Pro-rata coefficient and input VAT deduction: practical guide for businesses with taxable and exempt supplies

Principle of VAT neutrality

The fundamental principle of value added tax (hereinafter “VAT”) is its neutrality for businesses. VAT is intended to burden only the final consumer, not the business supply chain itself. The Court of Justice of the European Union repeatedly emphasises that the right to deduct is an integral part of the VAT mechanism and, in principle, cannot be restricted. The purpose is to relieve the taxable person entirely of the burden of VAT due or paid in the course of their economic activity.

Statutory obligation and allocation of inputs by actual use

The VAT Act imposes a strict obligation on every taxable person that carries out both taxable and exempt activities. Before claiming input VAT deduction from a purchase invoice, you must know precisely how you will use the purchase. This process is known as allocation by actual use and applies to businesses that carry out both taxable activities and exempt activities without the right to deduct. You cannot simply deduct 100 % of the VAT from all invoices. You must divide the invoices into three notional business baskets according to their intended use. Transactions subject to reverse charge, whether domestic or intra-Community within the EU, are not treated as exempt activities for this purpose. They are taxable supplies with the right to deduct.

Basket No. 1 for full right to deduct

This includes all invoices for goods and services that you use exclusively for your taxable activities. That means transactions where you apply VAT on output, or statutory exempt activities with the right to deduct, such as the export of goods to third countries or international transport. If you purchase material for the manufacture of products that you sell with VAT, you deduct input VAT in full.

Basket No. 2 without the right to deduct

This basket includes invoices related to activities exempt from VAT without the right to deduct under Section 28 to Section 42 of the VAT Act, Act No. 222/2004 Coll. These include financial and insurance services, postal services, healthcare, education and the lease of real estate to private individuals (non-taxable persons). If, for example, you own an apartment building and lease the flats to private individuals as an exempt supply, you cannot deduct any of the VAT on insulating or repairing the building.

Basket No. 3 mixed basket for pro-rata coefficient deduction

This basket is the most complex. It contains purchases that serve both taxable activities and exempt activities. Typical examples are overhead costs of the entire company, such as rent for a shared office, accounting invoices, shared utilities, cleaning services, or the purchase of a company car for the human resources department. Since these inputs support both types of your activities, you can only partially deduct VAT from them after recalculation by a coefficient that expresses the ratio of taxable income to the taxable person's total income.

What the coefficient does not affect

The objective of the VAT Act is for the coefficient to reflect the main and regular business activity, not isolated transactions with a large financial value that could distort it. Therefore, under Section 50(2) of the VAT Act, you do not include in the coefficient calculation the value of:

• the sale of a business or a part of it constituting an independent organisational unit,
• the sale of assets used for the purposes of your business, e.g. the sale of a company building or an old car, excluding ordinary inventories,
• financial services exempt from tax under Section 39 of the VAT Act if you provide them only occasionally, e.g. the occasional provision of an interest-bearing loan to a subsidiary or a one-off transfer of an ownership interest,
• the occasional transfer and occasional lease of real estate.

An occasional transaction is considered one that does not have the character of your principal activity, does not form a substantial part of turnover, is not carried out repeatedly, and does not require recurring expenses. Properly excluding these items can protect you against a significant drop in the coefficient.

Provisional vs. annual coefficient

Even though the annual coefficient is only known after the end of the calendar year, you cannot simply guess a provisional number during the year. The entire process has exact rules.

Provisional deduction

During the year, in individual months or quarters, you apply a provisional coefficient. This coefficient is the annual coefficient from the preceding calendar year. If you do not have a previous coefficient, for example if you are a new company, you determine it by an estimate based on expected income, but you must obtain the prior consent of the Slovak tax administration, which in practice is confirmed by drawing up minutes of an oral hearing.

Annual settlement

After the end of the year, in the final tax return for December or the 4th quarter, you aggregate the actual annual turnover and calculate the definitive annual coefficient. You then use it to recalculate all mixed invoices for the past year and settle the resulting difference, whether in favour of or to the debit of the state budget, in this final tax return.

