VAT Deductibility: Prorata Rule & Non-Deductible Items

Recommended resources

The freely available resources this lesson will direct you to.

Welcome back. In our last lesson, we explored the crucial distinctions between taxable, exempt (with and without the right to deduction), and out-of-scope transactions. We established that the "right to deduction" is a pivotal concept, determining whether the VAT a business pays on its purchases is a recoverable amount or a final cost.

Today, we will delve into the mechanics of this right. Your learning outcome is to determine the rules for VAT deductibility (prorata rule) and identify non-deductible items. This is an area where precision is paramount. Misclassifying an expense as deductible when it isn't, or failing to apply the prorata rule correctly, are common errors that can lead to significant adjustments during a tax audit.

We will tackle this in two parts:

First, we will identify expenses that are completely excluded from the right to deduction by Moroccan law.
Second, we will learn how to calculate the deductible portion of VAT for businesses with mixed activities using the prorata rule.

1. The General Principle of Deduction

As a brief recap, the VAT system works through a mechanism of deduction. A business collects VAT on its sales (TVA facturée) and deducts the VAT it has paid on its professional purchases (TVA récupérable). The difference is what is remitted to the state.

However, this right to deduction is not absolute. It is governed by strict rules. The most fundamental condition is that the expense must be incurred for the needs of the business (besoins de l'exploitation). Beyond this, the law explicitly excludes certain types of expenses from any right to deduction.

2. Expenses Excluded from the Right to Deduction

Moroccan tax law, specifically Article 106 of the General Tax Code (CGI), lists several categories of goods and services for which the incurred VAT is never deductible. It is critical to memorize these, as they are a frequent point of attention in accounting.

To get familiar with these exclusions, let's go directly to an official source.

Guide du rembourssement de la TVA

This guide from Maroc PME, a government agency, provides a clear summary of VAT rules and directly references the relevant articles of the tax code. We will use it to identify the official list of non-deductible items.

Please read two sections in this guide: Start at the section titled '2-2- Justification des achats'. Read the list that begins with 'Ne peuvent bénéficier du remboursement, les taxes qui sont exclues du droit à déduction...'. Then, find the annex titled 'Opérations exclues du droit à déduction (article 106)' near the end of the document. This provides the direct text of the law. Your goal is to identify the main categories of expenses that are excluded from VAT deduction.

Based on your reading, let's summarize the most common exclusions you will encounter in a Moroccan SME:

Goods and services not used for business operations: This is the foundational principle. Any purchase for personal use is excluded.
Passenger vehicles (véhicules de tourisme): The VAT on the purchase, maintenance, or rental of passenger cars is not deductible. This is a very common point of confusion. The VAT on utility vehicles (véhicules utilitaires like vans or pickup trucks) used for the business, however, is deductible.
Petroleum products: The VAT on gasoline (essence) is generally not deductible. The VAT on diesel (gasoil) is only deductible for specific business uses, such as commercial transport vehicles, not for standard passenger cars.
Mission, reception, and representation expenses (frais de mission, de réception ou de représentation): This is a broad category that includes:
- Hotel and accommodation costs.
- Restaurant meals.
- Travel expenses (plane/train tickets) for employees or clients.
Gifts and liberalities: VAT on gifts given to clients or partners is not deductible.

The image below provides a helpful visual summary of these key exclusions.

Main Exclusions from VAT Deductibility — This image visually summarizes the main categories of expenses for which VAT is not deductible. Note how it aligns with the provisions of Article 106 of the CGI.

Test your understanding!

A Moroccan consulting company, "Conseil Pro SARL," incurs the following expenses in a month. For each one, state whether the VAT is deductible or non-deductible, and why.

Purchase of a new Peugeot 208 for the CEO to use for client meetings.
Purchase of three new Dell laptops for the consultants.
A 1,200 MAD restaurant bill (including 200 MAD of VAT) for a lunch meeting with a major client.
The monthly leasing payment for a Renault Kangoo (a utility van) used for delivering materials.

Show answer

Non-Deductible. The Peugeot 208 is a passenger vehicle (véhicule de tourisme). According to Article 106, VAT on such vehicles is excluded from deduction.
Deductible. The laptops are clearly for business use (besoins de l'exploitation) and do not fall into any excluded category.
Non-Deductible. The restaurant bill is considered a representation expense (frais de représentation). VAT on these expenses is not deductible. The entire 1,200 MAD becomes an expense for the company.
Deductible. The Renault Kangoo is a utility vehicle (véhicule utilitaire). As it is used for business operations, the VAT on its leasing cost is fully deductible.

3. Partial Deduction: The Prorata Rule

Now, what happens if a company engages in a mix of activities?

