ECJ Rules on Lithuanian VAT Default Interest Limits

The case brought by the Tax Disputes Commission before the Court of Justice of the European Union (ECJ) examines whether Lithuanian VAT default interest, which can significantly exceed the original tax debt, is compatible with EU law and the principle of proportionality. 

The dispute involves Nekilnojamojo turto valdymas, a Lithuanian-based company, the Tax Authority, and nearly EUR 5 million in interest and penalties. Combined, the amount of penalties and interest, and the issues in question, the case serves as a stark reminder that the true cost of a tax dispute can dwarf the original debt itself, and that EU law may have something to say about it.

Background of the Case 

Following a tax audit for 2012–2016, the Lithuanian Tax Authority determined that a company had incorrectly reduced its VAT liability using invalid invoices, characterizing the actions as VAT fraud. The Tax Authority recalculated the debt, imposing over EUR 6.5 million in VAT, EUR 2.4 million in interest, and EUR 1.86 million in penalties. Despite multiple appeals to the Tax Disputes Commission and Lithuanian courts, the decisions against the company were upheld.

The company later requested a waiver of interest and penalties. However, in 2021, the Tax Authority rejected this request, stating the company failed to meet legal exemption criteria or demonstrate exceptional circumstances justifying leniency based on fairness. By April 2021, default interest had grown to nearly EUR 3.15 million, calculated from the original due date through the full duration of the tax inspection and subsequent litigation.

In 2024, the company sought partial relief, arguing that the majority of the interest was punitive rather than compensatory. They argued that applying interest throughout the entire dispute period was disproportionate. Following another denial by the Tax Authority, the company appealed to the Tax Disputes Commission. The Commission questioned whether these national rules were compatible with EU principles, especially given that both administrative and criminal proceedings were running simultaneously.

Main Questions from Request For Ruling

The Commission asked the ECJ whether, in a situation where default interest on unpaid tax includes a punitive element and is applied alongside criminal proceedings for the same conduct, EU law allows such a system when there are no clear rules to coordinate the administrative and criminal processes.

With the second question, the Commission asked whether EU law permits a rigid system in which interest functions as a fixed penalty that applies regardless of how serious the infringement is, especially when there is no possibility to reduce or waive that punitive component, even in cases where it might be disproportionate.

Applicable EU VAT Directive Article

Given the context and the nature of the dispute, the ECJ interpreted Articles 2(1) and 273 of the EU VAT Directive, which define transactions that are subject to VAT, and give EU countries a degree of flexibility in how they enforce VAT obligations, respectively. Additionally, the ECJ interpreted Article 325(1) and (2) of the Treaty on the Functioning of the European Union (TFEU), and Articles 49(3) and 50 of the Charter of Fundamental Rights of the European Union.

Lithuania National VAT Rules 

The ECJ noted that Article 123, which in the version applicable to the dispute deals specifically with non-compliance with VAT payment rules, is essential for settling the dispute. While the Article provides that persons who breach the provisions of the VAT law are required to pay default interest, it states that the calculation and application of that interest are governed by the separate Law on Tax Administration. Therefore, the ECJ also considered several articles from the Lithuanian Law on Tax Administration.

Importance of the Case for Taxable Persons

The case raises fundamental questions about the limits of national tax enforcement powers and the extent to which EU proportionality principles can override domestic penalty regimes. As such, it directly concerns any business facing a prolonged tax dispute, where automatically accruing interest and penalties can transform a manageable debt into an overwhelming financial burden.

Analysis of the Court Findings

After ruling on the admissibility of the request for a preliminary ruling, a challenge raised by the Lithuanian Government, the ECJ turned to the admissibility of the first question. This issue was raised by the European Commission, which argued that it is not necessary to resolve the dispute. The European Commission claimed that the principle of ne bis in idem under Article 50 of the Charter only applies where there has already been a final judgment, either a conviction or an acquittal, for the same offence. 

Given that the criminal proceedings against the company are still ongoing and no final decision has been issued, the European Commission held that the second element of the principle is missing. While the ECJ agreed that the existence of a final decision is a prerequisite for invoking this principle, it held that it is generally not engaged in situations where criminal proceedings are still ongoing. 

The ECJ noted that Article 50 is intended to prevent duplication of proceedings that have already been conclusively resolved, not to pending or parallel proceedings. Consequently, the ECJ found the first question inadmissible because the criminal case against the company had not yet reached an outcome.

