Author: Tõnis Elling
Another change has been made to the Value Added Tax Act, under which, starting 1 December of this year, only 50% of the input VAT on cars and car-related expenditures may be deducted.
If we read the explanatory memorandum to the law, we see that the reason for the amendment is that most companies use cars for both business and personal purposes and tax authorities have a hard time verifying the proportion of the business use. Legislators justify the amendment with the fact that it is difficult to check up on private use and most other member states also restrict input VAT deductions on company vehicles.
Only 50 percent of the input VAT on expenditures related to cars can be deducted
Instead of taxing personal use of company cars, the amendments to the Value Added Tax Act restrict deductions for VAT paid on vehicle purchases, use under lease agreements (including renting and leasing) and purchases of goods and services (fuel, repair, service etc). The goal is fairer taxation of the use of motor vehicles, which will also increase state budget revenue receipts. Briefly put, the law abolishes the term personal use of motor vehicles and now just 50% of input VAT on cars and car-related expenditures can be deducted. The goods and services purchased for the use of motor vehicles include, for example, extras and equipment, and parking fees. But expenses of installing corporate markings or ads on motor vehicles are not related to use of the vehicle.
Based on the fact that the amendment pertains only to passenger cars and that it may be too onerous for the taxpayer to search various legal acts for definitions, Parliament decided to set forth the term “passenger car” in the Value Added Tax Act as well. Previously the term was only defined in the Traffic Act. The regulation of the Minister of Economic Affairs and Communications further refines the provisions of the legislation. The definition of passenger car in the Value Added Tax Act is a M1 category vehicle whose laden mass does not exceed 3,500 kg and which has no more than eight seats in addition to the driver’s seat.
Good to know: five exceptions
While generally only 50% of input VAT can be deducted on passenger cars and related expenditures, there are five exceptions that deserve a closer look.
The 50% restriction does not apply (i.e. 100% can be deducted) in these cases:
- Sale of passenger car – the car is bought for the purpose of resale, on condition that the taxable person is engaged in the sale of passenger cars and the taxable person does not otherwise use vehicles purchased for resale.
- Lease of passenger car – the car is bought for the purpose of leasing or rental, on condition that the taxable person is engaged in renting or leasing passenger cars and the taxable person does not otherwise use vehicles purchased for this purpose.
- Taxi service – the car is primarily used for taxi service on condition that the taxable person has a taxi permit and licence card.
- Driving lessons – the vehicle is used primarily for driving lessons provided that the taxable person has a licence for driver education or the taxable person renders service as a driving instructor to persons with a driver education licence.
- Use only for business purposes – the car is used without exception only for business purposes, not including granting the car into the use of employees, contractors or management/supervisory board members for a fee.
While the first four exceptions pertain to specific and narrow fields, the fifth is one with broader relevance. This is the only saving grace for companies who are not engaged in sale and lease of motor vehicles and who do not provide taxi service or organise driving lessons.
Ordinarily, companies thus have an opportunity to prove to the tax authority that the purchased vehicles is used 100% for business purposes and the 100% deduction of input VAT is completely justified. Whether and how this can be done is up to each taxpayer to decide. There is probably no need to reinvent the wheel. Maintaining a travel diary and GPS equipment is still a good resource. Courts have also already deliberated cases where taxpayers have to justify the fact that their company car is parked at night near their dwelling, and so on.
It is important to stress that under the amendment, a car is considered to be in personal use also if the taxpayer gives an employee a car to use and presents an invoice, with VAT, for the use. We will discuss how to avoid double taxation in such a case later on.
Five exceptions and the two-year rule
The right to deduct 100% input tax only applies if the car is used according to the conditions in the five exceptions over a period of two years. If the purpose of the use of the vehicle changes during those two years /(the two-year period is not observed for cars purchased for resale) so that it no longer meets the conditions of the exceptions, the taxable person has to repay 50% of the deducted input VAT to the state. In such a case, interest is added to the repayable input VAT, and the interest is calculated from the time of the deduction until the repayment is made to the state budget.
Figuratively speaking, this means that if the taxpayer specifies that a vehicle it purchased is used only for business purposes and 100% of the input VAT can be deducted, it has to make sure that the car is indeed used only for business purposes in those two years.
Avoid any private use of vehicles for two years!
Any kind of private use is out of the question, or the 50% input VAT must be paid back with interest. If it should happen that a company employee needs to use the car for personal use at some point in those two years, this must not be allowed. It should not be allowed even if the employee offers to pay for the use on the basis of an invoice. It is a strange situation where leasing a car to a person not related to the company is considered enterprise and allows 100% of the input VAT to be deducted, but allowing an employee or related person is not enterprise.
To avoid the obligation of paying VAT stemming from an employee’s personal use of the vehicle and double taxation arising from the 50% restriction on input VAT deductions, a provision was added to the Value Added Tax Act.
Section 4 of the Value Added Tax Act was updated with a clause 8, which states that supply does not occur from granting a car to the use of employees, contractors or management/supervisory body members for a fee, unless the car is used mainly for taxi service or as a car used for driving lessons.
Even if a car used for business purposes is granted to use for a fee to the taxable person’s employee, contractor or management or supervisory board member, there is no right to fully deduct the VAT assessed on the purchase of such a car and automotive goods or services as this can be considered granting the car for personal use.
To avoid double taxation, the granting of a car into use for a fee is not considered supply as the deduction of input VAT is restricted to 50% if a company car is used for personal use.
The term “use of passenger car for self-supply” will also disappear from the Value Added Tax Act.
The tax authority must be notified
A key consideration is that whether input VAT is deducted on the car and automotive expenditures at a rate of 50% or 100%, the tax authority must be notified accordingly on the VAT declaration form. The tax authority desires information on all vehicles and related expenditures.
If a taxable person has the right to deduct only part of the input VAT on the sum of all expenditures, the same proportion also applies to vehicles, but not over 50%. For instance, if in the case of a given taxable persons, the ratio of taxable to tax-exempt supply is 30:70, they are entitled to deduct only 30 percent of the input VAT on all expenditures. The same 30 percent applies to passenger vehicles as well. If the ratio of taxable to tax-exempt supply is 70:30, only 50% of input VAT can be deducted.