Allowance of Credit – General Rules

Under the credit or invoice VAT used almost universally, tax liability for each period is calculated as the difference between the tax chargeable on taxable sales (output tax) and tax charged both on taxable purchases and on taxable imports (input tax credit). Some credit-invoice VATs are worded so that the input tax is deducted from tax on taxable sales (output tax). In this book, input tax credit and input tax deduction are used interchangeably to mean the subtraction of input tax from output tax.

Unlike an income tax imposed on an income base that requires capital goods to be capitalized and depreciated and beginning and ending inventories to be taken into account in determining gross income from sales, VATs typically are consumption-based taxes that allow an immediate input credit for tax imposed on purchases of capital goods and inventory items. There are some exceptions discussed in this chapter.

The EU VAT Directive contains extensive rules on the availability of input tax credits (which the Directive refers to as deductions). An input credit is available for tax on purchases of goods or services, imports of goods, or certain taxable self-supplies if these items are used for purposes of taxable transactions. Taxpayers may engage in tax-motivated transactions in an attempt to convert assets used in making exempt supplies into assets used in making taxable supplies.