Liquidation of fixed assets and the obligation to correct input VAT

In the course of running a business, entrepreneurs often face the need to liquidate fixed assets (including investments in fixed assets of third party) or intangible assets (further: ITA). If an entrepreneur has deducted input VAT when purchasing or producing such fixed assets or intangible assets, liquidation may mean that the entrepreneur has to adjust the VAT deduction made. When and on what terms should such a correction be carried out according to the tax authorities, and when is it not required?

According to the Value Added Tax Act, the correction of input VAT may be necessary, m.in. in connection with a change in the use of a fixed asset or ITA – according to Article 91(7) of this Act, the provisions on the adjustment of VAT deduction “shall apply accordingly in the event that the taxpayer had the right to reduce the amounts of tax due by the entire amount of input tax on the goods or services used by him and made such a reduction, or did not have such a right, and then the right to reduce the amount of tax due by the amount of input tax on that good or service changed”.

What can be considered a change of purpose?

An obvious example would be the purchase of a fixed asset or ITA with the intention of using it for VAT-taxable activities (e.g. the provision of leasing services) and deducting the input VAT on such purchase, and then transferring this fixed asset or ITA for use in activities exempt from VAT (e.g. for the provision of financial services, maintaining bank deposits for natural persons). In such a case, it may be necessary to adjust the previously deducted input VAT (if such a change of purpose takes place during the so-called “VAT correction period”, which is discussed in more detail at the end of the article).

But what about the liquidation of a fixed asset or ITA in a situation where the taxpayer does not change the profile of its business activity and it remains fully taxable / subject to VAT (at reduced or standard VAT rates)? Does such an event also constitute a “change of purpose”, or can it be considered that the liquidation is related to the taxable activity and, as a result, does not change the taxpayer’s right to deduct input VAT on the acquisition or production of such an asset? How should the concept of liquidation be understood under the provisions of the Value Added Tax Act?

Physical liquidation of a fixed asset or an intangible asset (ITA)

The practice of tax authorities and the jurisprudence of administrative courts show that liquidation is primarily the physical removal, dismantling of individual elements or the entire fixed asset (or ITA) due to the loss of efficiency and usefulness for the taxpayer. On the other hand, in order to assess whether such liquidation constitutes a change of purpose (from taxable to non-taxable activity), it is necessary to take into account the reason for such liquidation, i.e.:

if the taxpayer has a business justification to get rid of the fixed asset or ITA, because, for example, it considers it necessary for further expansion, expansion of (taxable) activity, increase in sales, etc. – then such liquidation is not treated as a change of purpose and does not require a input VAT adjustment / correction; this may be the case, for example, in the following situations¹:
- liquidation/demolition of real estate (or its part of) for the purpose of constructing a new building, building complex or other investment,
- disposal of machines purchased for a specific contractor, due to the impossibility of using them for the production of goods for other clients (contractors),
- scrapping of the device due to its regular breakdown, causing too frequent and long downtime, and too high estimated cost of repairing the device,

if, on the other hand, the decision to liquidate the fixed asset or the intangible asset does not have a rational, business justification – then a correction in the scope of input VAT deduction may be required.

The assessment of business needs and reasons for liquidation is quite subjective, so it is crucial to analyze each case individually and collect appropriate documentation by the taxpayer.

… but is it just physical liquidation?

It is worth remembering that in the case of movable fixed assets or ITA, the concept of liquidation does not always have to be associated with the physical dematerialization of the asset. The practice of tax authorities and court case law confirm that the reason for the liquidation of a fixed asset/ITA (stated, for example, in the form of a liquidation protocol) may also be m.in.:

theft of a fixed asset (ITA),
total consumption of the fixed asset (ITA),
irreversible damage to a fixed asset (ITA), e.g. as a result of fire,
loss of usefulness of a fixed asset or ITA related to technical or technological progress.

