EU Law Primacy in VAT: ECJ Rules on Hungarian National Practice

In a case questioning Hungary's national practice against EU VAT law, Global Ink Trade, a Hungarian wholesaler, challenged the denial of its VAT deduction for office supplies purchased from a shell company, Office Builder. 

There are several core issues in this case, including the Hungarian Supreme Court's continued imposition of additional national conditions on the right to deduct VAT, the question of whether national courts must follow ECJ rulings even when they conflict with established national case law, and the extent to which a taxable person can be required to verify their supplier’s legitimacy and tax compliance without being unfairly burdened.

Background of the Case 

Between July 2012 and 2013, Global Ink purchased office supplies based on the invoice issued by the company Office Builder. After the Tax Authority investigated the Office Builder, it found that the company was a shell company, with no real business activity. 

Moreover, Office Builder failed to meet all its tax obligations, and its director, who was later arrested, denied ever issuing the invoice or even having any dealings with Global Ink. Additionally, the investigation determined that communication between these two companies was conducted via an email address that was not officially linked to Office Builder.

Throughout the investigation, the Tax Authority interviewed several witnesses who confirmed that Global Ink had indeed received the goods. Furthermore, the Global Ink director clarified that he began working with Office Builder after seeing the newspaper advertisement, checking its business details in the commercial register, and meeting a representative once in person. After this meeting, the whole communication was done by email. 

Despite these claims, the Tax Authority held that invoices issued by Office Builder to Global Ink could not be trusted because the company’s director denied ever issuing them. Based on these findings, the Tax Authority concluded that the transactions recorded on those invoices had not actually occurred between the two companies, thereby denying Global Inks' right to deduct the VAT shown on the invoices. 

As an additional argument, the Tax Authority stated that Global Ink failed to exercise proper diligence in verifying who its supplier really was and whether it met its tax obligations, thereby amounting to passive participation in tax evasion. Global Ink challenged these conclusions before the Budapest High Court, arguing that the denial of the right to deduct VAT was unjustified because the Tax Authority had based its findings on unproven assumptions and had failed to bear the burden of proving any irregularities.

The High Court noted that in 2020, the European Court of Justice (ECJ) had already interpreted the relevant EU VAT Directive provisions in comparable Hungarian cases. Nonetheless, the Hungarian Supreme Court continued to apply its earlier national case law, which effectively imposed additional conditions on the exercise of the right to deduct VAT that are not found in the EU VAT Directive.

As a result of the Supreme Court's approach, taxable persons are effectively obliged to undertake extensive investigations into their suppliers, including checking whether those suppliers have properly declared and paid VAT, which conflicts with the ECJ's case law. Since the Supreme Court’s precedents formally bind the High Court, it must justify any decision that deviates from them. For this reason, the High Court decided to pause the proceedings and refer several questions to the ECJ for a preliminary ruling.

Main Questions from Request For Ruling

With the first question, the High Court asked whether the Supreme Court breached the primacy of EU law and the right to effective judicial protection under the EU Charter when it interpreted that the ECJ ruling contained nothing that would overturn its previous approach or require it to modify its established national caselaw. 

The following question asks whether the primacy of EU law requires national courts of last instance to follow ECJ rulings even when they believe earlier EU decisions support their existing national case law. Additionally, the High Court wants to know if the answer to this question changes when the ECJ issues a decision in the form of an order. 

The third question asks whether, under the general duty to exercise due diligence under the EU VAT Directive, a taxable person can be obliged to maintain in-person contact with the invoice issuer or communicate only through the supplier’s officially registered email to claim a VAT deduction. It also asks whether these requirements constitute a failure to exercise due diligence, even though the taxable person had already conducted checks before entering into the business relationship.

Furthermore, the High Court sought clarifications on whether it is consistent with the EU VAT Directive and the ECJ’s case-law for an EU country to refuse a taxable person the right to deduct VAT on invoices that formally comply with the Directive, solely on the basis that the taxable person allegedly failed to act with due diligence in a broader sense.

Also, the High Court wanted to know whether the Tax Authority can treat a supplier’s director's mere denial as an objective fact demonstrating a lack of due diligence. And finally, with the last question, the referring Court asked whether the mere discovery by a Tax Authority that goods on the invoices are of EU origin and that the taxable person is the second member in a supply chain, where the first purchaser cannot deduct VAT but the second can, constitutes an objective fact sufficient to establish tax evasion.

Applicable EU VAT Directive Article

The ECJ highlighted Articles 167, 168(a), 178(a), and 273 as the most relevant for this case. While Articles 167 and 168(a) define when and on which transactions the right to deduct VAT arises, Article 178(a) requires that to exercise this deduction, the taxable person must hold an invoice that meets the EU VAT Directive’s formal requirements.

Article 273 defines that to impose additional obligations to ensure proper VAT collection and prevent evasion, EU countries must respect equal treatment between domestic and cross-border transactions and must not create formalities linked to the movement of goods across borders.

Hungary National VAT Rules 

In this case, the ECJ did not consider any national VAT rules and regulations, as the focus was on the primacy of EU law over national rules.

Importance of the Case for Taxable Persons

The case concerns several fundamental VAT principles, including the primacy of EU law, fiscal neutrality, legal certainty, the right to deduct VAT, the burden of proof, due diligence, and the effectiveness of EU Law. More specifically, the ECJ clarifies taxable persons' rights and responsibilities under the EU VAT system, including their right to deduct input VAT and the limits of their due diligence obligations.

