Limitation of VAT Deduction and Corporation Tax in Lithuania: SACL Case Law Insights

The article examines the case of denial of the right to deduct input VAT, whileat the same time showing how the case law of the Supreme Administrative Court of Lithuania (hereinafter - the Supreme Administrative Court of Lithuania - the "SACL") deals with the limitation of costs in the calculation of corporate income tax.

Limitation of VAT deduction

In the case law of the Supreme Administrative Court, which is also based on the case law of the Court of Justice of the European Union, when it is established that transactions (economic operations) have not actually taken place, then the right to deduct VAT is denied.

For example, in a recent case before the Supreme Administrative Court, the issue was whether it was lawful and reasonable for the tax authorities to conclude that economic transactions between the applicant and other companies did not take place and that the company was therefore liable to pay additional tax.

Here, in response to the appellant's claims that the tax authorities should have investigated the good faith of the company, the Court noted that the dishonesty of an economic operator can only be proved when the actual existence of an economic transaction is established, whereas the conclusion that no economic transactions have taken place negates the obligation to prove the bad faith of the person seeking to exercise the right to deduct VAT. Moreover, the Supreme Administrative Court emphasised that, when assessing evidence, the court must be guided not only by the rules of evidence, but also by the laws of logic, the criteria of justice, reasonableness and fairness.

It should be noted that in the appeal lodged, the applicant put forward a group of arguments concerning transactions with JSC X and stated that it had actually purchased and installed goods from JSC X for its customers. The Court of Appeal disagreed with those arguments and annulled the applicant's right to deduct input VAT.

In summary, the Supreme Administrative Court (SACL) held that the tax authorities have the right to refuse to grant a taxable person the right to deduct VAT if it is established, on the basis of objective evidence, that the transactions on which the right is based are the result of abusive conduct or the taxable person's own tax evasion.

However, the Court also commented on the systematic approach to be taken in such a situation as regards the allocation of costs as allowable deductions for the purposes of corporation tax.

What is important to know about corporation tax after the VAT deduction has been disallowed?

In addition, it should be noted that the Supreme Administrative Court in the present judgment also revealed that another relevant issue was at stake in this case: the Court of First Instance, after having recognised that the fuel was actually supplied to the applicant under the invoices issued in the name of JSC X and JSC Y, and that the company had incurred the costs, and applying the provisions of Article 69(2) of the Law on Taxes and Duties, held that the company was entitled to recognise the cost of the acquisition of fuel as an allowable deduction, and annulled the order for the payment of corporation tax, default interest and penalty.

According to the Supreme Administrative Court, the evidence in the case shows that the applicant ignored the obvious indications of tax fraud and, in fact, failed to take elementary measures to ensure that the supply operations did not lead to tax fraud. The fact that the appellant's transactions with JSC X and JSC Y covered only a small part of the market for the petrol purchased by the applicant, and that the company had a long and honest history, does not invalidate the facts established in the present case that the company should have been aware of the fact that it was involved in a VAT fraudulent transaction when purchasing the goods.

However, the tax authorities disagreed with that assessment and argued that the court was unjustified in recognising, in the context of the other established facts, that the expenditure on which the costs are recognised may be based on documents which do not have the force of law; they also pointed out that the court had failed to consider Article 11(4) of the VAT Act. The Supreme Administrative Court found the above-mentioned arguments of the tax authorities to be well-founded and upheld the appeal of the tax authorities in this part.

It is relevant here that the Supreme Administrative Court stated that the court of first instance was guided by the principle of substance over form in the assessment of tax, which provides, inter alia, that where a taxpayer has made a mistake in the preparation of accounting documents and in the submission of the tax return, as well as in other cases where the taxpayer's activity does not comply with the formal requirements of the legal acts, but the content of the activity is in accordance with the circumstances to which the tax laws refer taxation, the tax shall be calculated in accordance with the corresponding provisions of the tax laws in question (Art. 69 (2) of the Law on Taxes and Customs (LAS). Thus, the aforementioned principle is a general principle of tax law, which is applicable in relation to other tax law provisions.

Article 11(4) of the ITA stipulates that expenditure on the basis of which costs are recognised may only be based on documents having legal force, which must contain all the requisite elements of accounting documents required by the legislation governing accounting. In addition to these requisites, the documents supporting the expenditure on the basis of which the costs are recognised must also contain such additional requisites as may be prescribed by the Government of the Republic of Lithuania or an institution authorised by it. The Supreme Administrative Court noted that these legal norms are important not only for the specific entity but also for the tax and economic environment in general, i.e. they ensure that all participants in economic transactions comply with their tax obligations and that unlawful activities, such as, in the case at hand, the trade in smuggled or stolen diesel fuel or diesel fuel that is not sold without payment of the necessary taxes, are eliminated, and they may not be ignored by the principle of the primacy of substance over form.

Moreover, in the present case, in the accounting records of Company S, economic transactions were recorded which did not take place between the undertakings referred to in the conditions specified. In addition, Company S expensed sums of money on the basis of accounting documents which do not have the force of law, that is to say, Company S recorded in its accounting records transactions which did not take place under the conditions set out between the undertakings referred to. It is apparent from the circumstances of the case that Company S does not have accounting documents showing the true content of the disputed economic transactions, such as the real parties to the transactions, the persons who represented them, the origin of the diesel fuel, etc. In the absence of actual content, there is no reason to apply the principle of substance over form.

The Supreme Administrative Court pointed out that in the case-law of the Supreme Administrative Court of Lithuania it has been noted that "the fact that accounting documents (in the present case - VAT invoices), which are used as a basis for the taxpayer's right to deduct certain costs from gross income for the purposes of calculating corporate income tax, are not in accordance with the law, does not reflect the true substance of the economic transaction, per se (in itself) gives rise to a presumption of the legal fact that a person cannot recognise (justify) a cost that reduces corporation tax on the basis of those accounting documents (VAT invoices) and the data recorded in them. In such a case, the taxpayer, in the same way as for the purpose of proving its right to deduct VAT on the basis of the relevant VAT invoices, must provide evidence (prove) the legal facts which entitle it to write off the costs - the type, quantity, value of the goods/services purchased, the seller (provider) of the goods/services, and any other circumstances relating to the incurrence of the costs in order to generate revenue.

The above interpretations and case law are considered to be of great importance in practice, as they are binding for both the tax administration and the entities in the proper discharge of their tax obligations.