Also in such cases, it is reasonable to assume that there is no change in the purpose of the fixed asset or the intangible asset and the taxpayer is not obliged to make an adjustment in terms of input VAT deduction. But BEWARE! This does not apply to cases where the taxpayer can be attributed fault for the loss or loss resulting from a failure to exercise due diligence (in such a situation, the lack of correction may be considered an abuse of the right to deduct VAT). Therefore, also in this respect, it will be important whether and how the taxpayer is able to document and demonstrate that due diligence has been observed by him.

What about leaving improvements / outlays, i.e. investments in a fixed asset of third party? An exception to the general rule?

In practice, it often happens that, for example, when renting premises to conduct business (headquarters, shop, warehouse, etc.), the taxpayer makes improvements / outlays on the premises in order to adapt it to their needs, brand image, or the guidelines of the capital group. Such improvements / outlays are essentially for the lessee an investment in a fixed asset of the third party, entered into the fixed assets register and depreciated for tax purposes.

The problem arises when leaving such a premises, e.g. due to the unprofitability of continuing to operate in a given location. In such a situation, the taxpayer has three options:

dismantles the improvements/ outlays and either moves some elements to a new premises or disposes of them if they are no longer useful (because, for example, due to their close connection with the substance of the premises, it is not possible to dismantle them in a way that allows them to be reused) – in such cases, a input VAT correction will not be required in principle,
resells the outlays to the landlord – given that such a transaction is qualified as a paid provision of services taxed at 23% VAT, the correction of the previously deducted input VAT will not be necessary either,
leaves improvements / outlays (or at least part of them) in the vacated premises, without any settlement with the landlord (e.g. due to their lack of usefulness for the landlord and the unprofitability of dismantling by the taxpayer) – in such a case, in the opinion of the tax authorities, the conditions for making an adjustment to the input VAT due to the change of purpose are met, because the free-of-charge leaving of outlays is, as a rule, considered a non-VAT transaction, which does not give the right to deduct input VAT.

Our experience shows that the last case of investments in foreign fixed assets (described in letter c) is relatively common and concerns the material values of the expenditures (outlays) left. At the same time, in our opinion, the negative positions of the tax authorities and courts are unjustified and ignore the most fundamental rules of VAT. As a result, they are an issue that may be a source of dispute with the authorities and in which we can assist you.

Summary – what do we offer?

We can review the procedures and documentation justifying the change in the status of fixed assets or intangible assets, including their liquidation, and help implement more effective and safe rules of conduct (whether and under what conditions VAT deduction adjustment should be made).

Note: the analysis can be extended to include: the issue of income tax (i.e. the right or lack of the right to include the net tax value in tax-deductible costs).

If you have made or are planning to leave improvements / outlays in the property – please contact us, it is worth planning a safe way of proceeding, while at the same time trying to break the negative line of interpretation and jurisprudence.

An equally interesting and debatable topic, although not described above, is the liquidation of unfinished investments and determining the tax consequences of such a decision from the perspectives of CIT and VAT. We encourage you to take advantage of our experience in this area.

VAT correction period

Notwithstanding the above, it should be remembered that the mere change of purpose of a fixed asset or intangible assets will not always mean the obligation to make input VAT corection. According to the Value Added Tax Act, an adjustment is required only when an asset changes its purpose during the so-called VAT correction period.

The rules are basically simple²:

for fixed assets and ITA with a value of up to PLN 15 k – the adjustment/ correction period is one year, i.e. 12 months from the end of the settlement period in which the asset was accepted for use,
for fixed assets and ITA with a value exceeding PLN 15 k – the adjustment period is 5 years (for real estate 10 years), counting from the year of putting the asset into use, with 1/5 (1/10 respectively) of the amount of input VAT for each year of the correction of the case,

however, in practice, there may be problems with determining the moment (timing) when the input VAT correction is included in the VAT return.

If you want to know more details – we can help you with that.

Authors: Katarzyna Jaromińska / Agnieszka Czarnecka

1 In accordance with the individual interpretations of the Director of the National Tax Information.

2 In accordance with Article 91(2) of the Value Added Tax Act.