Swedish VAT pro-rata rules is in violation of EU law

KPMG has acted as representative in a case in the Supreme Administrative Court (SAC) where Swedish legislation regarding the determination of the deductible proportion of residual input tax in the case of a VAT mixed business has been found to be in violation of EU law.

The case revolved around how to calculate the deductible proportion of residual input tax in a company with both taxable and tax exempt transactions.

The Swedish Tax Agency (STA) had decided that the deductible proportion of the residual input tax for the company should be calculated based on the usage of the acquired goods and services, which is permitted under Article 173.2c of the Value Added Tax Directive (the directive). The STA was of the opinion that this provision is implemented in the Swedish VAT Act, through the VAT Act's provision of proportion based on reasonable grounds (Sw. skälig grund).

The company appealed against the STA’s decision and requested that the deductible proportion of residual input VAT should be calculated according to the turnover based method, which is the main rule for partial exemption calculation according to the directive. The company argued that the Swedish VAT Act's provision on apportionment based on reasonable grounds is not compatible with the directive, as it neither states turnover based method as a main rule, nor specifies any alternative methods that can or shall be applied. The company argued that the turnover based method in article 173.1 and 174 of the directive, has direct effect and that the company therefore should be allowed to determine the deductible portion based on this method.

Both the Lower Administrative Court and the Administrative Court of Appeal, like the Swedish Tax Agency, found that the Swedish VAT Act’s provision reasonable grounds supports applying the usage of costs as apportionment method. The company appealed the Administrative Court of Appeal's judgment to the SAC.

The SAC granted leave to appeal regarding the question of whether a company with VAT mixed activities can be denied using a turnover based method to determine the deductible proportion of residual input tax and instead be obligated to determine the deductible proportion of input tax using a usage based method.

The SAC notes that apportionment based on reasonable grounds, has its origin in old legislation from before Sweden entered the EU, and was not designed to implement the directive into Swedish legislation. The reasonable ground provision does not state the turnover method as a main rule, neither does it specify for which transactions another method must or may be used.

The SAC concludes that reasonable grounds therefore does not meet the requirements for clarity, precision and transparency set by the Court of Justice of the European Union for it to be considered an acceptable implementation of the directive into national law.

Further, the SAC concludes that it is not possible to apply a usage based method in accordance with Article 173.2 c of the directive, against the taxpayer’s will, since such a method has not been implemented in Swedish law.

The SAC also concludes that the fact that the directive’s main rule, turnover based apportionment, has not been properly implemented into Swedish law cannot be remedied by interpreting the Swedish law in accordance with the directive.

The SAC finally states that the directive's provisions on apportionment based on turnover, article 173.1 and 174, have direct effect and that a taxpayer therefore can rely directly on these provisions to calculate the deductible input tax using the directive's turnover based method.

The SAC’s ruling is very important from the point of view of legal certainty in that the vague and very unclear provision on apportionment on reasonable grounds is rejected by the highest instance. The ruling is significant not only because it provides guidance on the issue of apportionment of residual input tax, but because it underscores that the individual taxpayer affected by a provision must be able to be fully informed of his rights and obligations, and that provisions must therefore be implemented in a sufficiently clear, transparent, and precise way for the requirements of legal certainty to be met.

The SAC’s ruling provides clear and explicit guidance for individual taxpayers’ ability to invoke the directive's main rule, turnover based method with direct effect. A taxpayer who wants to apply a turnover based method to determine the deductible proportion of residual input tax in their mixed business, should be allowed to do so by invoking the provisions of the directive. Under such circumstances, the STA cannot decide that another, more reasonable, method should be applied, because there are no other methods implemented in national law.

An individual who wants to apply an apportionment method other than the turnover should however still be able to do so, at least until the current legislation changes.

The decision will lead to changes in the Swedish VAT Act, where reasonable grounds is abolished and provisions compatible with the directive are introduced. The content of such provisions remains to be seen. However, it is clear that the main rule, the turnover based method, must be implemented into Swedish law.

The ruling means those taxpayers engaged in mixed activities, and who previously calculated a deductible proportion of input tax based on reasonable grounds, should assess whether there are reasons to reconsider previous deductions of residual input VAT. Please feel free to contact us for a discussion about what this could mean for your business and the partial exemption method for residual input tax that you currently apply.

The representatives in the Case were Steven Robertson, Director, Indirect Tax and Thomas Andersson, Head of Tax disputes. Ellie Kvistrum, Manager, Indirect Tax, was member of the KPMG team.

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The article in Swedish