Partial Exemption, Sectoral Method, and Capital Goods Scheme
Omega Bank, resident in Country P, makes exempt financial services and taxable payroll-processing services. For the year, taxable turnover is €30 million and exempt turnover is €90 million. Omega installs a €4.2 million core banking platform used for both exempt and taxable activities, with input tax of €1.8 million. It also spends €600,000 on a marketing campaign for payroll services, with input tax of €100,000, and €200,000 on legal advice on a new exempt loan product, with input tax of €20,000. Omega's current method allocates residual input tax strictly by turnover, giving 25% recovery. The bank proposes a sectoral method: the platform is used 80% for exempt activity, but the payroll business could not operate without the core platform, so Omega argues 50% recovery is fair. Country P allows a special method if it reflects the use of inputs more accurately, requires a de minimis test (exempt input tax below €50,000 or 5% of total input tax), and requires a capital goods scheme adjustment over five years.
1. Compute the recoverable input tax under the turnover method and determine whether the de minimis test is met.
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First attribute input tax directly. The €600,000 marketing campaign relates directly to taxable payroll services, so its €100,000 input tax is fully recoverable. The €200,000 legal advice relates directly to an exempt loan product, so its €20,000 input tax is not recoverable.
The €1.8 million platform input tax is residual because the platform is used for both activities. The turnover ratio is taxable turnover divided by total turnover: €30 million / (€30 million + €90 million) = 25%. Recoverable platform input tax is 25% × €1.8 million = €450,000. Total recovery is €450,000 + €100,000 = €550,000. Non-recoverable input tax is €1.8 million − €450,000 = €1.35 million, plus the €20,000 legal input tax, giving €1.37 million.
The de minimis test is not met. €1.37 million exceeds €50,000. It also exceeds 5% of total input tax: total input tax is €1.8 million + €100,000 + €20,000 = €1.92 million, and 5% is €96,000. Because both thresholds fail, Omega cannot use de minimis to recover all input tax.
2. Evaluate whether Omega's proposed 50% recovery on the platform is defensible and what method it should adopt.
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A special method is allowed only if it reflects the use of inputs more accurately than the turnover method. Omega's argument is that the payroll business depends on the platform, so 50% recovery is fair. Dependency is not the same as use. The platform is used 80% for exempt activity, which suggests only about 20% of its use supports taxable payroll processing. A 50% recovery would recover €900,000 of platform input tax, €450,000 more than the turnover method, and would likely over-recover tax attributable to exempt supplies.
Omega should gather usage evidence: user counts, transaction volumes, processing time, system logs, and cost drivers. If payroll uses more platform capacity than its turnover share suggests, a sectoral method could allocate platform costs by usage and other costs by turnover. The method must be documented, consistently applied, and fair to both taxable and exempt activities. It must not cross-subsidise exempt lending. If the evidence supports 20% taxable use, the platform recovery should be closer to €360,000, not €900,000. Omega should obtain approval if Country P requires it and should retain the analysis for audit.
3. Explain how the capital goods scheme applies to the platform and what adjustments are needed for the marketing and legal costs.
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The core banking platform is a capital item, so its input tax recovery is adjusted over five years. In the first year Omega recovers 25% under the turnover method, or the approved special method if that is higher and supported. In each subsequent year Omega recalculates the taxable use proportion and compares it with the initial recovery. If taxable use rises, Omega claims an additional deduction; if taxable use falls, Omega repays the excess. A sale or disposal during the adjustment period can trigger a final adjustment. The platform's €1.8 million input tax is therefore not finally settled in year one.
The marketing and legal costs are not capital items for this purpose. The marketing input tax is directly attributable to taxable supplies and is recovered in full. The legal input tax is directly attributable to exempt supplies and is not recoverable. Omega should keep the platform's capital goods scheme records, the annual use calculations, and the special-method approval. It should also reconcile the scheme adjustments to its VAT returns so that the 25% initial recovery and later changes are transparent.