Analysis of the Court Findings

As a preliminary point, the ECJ answered the first and second questions together, understanding them as asking whether EU law's primacy prevents national rules requiring lower courts to follow higher court decisions, even when those lower courts believe the higher court’s approach conflicts with EU law.

Additionally, the ECJ had to decide on the admissibility of these questions, as the Hungarian Government argued that they were inadmissible. The main reason for this was that, in the government's view, the High Court is merely challenging the Supreme Court’s earlier decisions in cases that led to the ECJ orders, even though those earlier cases have no direct connection to the current dispute. Nonetheless, the ECJ found questions admissible and stated that they directly relate to the dispute and are not hypothetical.

On the substance of these joint questions, the ECJ recalled that, under the principle of the primacy of EU law, all national authorities must ensure the full effectiveness of EU law, and EU countries may not rely on domestic provisions to weaken or limit that effect. Therefore, when a national court refers a question to the ECJ and receives an interpretation of the EU rules, it must apply that interpretation when deciding the case.

In cases when the national court notices that the ECJ's interpretation is inconsistent with the approach of the higher national court, it must set aside that national precedent, even if national law typically obliges it to follow it. 

As a result of this interpretation, and in light of the duty to ensure the primacy and effectiveness of EU law, lower courts must disregard binding national case law and, where necessary, modify established judicial interpretations that conflict with EU law.  Additionally, whether the interpretation is provided in a formal judgment or a reasoned order is irrelevant, as both carry the same authority and legal effect.

Similar to the first and second questions, the ECJ addresses the third to fifth questions together. Therefore, the main issue is whether the EU VAT Directive prevents a Tax Authority from denying a taxable person’s right to deduct input VAT solely because the Tax Authority considers the invoices unreliable, based on the taxable person’s supposed lack of diligence and guidance from a Tax Authority circular.

In that regard, the ECJ underlined that, under established case law, the right to deduct input VAT is a fundamental element of the EU VAT system. However, to practice this right, a taxable person must meet both the substantive and formal conditions set out in the EU VAT Directive.

Regarding the substantive conditions, the EU VAT Directive sets out two. The first one is that a claimant must be a taxable person, and the second one requires that the goods or services used as inputs must be supplied by another taxable person and used for the taxable person’s own taxable output activities. Additionally, the formal condition requires that the taxable persons possess a properly issued invoice. Notably, all these conditions are met only if the underlying supply of goods or services occurred in the first place.

Nevertheless, a claim for VAT deduction may be denied if objective evidence shows the deduction is claimed for fraudulent or abusive purposes. Thus, even if all conditions are met, national authorities and courts must deny the deduction if fraud or abuse is proven. The denial of VAT deduction applies both when the taxable person commits the fraud themselves and when evidence shows they knew or should have known that their purchase formed part of a VAT-fraudulent scheme. 

Since denying the right is an exception to the fundamental principle, the burden of proof lies on the Tax Authority. However, the EU VAT Directive does not set specific evidence requirements or procedures. Therefore, EU countries must define national rules that do not undermine the effectiveness of EU law. Even though taxable persons must exercise greater care when there are indications of fraud at the time of acquisition, EU countries cannot oblige taxable persons to conduct complex, extensive checks that the Tax Authority itself can perform.

The ECJ understood the sixth question as asking whether, when a Tax Authority seeks to deny a taxable person the right to deduct input VAT on the grounds of participation in a VAT carousel fraud, the EU VAT Directive prevents the Tax Authority from relying solely on the fact that the transaction is part of a circular invoicing chain, without identifying all operators involved and their conduct.

The established case law sets the evidential requirement that forbids the Tax Authority from relying on assumptions or presumptions that shift the burden of proof onto the taxable person, as this would undermine the fundamental right to deduct VAT and the effectiveness of EU law. 

Courts Final Decision

In the end, the ECJ ruled that the principle of the primacy of EU law requires a national court to disregard the legal rulings of a higher national court if it considers them inconsistent with the ECJ interpretation of EU law, whether given in a judgment or a reasoned order.

Secondly, the ECJ concluded that Articles 167, 168(a), and 178(a) of the EU VAT Directive do not forbid Tax Authorities from refusing a taxable person the right to deduct VAT where the invoices are not credible due to circumstances showing a lack of diligence, assessed in line with a circular for taxable persons. However, in such cases, the Tax Authority must provide objective evidence of fraud, not require the taxable persons to conduct complex checks, apply the rules consistently with the circular, and ensure the circular is clear and foreseeable.

Finally, the ECJ underlined that the EU VAT Directive must be understood as meaning that a Tax Authority cannot refuse a taxable person the right to deduct VAT simply by showing that the transaction is part of a circular invoicing chain. 

Instead, the Tax Authority must provide a clear description of the elements of the fraud and prove the fraudulent conduct, and determine that the taxable person either actively participated in the fraud or knew, or should have known, that the acquisition of the goods or services was connected to it, without needing to identify all other operators involved.

Conclusion

Ultimately, the ECJ emphasized the need to strike a balance between protecting taxable persons’ rights and enabling Tax Authorities to combat VAT fraud. Also, the ECJ confirmed that the right to deduct VAT is a fundamental right, underpinning that EU law takes precedence over national rules that impose additional obligations. In the end, while Tax Authorities can deny deductions only based on objective evidence of fraud, they cannot do so on mere assumptions or on the existence of circular invoicing chains.

Source: Case C‑537/22 - Global Ink Trade Kft. v Appeals Division of the National Tax and Customs Administration, EU VAT Directive