Specific cases without the right to deduct VAT

Section 49(7) of the VAT Act also contains absolute prohibitions on deduction that apply to all taxable persons, regardless of whether they operate in transport, IT or construction. You cannot deduct VAT on goods and services purchased for hospitality and entertainment. This includes representation expenses, lunches for business partners, parties and similar costs. The only exception is where you provide refreshments as part of your own service, for example as a training provider when refreshments are included in the price of a professional seminar and their cost forms part of the total taxable amount for the training.

Likewise, you cannot deduct VAT from transitory items under Section 22(3) of the VAT Act. These are expenses that you pay in the name and on behalf of your customer and subsequently recover from them in the exact amount without charging VAT. Since these items do not form part of your tax base, you cannot claim any input VAT on them.

VAT on capital goods - rules and lessons from European Union case law

When the deduction must be adjusted

Input VAT on routine purchases such as printer paper or advisory services is dealt with once. The same does not apply to assets with a long-term value. Capital goods include movable property worth more than 1 700 EUR, real estate and intangible assets worth more than 2 400 EUR. They are subject to strict monitoring of changes in the purpose or extent of their use. If the ratio of their use for taxable and exempt activities changes over the years, you must adjust the VAT originally deducted. This will mean either repaying VAT to the state or claiming it back.

The latest amendment to the VAT Act introduced changes from 2025:

Concept of first use regulated by Section 52a of the VAT Act. The period for adjustment of the deducted VAT begins on the day of the actual first use of the asset for supplies, not on the day of its purchase or recognition in accounting. This better reflects situations in which an asset may remain in storage before operations begin.

Harmonisation of thresholds. The threshold for movable capital goods was set at more than 1 700 EUR excluding VAT, aligning it with the definition of non-current tangible assets in the Income Tax Act. For intangible assets, the threshold remains more than 2 400 EUR excluding VAT.

Monitored periods. The period during which you must monitor changes in the purpose of use of capital goods is:

• 5 calendar years including the year of its first use, for movable capital goods and intangible assets. Each year, 1/5 of the originally claimed deduction is adjusted.
• 20 calendar years including the year of its first use, for buildings, building land, flats, non-residential premises, and their structural modifications (technical improvements) that required a building permit or a decision on a building plan. Each year, 1/20 of the deduction is adjusted.

Important lessons from the case law of the Court of Justice of the European Union

Decisions of the CJEU take precedence over Slovak practice and provide important protection during a tax audit.

1. The Imofloresmira case (C-672/16) – An empty building does not mean an obligation to repay VAT. The Portuguese real estate company Imofloresmira owned commercial buildings and claimed a full input VAT deduction upon their purchase in view of the intention to lease them with VAT to taxable persons. The tax authority established that certain premises had been unoccupied and unused for more than two years. The authority assessed that a change in factors had occurred and ordered the company to repay a proportionate part of the originally deducted VAT.

The CJEU sided with the business. It ruled that as long as the property is demonstrably available on the market for leasing purposes, the owner makes active and demonstrable efforts by advertising or contacting agencies to lease it with VAT, and its non-use is caused by circumstances beyond their control, such as an economic crisis or a lack of tenants, the right to deduct tax remains fully preserved. Mere temporary non-use of the premises does not give rise to an obligation to adjust and repay deducted tax.

2. The HF case (C-374/19) – Beware of changing the purpose of empty premises. A completely different situation arose with the company HF, which operated a retirement home, an exempt activity without the right to deduct. It added an extension for a commercial café with an outside entrance for the public to the home. From the construction, it claimed a VAT deduction in a ratio where 90 % pertained to the taxed café and 10 % pertained to the exempt services of the home. Over time, however, it permanently closed the café, removed it from the register, and began using the space as a common room exclusively for the needs of the retirement home's exempt social services.

The CJEU ruled that in this case the company was required to adjust the original VAT deduction and repay the tax. Unlike in the Imofloresmira case, the café was neither left empty nor offered on the commercial market. The premises were actually and physically integrated into the exempt operation of the retirement home. This severed the close and direct link with taxable supplies, and the company had to repay the VAT to the state.

^{The content of this article is for informational purposes only and in no way replaces professional legal, tax, or accounting advice. The company Dravecký & Partner bears no responsibility for any decisions made based on the information provided herein, nor for any potential damage that might arise from such actions. Before applying any information to your specific situation, we strongly recommend consulting with a qualified expert.}