjust later? Proof of intentions Need to be sufficient to enable CGS computations for long years Records

25. Practical/technical complexities The applicability of the deemed supplies rules (item 14 of the Second Schedule of VAT Act) after the adjustment period VAT deregistration during/after the adjustment period No CGS adjustment but supply is taxable/exempt following normal rules Supplies of capital goods after the adjustment period

26. Practical/technical complexities No rules Continuity of CGS at the level of the transferee/surviving entity or CGS adjustment as assets cease to exist within the framework of an enterprise? TOGC and mergers Capital allowances depends on the accounting treatment of CGS adjustments CGS and capital allowances

27. Practical/technical complexities E.g. a chartering vessel docked for repairs Temporary absence of income Sale of furniture is VAT-able if input VAT was claimed with a consequent one-time adjustment. Sale of furnished property

28. Other relevant cases

29. Other relevant CJEU cases  Case C-268/83 D. A. Rompelman and E.A. Rompelman-Van Deelan (1985)  Acquisition of future right over property to be let out is an economic activity  Declared intention may need to be supported by objective evidence  Case C-97/90 H. Lennartz (1991)  Tax consultant acquired asset for mixed use  CGS applies when goods are acquired in a taxable person’s capacity and allocated to the economic activity  The assessment of person’s assertion is a question of fact 25

30. Other relevant CJEU cases  Case C-291/92 Dieter Armbrecht (1995)  Hotelier selling guesthouse, restaurant and private dwelling  The CGS only applies on the business assets that were initially purchased by a taxable person in that capacity and acting as such  Case C-37/95 Ghent Coal Terminal NV (1998)  Development of land that subsequently had to be exchanged  Right to deduct remains even when use of the goods / services was not made for reasons beyond one’s control  A CGS adjustment may need to be made 25

31. Other relevant CJEU cases  Joined Cases C-487/01 and C-7/02, Gemeente Leusden and Holin Groep BV cs (2004)  Leusden let playing field + VAT  Holin Groep let offices + VAT  Amendment in law resulting in VAT exemption  EVD and principles of legitimate expectations and legal certainty do not preclude such change in law, resulting in a CGS adjustment 25

32. Graziella Demanuele Bianco Senior Manager, VAT KPMG Tel: +356 2563 1032 Email: gdemanuelebianco@kpmg.com.mt Thank you