15 May 2013

VAT deduction right

The Luxembourg VAT authorities impose the direct allocation and special prorata methods based on allocation key other than that based on turnover. This change is applicable as from 2013.

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On 15 May 2013, Luxembourg’s authorities have issued a new circular (circular 765) regarding the computation of the VAT deduction right.

The VAT Directive 2006/112/EC11 and Luxembourg’s VAT law foresee three methods in order to compute the VAT deduction right of taxable persons performing both activities allowing the right to recover VAT incurred on costs (taxable activities and some exempt activities such as financial and insurance services to non EU counterparties) and activities that do not allow the right to deduct VAT incurred on costs (such as most financial and insurance services with EU counterparties, real estate transactions, out of scope transactions). Businesses which are impacted as a result of this are: banks, PSF, insurance companies, real estate companies, management companies of funds, financing companies, “mixed” holding companies, etc.

These three methods are:

  • The “general prorata” based on the turnover key (prorata between the turnover allowing the deduction of VAT and the total prorata)
  • The “direct allocation” method which imposes the allocation of costs between activities allowing the right to recover VAT incurred on costs and the other activities
  • The “special prorata” based on appropriate allocation keys

Up to now, the most commonly used method in Luxembourg was the “the general prorata”. In its circular, Luxembourg’s VAT authorities has indicated that the “direct allocation and special prorata” methods will become the principle methods to be applied by taxable persons while the “general prorata” will become the residual method for general costs that could not be attributed based on other keys than the turnover key.

This circular puts emphasizes on the fact that analytical accounting should allow one to determine the appropriate allocations, including small and medium enterprises. The circular also provides some examples of keys, such as the number of employees or the square meters dedicated to each activity.

This is a major step for Luxembourg’s marketplace as circular 765 will enlighten businesses to review their VAT deduction methods, which may lead to a decrease in the level of VAT deductible for some businesses and could also be an opportunity for others. In any case, it will impose a more in-depth analysis and a careful monitoring of VAT deduction calculation in the coming years. This change is applicable as from 2013.

If you would like to discuss the potential implication of the circular on your business in more detail, please contact an EY VAT contact.


Download the Tax alert (pdf, 137.8kb)


1 Directive Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax.