Difficulties for the acquirer: Adjustment of input VAT deduction for the merger year
On VAT grounds, a merger may prove challenging for the acquirer if either the acquirer or the target applies proportional input tax deduction in the merger year.
General comments on input tax deduction
A VAT payer is entitled to deduct input tax on the purchase of goods and services if the goods and services are used by the VAT payer for VAT-taxable business activity. However, the input tax is not deductible when the goods and services are used for activities that are either VAT-exempt or VAT-excluded.
If a VAT payer conducts business activity that is partially VAT-taxable and partially VAT-exempt, it should allocate the goods and services purchased to VAT-taxable or VAT-exempt activities. The input tax deduction is allowed only to the extent of the calculated input tax resulting from the purchase of goods and services attributable to VAT-taxable activities.
If the purchased goods and services cannot be attributed to a specific activity of the VAT payer, the part of the input tax that is proportionately attributable to VAT-taxable activities is deductible.
The input tax deduction ratio is determined as a percentage of the annual turnover of VAT-taxable activities in the total annual turnover of VAT-taxable and VAT-exempt activities on the basis of the turnover achieved in the year preceding the year for which the ratio is determined. This is the preliminary VAT ratio.
After the yearend, the VAT payer should adjust the input tax deduction originally deducted based on the preliminary VAT ratio, based on the final VAT ratio. This is determined based on the actual turnover achieved in the year ended as the share of the annual turnover from VAT-taxable activities in the annual turnover from VAT-taxable and VAT-exempt activities. The adjustment of the input tax deduction is made in the VAT return for the first period of the following year.
Special rules apply to the adjustment of input tax deduction for the acquisition of depreciable fixed assets and intangible assets, as well as land and perpetual usufruct rights.
Entity adjusting input tax deduction for the merger year
The amount of the adjustment includes the sum of input tax deduction adjustments calculated separately for the acquirer and the target.
As the legal successor of the acquired company, the acquiring company should make an adjustment for the amount of the adjustment of the target and the acquirer in its VAT return for the first accounting period of the year following the merger year.
Calculation of the adjustment of input tax deduction for the merger year
To calculate the adjustment for the merger year, the acquirer should calculate separately the adjustment amount for the acquirer for the merger year and the adjustment amount for the target for the period from the beginning of the merger year to the merger date, and then add up the adjustment amounts calculated in this way.
In the interpretive practice of the tax authorities, two positions can be identified for determining the adjustment.
Position 1: The adjustment amounts for the target and the acquirer should be calculated by comparing the target’s preliminary VAT ratio for the period from the beginning of the merger year to the merger date and the acquirer’s preliminary VAT ratio for the merger year with the aggregate final VAT ratio for the merger year.
The aggregate final VAT ratio for the merger year is determined equally for the acquirer and the target. It should be determined based on the sum of the target’s turnover for the period from the beginning of the merger year to the merger date and the sum of the acquirer’s turnover in the merger year.
This position was upheld for example in the individual interpretation by the director of the National Revenue Information Centre of 17 August 2017, no. 0113-KDIPT1-2.4012.331.2017.1.KW.
But it seems that this approach is incorrect, as the final VAT ratio would not reflect the actual structure of the business activities conducted by the acquirer and the target in the merger year, and thus its use to calculate separately the amounts of adjustments of the acquirer and the target could lead to a distortion of the right to deduct the input tax of these companies.
Position 2: The adjustment amounts for the target should be calculated by comparing the target’s preliminary VAT ratio for the period from the beginning of the merger year to the merger date and the acquirer’s preliminary VAT ratio from the beginning of the merger year to the merger date. On the other hand, the amount of the adjustment for the acquirer is determined by comparing the acquirer’s preliminary VAT ratio for the merger year with the final VAT ratio of the acquirer for the merger year.
The final VAT ratio of the acquirer for the merger year should be determined based on the turnover of the acquirer in the merger year without the turnover of the target for the period from the beginning of the merger year to the merger date. On the other hand, the target’s final VAT ratio for the merger year should be determined based on the target’s turnover for the period from the beginning of the merger year to the merger date.
This approach seems more justified, as it reduces the risk of infringing the right to deduct input tax by the target and the acquirer.
This position was confirmed for example in the individual interpretations by the director of the National Revenue Information Centre of 7 November 2018, no. 0114-KDIP4.4012.609.2018.1.MP, and 12 September 2017, no. 0114-KDIP1-1.4012.299.2017.1.DG, as well as the individual interpretation by the director of the Warsaw Tax Chamber of 3 January 2017, no. 1462-IPPP1.4512.937.2016.1.AW.
Preliminary VAT ratio for the year following the merger year
As the preliminary VAT ratio is determined on the basis of the turnover achieved in the previous fiscal year, the acquirer’s preliminary VAT ratio for the year following the merger year should be determined based on the sum of the acquirer’s turnover achieved in the merger year and the target’s turnover for the period from the beginning of the merger year to the merger date.
In my view, if the preliminary VAT ratio were determined based only on the turnover of the acquirer in the merger year, without taking into account the turnover of the target in the period before the merger date, the established proportion would be unrepresentative of the total business activity of the acquirer, as a merged entity, conducted in the year following the merger year.
Mateusz Rowiński, Tax practice, Wardyński & Partners