Regarding the second question, the ECJ examined two parts: whether the default interest should be considered criminal or punitive in nature and whether a rigid, non-adjustable interest system is compatible with EU principles of proportionality.

The Conditions for the Application of Article 49(3) of the Charter

Regarding the first part of the second question, the ECJ recalled that under the established case law, the assessment of whether a sanction is criminal in nature and whether it meets the proportionality requirement is not determined solely by how national law classifies the measure, but must instead be conducted by reference to three cumulative criteria. 

These three criteria are: the legal classification of the offence under national law, the intrinsic nature of the infringement, and the severity of the penalty that may be imposed. The ECJ also noted that even if a measure is classified as administrative under national law, it may be deemed criminal if its purpose is essentially punitive.

Concerning the legal classification of the measure under national law, the ECJ noted that under Lithuanian law, such interest is not classified as a criminal penalty but is instead imposed within the framework of an administrative tax procedure. Regardless of the fact that tax offences may give rise to criminal liability, those sanctions are imposed in separate and independent criminal proceedings, distinct from the administrative system of default interest.

Regarding the intrinsic nature of the measure, the ECJ underlined that the key question is whether the purpose of the sanction is punitive. A measure that pursues a punitive objective is generally considered criminal in nature. In contrast, a measure that is limited to compensating for the damage caused by the infringement is not considered criminal.

In the context of the present case, the default interest mechanism under Lithuanian law is described as serving two main purposes: to encourage taxable persons to pay VAT on time or as soon as possible after it becomes due, and to serve a compensatory function. Given that the ECJ has already consistently held that default interest serves a dual function, it stated that default interest on VAT arrears, such as that at issue in the present case, cannot be regarded as having a punitive or criminal nature.

Turning to the third criterion, the degree of severity of the penalty, the ECJ noted that the information available in the case file does not suggest that the default interest imposed in the main proceedings is of such a level of severity that it could be classified as criminal in nature. In any case, based on the case law, it is clear that default interest is designed to compensate for the consequences of late payment of tax, and that its purpose is to neutralise the financial advantage gained by a taxable person, rather than to punish for wrongdoing.

The Principle of Proportionality and Its Limits on Sanctions

To comply with the principle of proportionality when adopting measures, EU countries must ensure that they are suitable for achieving their objective, applied consistently and systematically, and not go beyond what is necessary to achieve that objective. Also, the burden imposed by the measure must not be excessive in relation to the aim pursued. 

From a tax point of view, the administration of punitive measures, such as default interest or penalties, must be carefully calibrated to effectively ensure compliance and protect public revenue without imposing disproportionate disadvantages on taxable persons. While the EU countries, under the EU VAT Directive and TFEU, have flexibility in designing VAT enforcement systems, including default interest regimes, those systems must strike a balance between effectiveness and fairness.

Regarding the Lithuanian rules on default interest, they apply when VAT is not paid on time and are designed to ensure that unpaid tax is ultimately recovered. Thus, this measure pursues a legitimate objective recognised under EU law, which is to ensure the correct collection of VAT and prevent tax fraud. Once again, the ECJ noted that it is up to the national authority to determine whether the specific national rules meet the proportionality requirements. However, it provided guidance for the assessment. 

The ECJ stated that the three key criteria are key when assessing the measures’ proportionality: whether such a measure of default interest is suitable for achieving its objectives, whether that measure is necessary, and whether the measure is proportionate in the strict sense, meaning whether the burden it imposes is excessive in relation to its objectives.

Courts Final Decision

In addition to finding the first question inadmissible, the ECJ concluded that a rigid and uniform system of default interest, applied automatically and with limited flexibility, is compatible with EU law, as long as it serves legitimate objectives such as ensuring effective tax collection and preventing fraud, and does not go beyond what is necessary to achieve those aims.

Conclusion

The ECJ upheld the validity of standard default interest regimes, clarifying that they are compensatory rather than criminal. However, it reminded national Tax Authorities that such measures must remain proportionate and focused on neutralizing the financial benefits of late payment rather than serving as an excessive secondary penalty. In the end, the ECJ provided valuable clarification and guidance for both the taxable persons and EU countries and their authorities.

Source: Case C‑544/24 - ‘Nekilnojamojo turto valdymas’ BUAB v State Tax Inspectorate under the Ministry of Finance of the Republic of Lithuania, EU VAT Directive, Treaty on the Functioning of the European Union (TFEU),  Charter of Fundamental Rights of the European Union