Some operations that give a full right to deduction (i.e., taxable sales or exempt sales with right to deduction).
Some operations that give no right to deduction (i.e., exempt sales without right to deduction).

Consider a company that both sells computer equipment (taxable) and provides exempt educational services. It receives a single electricity bill. How much of the VAT on that electricity bill can it deduct? It would be unfair to deduct 100% of the VAT, since some of the electricity was used to generate non-taxable revenue.

The solution is the prorata de déduction. This is a percentage that represents the portion of the company's business that generates a right to deduction. This percentage is then applied to all common expenses (overheads like rent, telephone, electricity, etc.) to determine the deductible amount of VAT.

The following reading explains this concept clearly.

Prorata de déduction de la TVA

The article 'Prorata de déduction de la TVA' from Upsilon Consulting offers a concise and practical explanation of this rule. It covers who is affected, the calculation formula, and a clear example.

Please read the sections titled 'Le prorata de déduction : Qui est concerné?', 'Comment est calculé le pourcentage de déduction (prorata)', and 'Application pratique du principe de prorata'. Focus on understanding the formula and the logic of what goes into the numerator and the denominator.

The Prorata Formula

As you saw in the article, the prorata is a fraction based on the company's turnover (chiffre d'affaires, or CA). The formula is:

Prorata = \frac{CA giving right to deduction}{Total CA}

More specifically:

Prorata = \frac{CA taxable (TTC) + CA exempt with right to deduction + CA under suspension regime}{Numerator + CA exempt without right to deduction + CA out-of-scope}

Let's walk through a practical example:

A company has the following annual turnover (all amounts are pre-tax):

Local sales of goods (taxable): 800,000 MAD
Export sales (exempt with right to deduction): 400,000 MAD
Rental of unfurnished property (exempt without right to deduction): 300,000 MAD

Step 1: Calculate the numerator.
This is the turnover that gives a right to deduction.

Numerator = 800,000 (taxable) + 400,000 (exempt w/ deduction) = 1,200,000 MAD

Step 2: Calculate the denominator.
This is the total turnover from all activities.

Denominator = 1,200,000 (from numerator) + 300,000 (exempt w/o deduction) = 1,500,000 MAD

Step 3: Calculate the prorata percentage.

Prorata = 1,200,000 / 1,500,000 = 0.80 or 80%

How to apply it:
For the entire following year, this company will apply an 80% prorata to the VAT on all its common expenses. If its monthly phone bill has 100 MAD of VAT, it can only deduct:
100 MAD * 80% = 80 MAD.

The remaining 20 MAD is non-deductible and is added to the cost of the phone expense in the company's books.

Important Note: The prorata applied during a year (Year N) is typically a provisional one calculated based on the final data from the previous year (Year N-1). At the end of Year N, a final prorata is calculated with Year N's data, and a regularization (an adjustment) is made.

Test your understanding!

A real estate company in Morocco has the following annual activities:

Sales of commercial offices (taxable): 5,000,000 MAD
Rental of residential apartments (exempt without right to deduction): 2,000,000 MAD

In January of the following year, the company receives a bill from its accounting firm for 10,000 MAD + 2,000 MAD VAT. How much of this VAT can the real estate company deduct?

Show answer

Step 1: Calculate the prorata for the year.

Numerator (taxable CA): 5,000,000 MAD
Denominator (total CA): 5,000,000 + 2,000,000 = 7,000,000 MAD
Prorata = 5,000,000 / 7,000,000 ≈ 0.7142 or 71.42%

Step 2: Apply the prorata to the VAT on the common expense.
The accounting service is a common expense (an overhead).

VAT on the accounting bill: 2,000 MAD
Deductible VAT = 2,000 * 71.42% = 1,428.40 MAD

The remaining 571.60 MAD is a non-deductible charge that will be added to the accounting fees expense account.

Conclusion

You have now mastered the two key limitations on VAT deductibility. This is a significant step forward, moving from the general theory of VAT to the precise rules of its calculation.

Key Takeaways:

The right to deduct VAT is not automatic. Article 106 of the CGI specifies items for which VAT is never deductible, most notably passenger vehicles and representation expenses.
When a business has both activities that grant a right to deduction and activities that don't, it must calculate a deduction prorata.
This prorata is a percentage representing the proportion of "good" turnover to total turnover. It is applied to the VAT on all common overheads to determine the deductible portion.
Any VAT that is non-deductible (either through a total exclusion or by application of the prorata) is not lost, but rather becomes part of the cost of the expense itself, slightly reducing the company's profit.

Preview of the Next Lesson:
We have now assembled all the essential components: collected VAT, the rules of deduction, exclusions, and the prorata. In our next lesson, we will put it all together to calculate the net VAT due or VAT credit for a given period. This is the culmination of our VAT module and the core task in preparing a monthly or quarterly VAT declaration.