Lithuania Tax Court on Loans, PIT & Burden of Proof

The Supreme Administrative Court of Lithuania (hereinafter – SACL) examined a tax dispute. The dispute between the parties concerned the legality and validity of the tax administrator’s instructions requiring the Applicant to pay personal income tax PIT into the State budget.

Application of the Expenditure Method Under Article 70 LTA

The tax administrator, acting pursuant to Article 70 of the Law on Tax Administration LTA and the rules implementing it, applied the expenditure method and established that the Applicant had covered the expenses incurred for granting a loan using income received from sources unknown to the tax administrator. The Applicant had not declared that income in accordance with the procedure established in Articles 25 and 27(1) of the Law on Personal Income Tax LPIT, nor had he calculated and paid PIT on it into the budget.

Case Law on Civil-Law Contracts as Evidence of Fund Receipt

Contracts as Presumptive, Not Conclusive, Proof

In the dispute, the SACL noted that the case law of the Supreme Administrative Court of Lithuania states that various civil-law contracts concerning the receipt of certain funds are not, for the purposes of applying the Law on Personal Income Tax, primary and direct evidence that indisputably confirms the fact of receipt of the relevant funds. Contracts of this type merely provide grounds for the assumption that a person may have received certain funds under those transactions; however, they do not in themselves prove that the person actually received and disposed of those funds.

Burden of Proof: Taxpayer vs. Tax Administrator

It is relevant for readers to note that, in such cases, the actual fact of receiving or not receiving funds becomes the subject of proof. This fact may be proven or rebutted by all admissible means, both direct and indirect evidence, with such evidence assessed according to the general rules for the assessment of evidence. Therefore, in such cases, determining whether a person received or did not receive the relevant funds, and whether those funds are taxable with PIT or not, depends on the specific circumstances of the case, the totality of evidence collected in the case, and similar factors.

All of this also determines the nature and scope of the circumstances to be proven in the case. It is the person who must prove that, under civil-law transactions, they actually received funds that are not subject to PIT, while the tax administrator must accordingly prove that the person did not receive those funds under the transactions indicated by them, that the origin and nature of the funds are different, and so on.

The Principle of Substance Over Form in Tax Relations

The mere submission of separate formal evidence concerning income, in the absence of the actual fact of receipt of income confirmed by a comprehensive analysis of the factual circumstances of receiving that income, does not substantiate the receipt of the income itself. Such a conclusion must also be drawn in view of the provisions of the LTA establishing the principle of substance over form, under which, in tax legal relations, priority is given to the substance of the activities of the participants in those relations rather than to their formal expression.

The Risk of Cash Income and Non-Declaration

The Court also emphasised that the Supreme Administrative Court of Lithuania has repeatedly stated that, where a taxpayer chooses to receive income in cash, as a result of which the fact of receipt of that income is not recorded in account entries at credit institutions, and does not declare that income when submitting income tax returns for the relevant tax period, for example where submission of such a return is not mandatory, the taxpayer also assumes the entire risk related to the burden of proof falling on them.

Assessment of Evidence: The Appellant as a Professional Businessperson

Therefore, it is important to mention that, when assessing the evidence in the case, the written documents and the explanations of the parties, the SACL noted that the appellant is a businessperson, a professional in their field, who is fully aware of the obligation to pay taxes and of the general requirements laid down in Article 3 of the Law on Financial Accounting of the Republic of Lithuania for substantiating and recording economic operations, namely that all economic operations must be substantiated by accounting documents and recorded in accounting registers.

Moreover, in this case, the evidence is assessed as a whole, rather than separately, as the appellant sought in the appeal. The Court noted that, during the tax dispute, the appellant provided inconsistent and contradictory explanations and that, taking into account the totality of evidence in the case, the appellant’s explanations regarding the receipt of funds from individuals for the acquisition of shares were unconvincing.

It should be mentioned that the Court found that the case material showed that the tax administrator had analysed the appellant’s income and expenses for the relevant period and had sought to determine the balance of the Applicant’s available income using various sources of information. In the tax administrator’s opinion, the Applicant had received income from unidentified sources on which taxes had not been paid.

