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Richard Knobloch | May 21, 2024

GT verdict: Does the restriction of VAT deduction on cars fulfil its consolidation purpose?

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With effect from 1 January 2024, there is a restriction on the deduction of VAT on the purchase of passenger cars, specifically for passenger cars of category M1, i.e. for motor vehicles with a maximum of eight seats excluding the driver’s seat and without a standing passenger compartment. The restriction applies to passenger cars that are non-current assets with a purchase price exceeding CZK 2 million, excluding VAT, and consists in the fact that the amount of VAT exceeding this tax base cannot be deducted by the taxpayer. In other words, the taxpayer, even if he uses the car entirely for his business purposes, can deduct VAT only up to CZK 420,000. This restriction does not apply only to ambulances and hearses and in the case of licensed road motor transport (e.g. taxi services). In March of this year, the Ministry of Finance sent out for comments a forthcoming amendment to the VAT Act, which will abolish the above-mentioned restriction at the end of 2026. The limitation of the VAT deduction for passenger cars adopted as part of the so-called consolidation package is thus intended for a period of only 3 years. Given that most users purchase a car less frequently than over a three-year period, the question arises whether such a measure makes any real sense and whether it will contribute in any way to the consolidation of public finances.

VAT rules are harmonised in the European Union, primarily through Council Directive 2006/112/EC. However, the provisions of this Directive do not contain any restrictions on the deduction of VAT on passenger cars, so the Czech Republic used as a legal basis its Article 177, on the basis of which a Member State may, for reasons of the economic cycle, exclude wholly or partly from the deduction regime all or some capital assets or other assets. The introduction of such a restriction is subject to consultation by the VAT Committee of the European Commission and in the application for its introduction the Czech Republic argued that the negative economic effects of the Covid pandemic, the Russian invasion of Ukraine, rising energy costs and high inflation are contributing to the public finance deficit and that the restriction of VAT deductions on expensive cars should be one of the measures to reduce the deficit. As an example, the Czech Republic said that of the 101 new Ferrari cars registered in 2020, 96 were registered on the company. It was precisely in view of the condition of cyclical economic reasons that the measures were limited in time to the aforementioned 3 years.

For a comparison of the different approaches, it is not necessary to go far back in history; many readers will remember that VAT deductions for passenger cars used to be excluded altogether and that the solution to get the deductions was to install a so-called grille in the car, which changed its category and made it no longer a passenger car for VAT purposes. VAT deductions for passenger cars were introduced on 1 April 2009 in response to the financial crisis of 2008, the subsequent economic recession and efforts to stimulate demand for passenger cars, in addition to, for example, the introduction of the scrappage allowance. By the way, full VAT deductions for passenger cars were introduced by the government of Mirek Topolánek at the time, with Miroslav Kalousek as Finance Minister. While then the remedy for the economic crisis was to allow VAT deductions on passenger cars, now the remedy is to limit them.  

As can be seen from the above example with Ferrari, it is obvious that in the case of luxury cars, they are usually bought by companies or individuals as VAT payers. There are several options how to deal with this limitation of VAT deductions. Leaving aside the relatively absurd situations representing an abuse of tax law, such as the purchase of a car for a price, excluding VAT, of up to CZK 2 million and the subsequent purchase of expensive wheels or an expensive service inspection, the solution may be to postpone the purchase of a new car until 2027 and possibly lease it from abroad until then, where the dealer is not similarly restricted on VAT when leasing it. And these steps, which are economically quite rational from the buyers’ perspective, will not contribute in any way to the consolidation of public finances.

As regards the substance itself, i.e. the possibility of claiming a VAT deduction on the purchase of a passenger car, this claim is debatable, at the very least. Although the passenger car is essentially an ordinary work tool, it can also be used for private purposes. And while, for example, in the case of business laptops or mobile phones, the tax administrator does not usually address the possible private use, in the case of passenger cars it is a more valuable asset for, which the tax administrator normally assesses the purpose of use, and basically the only way to prove the use of a passenger car for economic activities is a properly kept logbook, which is, however, only a formal document. The fact that allowing VAT deductions for passenger cars is an inherently problematic issue is also demonstrated by the approaches of neighbouring countries, which could not be more different. A number of countries, or most of the European ones, practically exclude VAT deduction for passenger cars, usually with certain exceptions for taxi services, driving schools, car rental companies, etc. These countries include Austria, Hungary, France, Denmark, Sweden, Greece and Bulgaria, while those outside the EU include the UK and Norway. But then there is another group of countries that do not restrict the deduction of VAT on cars if they are used for economic purposes, such as Germany, Slovakia, the Netherlands, Luxembourg and Switzerland. Last but not least, there is also a third group of countries that only partially limit the VAT deduction, such as Poland, Spain, Latvia and Croatia, where the deduction can only be claimed up to 50%, Italy with a 40% VAT deduction, Belgium with 35 or 50% and Ireland with a 20% VAT deduction, which can only be claimed on low-emission cars. In Lithuania, only electric cars and plug-in hybrids are eligible for the deduction, but only if the price of the car is up to EUR 50,000 including tax. And as the above list shows, none of the third group of countries that partially limit the VAT deduction for passenger cars has the same approach to this limitation as the Czech Republic does now, i.e. none of the neighbouring countries limits VAT deductions exclusively to the maximum value of deductible VAT and, moreover, temporarily, for a relatively short period of time in terms of the lifetime of cars.

What does the above imply, then? Firstly, the limitation of the right to deduct VAT on passenger cars is not an exception in European countries, rather the opposite. Secondly, the Czech Republic has chosen an innovative approach to limiting the VAT deduction for passenger cars, which none of the neighbouring countries uses. Thirdly, the introduced restriction has brought a number of practical problems, among which we can mention the lack of clarity regarding demonstration cars, namely whether the limitation of VAT deductions on the part of dealers also applies to these cars. Last but not least, given the temporary nature of the chosen measure, its impact on the domestic economy and the consolidation of public finances will be questionable to say the least, as it can be assumed that buyers will either postpone the purchase of new luxury cars or will deal with it in another way so as not to be limited by VAT. It will also be interesting to see how the new Finance Minister or the new government will approach the issue of limiting the VAT deduction after the expiry of the three-year period.