EU legislative framework

Article 173.1 of the VAT Directive states that in case of goods or services used by a taxable person both for transactions where VAT is deductible, and for transactions where VAT is not deductible, only the proportion of the VAT as is attributable to the former transactions shall be deductible.

As a main rule, the pro-rata (i.e., deductible proportion) shall be determined based on turnover according to articles 173.1 and 174 in the VAT Directive. However, member states may derogate from this by using alternative methods as listed in Article 173.2. For example, Article 173.2 c states that member states may authorize or require the taxable person to make the deduction on the basis of the use made of all or part of the goods and services.

The Swedish pro-rata rule — reasonable grounds

Member states may voluntarily derogate from turnover as a main rule under Article 173.2 c) of the VAT Directive. According to ECJ-case law C-183/13 Banco Mais, the VAT Directive does not preclude member states from using, for a given transaction, a method or formula other than the turnover-based method, provided that the method used guarantees a more precise determination of the deductible proportion of the input VAT than that arising from the application of the turnover-based method.

According to the Swedish VAT Act, the pro-rata for mixed supply business shall be determined based on reasonable grounds. Reasonable grounds do not state turnover as a main rule and do not specify any other method to determine the pro-rata. What is considered reasonable grounds is therefore to a certain degree unclear and should be assessed case-to-case.

It should be noted that Sweden implemented the current pro-rata rule prior to joining the EU in 1995. However, the Swedish Tax Agency (STA) has historically argued that reasonable grounds are compatible with the VAT Directive.

However, on 17 October 2023, the SAC delivered a judgment stating the Swedish pro-rata rule is violating EU law. The case concerned a company that conducted mixed VAT-able business in the area of finance and insurance, as well as car leasing. The STA considered that the pro-rata should be determined on a sectorized method, due to a higher accuracy, which would result in a two-thirds deductible proportion of the input VAT. The company considered that turnover should be used as a method that would result in an almost 95% deductible proportion of the input VAT.

The SAC concluded that the Swedish pro-rata rule, with reasonable grounds, is not a correct implementation of Article 173.2 c in the VAT Directive. The SAC referred to ECJ-case law C-102/08 Salix, stating that the implementation of an EU directive does not necessarily require that its provisions be incorporated formally and verbatim in express, specific legislation; a general legal context may be adequate for the purpose if it does guarantees the full application of the directive in a sufficiently clear and precise manner. However, each Member State is bound to implement the provisions of directives in a manner that fully meets the requirements of clarity and certainty in legal situations imposed by the community legislature, in the interests of the persons concerned established in the Member States. To that end, the provisions of a directive must be implemented with unquestionable legal certainty and with the requisite specificity, precision, and clarity.

As the Swedish pro-rata rule reasonable grounds does not specify any method, through either turnover or any alternative method, the SAC concluded that the rule does not meet the requirements of clarity, precision, and transparency. However, the VAT directive's provisions have a direct effect that the company can directly rely on. As Articles 173.1 and 174 of the VAT Directive state the turnover method as the main rule, and as alternative methods, according to Article 173.2, only can be used if the Member States have implemented them, the taxpayer cannot be prohibited from using turnover to determine the pro -rata. The SAC also concludes that the wrongful implementation of the Swedish VAT Act cannot be solved through an EU-conformed interpretation of reasonable grounds to achieve compatibility with the main rule in the VAT Directive, as that interpretation would imply that the turnover method should always be used, which is not consistent with the wording of the provision.

Going forward with the Swedish pro-rata rule

As of 17 October 2023, due to the SAC judgment, the STA and Swedish Courts cannot prohibit a taxable person from using the turnover method when determining the pro-rata for a mixed VAT-able business. This is due to a direct effect of articles 173.1 and 174 in the VAT Directive, which states turnover as the main rule. In Sweden, we are currently seeing a change in the landscape, as previous decisions are being repealed by authorities. For example, on 13 November 2023, the Administrative Court of Appeal in Stockholm repealed previous judgments on pro-rata based on the SAC judgment.

It should also be noted that a taxable person with a mixed supply business still can apply alternative methods, such as a sectorized method, under the current legislation. The SAC judgment only states that a taxable person cannot be prohibited from applying the turnover method. Therefore, the taxable person may use the method that is most beneficial for the pro-rata. However, we expect the SAC judgment to give rise to a new pro-rata rule in Sweden, where articles 173 and 174 in the VAT Directive will be properly implemented. Therefore, it will be important for companies to monitor upcoming changes in the Swedish pro-rata rule in the near future.

Dutch pro-rata rule

In line with the EU VAT Directive, in the Netherlands, taxable persons can only claim input VAT refunds for the portion of goods or services utilized for VAT-taxable supplies. For goods and services that are both used for taxable and non-taxable supplies (overhead costs), the pro-rata method is implemented. The default pro-rata calculation method is based on turnover, setting off taxable versus exempt income.

However, if such a pro-rata does not accurately reflect the actual use of the goods and services, taxable persons may apply the "actual use" method to determine the recoverable input VAT on overhead costs. For this, there should be objective and accurate data that demonstrates and justifies the application of the actual use method. This calculation can be based on margins, sectorized turnover, surface area (square meters), or volume (cubed meters) utilization, provided that this basis accurately reflects the use of the goods and services. In practice, this is not a light test, and the Dutch tax authorities and tax courts are rather careful when allowing the actual use method.

The Dutch Supreme Court has established that the most precise method must be employed. As a result, if the turnover percentage pro-rata method is more accurate, it will be used to calculate the deductible portion instead of the "actual use" method.