Input tax deduction: New regulations for banks

In a letter dated December 9, 2024, the BMF renewed its legal opinion on input VAT deduction for credit institutions. In such letter, it comments on how, in the tax authorities’ opinion, the input VAT deduction for credit institutions can be properly determined.

In the letter, the BMF positions itself as a “quasi-legislator” and in future requires banks to prepare procedural documentation on the determination of input tax allocation, an explanation as to why the selected allocation method should be the precise method, and requires a clear, simple and comprehensible record of the input tax deduction for third parties pursuant to Art. 22 UStG (German VAT Act) and Art. 63 UStDV (German VAT Ordinance).

Furthermore, the BMF states that an input tax allocation based on “segments” is the appropriate method for the banking industry, but considers leasing transactions, for example, as non-typical banking activities. The BMF requires this approach to be implemented by December 31, 2025, and will not object if the taxpayer continues to apply the old regulation from the BMF letter dated April 12, 2005, until that date.

BMF letter: Clear specification of the requirements

Advance conclusion: The new regulations represent a clear specification of the requirements for input VAT deduction and input VAT allocation at credit institutions. Proper procedural documentation and records in accordance with Art. 22 UStG and Art. 63 UStDV are required. The respective credit institution is required to comply with the BMF letter and to prepare appropriate procedural documentation at an early stage.

In summary, the tax authorities state the following:

1. Input tax allocation (Art. 15 (4) UStG)

The BMF letter first addresses the general allocation requirements of VAT law. Accordingly, the allocation of input tax amounts is necessary when input services are used both for transactions that allow for input tax deduction and for transactions that exclude input tax deduction.

• Principle of direct allocation: Input services must initially be allocated directly to the corresponding output transactions. Clear and comprehensible documentation is required in this process (Art. 22 UStG).
• Economic allocation: If a direct allocation is not possible, an economic allocation is made according to cost allocation criteria. This is based on Art. 173 (1) of the VAT Directive, whereby in Germany “other economic allocations” take precedence over a general turnover key (Art. 15 (4) sentence 3 UStG). The scale chosen to allocate input VAT must be appropriate, i.e., realistic and objectively comprehensible, in order to reflect the actual economic use. For example, selective elements must not be applied (see decision of the German Federal Court of Finance (“BFH”) of October 23, 2019 – XI R 18/17). However, it is generally possible to apply different keys in a company.
• Appropriate allocation standards: The selected method must be realistic and objectively comprehensible in order to reflect the actual economic use. For example, selective elements must not be applied (see BFH decision from October 23, 2019 - XI R 18/17).

2. Requirement for credit institutions: segmentation

The tax authorities consider segmentation to be one of the most precise methods of input tax allocation for credit institutions and define the calculation as follows:

• Definition: Segmentation means dividing a company into organizationally separable units (e.g., branches, business areas such as investment banking or private customer business, or product groups). This method allows a differentiated consideration of input tax allocation within a company.
• Approach:
  • Segmentation: A segment exists if the respective segment performs activities that can be delimited separately. The BMF letter lists controlled companies, foreign permanent establishments, branches, business units, departments or product groups as examples of segments. Segments can be formed by combining activities that are as similar as possible.
  • Segment key for input tax allocation: Where possible, input services are allocated directly within a segment. If an input service is purchased for several segments, it is split up. Input tax is then allocated using a key that is created individually for each segment.
  • Residual key: Overhead costs that cannot be directly allocated or expenses that cannot be allocated to a specific segment are distributed at company level using a residual key. This method minimizes the imprecise allocation of such costs.
• Objective: Segmentation leads to an appropriate and more precise allocation of input tax amounts and minimizes the allocation based on general keys.

3. Recording obligations

The documentation is central to the recognition of input tax deduction and allocation:

• Legal basis: In accordance with Art. 22 (3) UStG and Art. 63 UStDV, the procedure must be recorded in such a way that an expert third party can verify the allocation within a reasonable period of time. Incorrect or incomplete records can lead to an estimate by the tax authorities (Art. 162 AO (German General Tax Code)).
• Obligations:
  • Comprehensible presentation of the allocation of incoming and outgoing sales.
  • Detailed recording of the assessment bases and tax amounts separately according to the tax groups (taxable, tax-exempt, entitled to deduct input tax).
  • Special due diligence obligations for simplification regulations (e.g., Art. 63 (5) UStDV).

4. Application regulation

The principles of the letter are to be applied in all open cases. However, there is a transitional period until December 31, 2025.

• Special rules in the transitional period: If entrepreneurs apply the regulations of the previous BMF letter dated April 12, 2005 until December 31, 2025, this will not be objected to, provided the requirements of the previous BMF letter are met and there are no conflicting new regulations.
• Need for action:
  • Credit institutions can apply the principles of the new letter with immediate effect
  • Companies that have been operating under older principles can only refer to these until the end of the transition period.
  • Companies can no longer apply the previous BMF letter for circumstances that are realized from January 1, 2026. The requirements of the new letter, in particular with regard to more precise methods such as segmentation, must mandatorily be taken into account.

We will be happy to support you in using the transition period for optimal implementation of the new principles!