For example, it is relevant to mention that the case material also shows that, when examining the appellant’s comments on the repeated inspection report, and in order to collect additional evidence about the circumstances of the use of funds under the formalised agreements, an analysis of the appellant’s financial position was carried out. The purpose of this analysis was to determine:

• whether cash amounts were deposited into the appellant’s bank account during that period; 

• what the appellant’s income and expenses were during that period; 

• what loans the appellant took during that period, what they were used for, and what interest the appellant paid; 

• what movable and immovable property the appellant acquired during that period. 

Why Borrowing While Holding Cash Defies Ordinary Logic

The collected data clearly showed that, during the period when an individual allegedly repaid monetary funds to the appellant in cash, the appellant did not deposit cash into bank accounts, but instead borrowed significant amounts of money from credit institutions. Under a credit agreement, the Applicant was granted a loan “for housing construction”, while paying bank interest, that is, incurring additional expenses.

In the Court’s opinion, borrowing from a credit institution and paying interest while allegedly holding a large amount of cash contradicts ordinary logic and is unconvincing. The appellant explained that the money received from the individual had not been used because it would have had to be converted into Lithuanian litas, which would have caused financial losses; in other words, it was not beneficial for the appellant to exchange US dollars.

The Court agreed with the appellant’s statement that currency conversion involves certain losses. However, this does not mean that it is more beneficial to borrow significant amounts of money from credit institutions and pay bank interest than to use available funds held in another currency.

Late Submission of Agreements and Doubts About Authenticity

Thus, the Court observed that the case material showed that neither during the operational inspection nor during the first tax inspection did the appellant’s explanations contain any information about signed agreements under which cash had allegedly been received. Only during the tax dispute, after the fact of insufficient income to cover expenses had already been established, were documents concerning received income, namely funds returned under agreements, submitted together with the complaint to the tax administrator. This gave grounds to doubt the authenticity of such agreements.

Furthermore, in the Court’s opinion, during the repeated inspection neither the appellant nor the other person was able to specifically explain the circumstances of the transfer of cash under the submitted agreements. Both the appellant and the person stated that the monetary funds had been transferred in cash through third parties, but neither of the individuals identified those persons, specified exactly when and where the transfer of money took place, or indicated when and how the confirmations of the transfer of money had been signed.

Documentation Requirements Under Article 19 LPIT

Finally, it should additionally be mentioned that the SACL also noted that, under Article 19(1) of the LPIT, the acquisition price of property, commission paid, and taxes and fees related to the sale of that property may be deducted from the income received. Article 19(3) of the LPIT provides that only those amounts may be deducted which are substantiated by documents containing all mandatory accounting-document details required by the Law on Accounting of the Republic of Lithuania and other legal acts, and/or by valid transactions, and/or by documents drawn up by foreign entities and residents, provided that the content of the economic operation can be determined from those documents.

The obligation established in Article 19(3) of the LPIT to possess documents from which the content of an economic operation can be determined is aimed at combating the shadow economy, smuggling, illegal work, tax avoidance and tax fraud. The appellant did not have such documents.

Conclusions of the Supreme Administrative Court

In summary, the appellate court assessed that the contested court decision had reasonably refused to recognise the amount of money indicated in the disputed share purchase-sale agreements as expenses for the acquisition of shares.

It is relevant that the parties to the proceedings also presented additional arguments; however, in the opinion of the panel of judges, the stated circumstances were not essential for resolving the administrative case and did not in any way alter the conclusion reached in this decision.

In this context, the Court mentioned that the case law of the European Court of Human Rights and the Supreme Administrative Court of Lithuania has repeatedly noted that the court’s duty to give reasons for its decision should not be understood as a requirement to respond in detail to every argument. This was clearly stated, for example, in the European Court of Human Rights judgment of 19 April 1994 in Van de Hurk v. the Netherlands, the judgment of 19 December 1997 in Helle v. Finland, and subsequently on numerous occasions in the case law of the SACL.