Restrictions on VAT Deduction: Key Legal Cases & Compliance Insights

The article examines the most frequent cases of denial of the right to deduct input VAT, revealing what specific circumstances of disputes lead to it and how they are assessed by the case law of the Court of Justice of the European Union (hereinafter - the CJEU) and the Supreme Administrative Court of Lithuania (hereinafter - the Supreme Administrative Court of Lithuania - the SACL).

The most common cases of denial of the right to deduct input VAT

In practice, the most frequent cases, and the ones that raise the most questions of uncertainty for accountants, are situations where the right to deduct input VAT is denied because of knowledge or should have known of fraudulent VAT practices of the contractors. However, this ground is rather evaluative, the tax authorities analyse various circumstances which may "outweigh" the decision to tax, so it is important to explain in detail what these circumstances are according to case law.

Readers will presumably be familiar with what input VAT deduction is and the principles that apply, so we move straight on to the issues that are most relevant to accountants in practice.

For example, in a specific new case, the Supreme Administrative Court decided whether it was proven that the taxable person knew or should have known that he was involved in a fraudulent VAT transaction when purchasing goods. The Court noted that this legally significant circumstance must be substantiated by objective evidence by the tax administration. The Supreme Administrative Court also set out the legal basis for the application of the VAT deduction and referred to the case law of the Supreme Administrative Court (SACL) and the European Court of Justice (ECJ) on the issue.

Importantly, the Chamber rejected the applicant's arguments regarding the legal consequences for him alone as an intermediary. Thus, the liability of each taxpayer is individual and takes into account the infringement committed by the taxpayer who is held liable and not by another taxpayer or the level of tax penalties imposed on him.

In the case itself, the Court of First Instance of the Supreme Administrative Court noted that, with regard to the appellant's claims that the administrator had failed to prove the fact of the Company's dishonesty, it had been established beyond doubt that during the period at issue in the dispute, the director of the Company and of the Company's contractor were the same person. It appears from the facts of the case that the applicant has admitted that the Company only formally concluded a contract with the UAB, under which the UAB undertook to pack the goods (bottles) supplied by the Company with its own forces and resources. The case establishes that the director of the Company personally knew the manager of the companies during the period in question, who did not provide any evidence during the investigation to substantiate the actual provision of packaging services. The Supreme Administrative Court notes that one company did not actually purchase the services from the other company and therefore the applicant could not have purchased the packaging services at issue. The case establishes that the Director of the Company personally knew the person who managed UAB S during the period in question. It is also established that ST UAB did not carry out transactions with S UAB. Moreover, during the period at issue, the accounting records of the Company and its contractors were kept by the same person, who is included in the database of tax offences, cases of abuse and other information relevant for the control of tax assessment and payment. In the assessment of the Board of Judges, the totality of the circumstances established in the case is sufficient to conclude that the economic transactions between the Company and the applicant, which were documented by the disputed VAT invoices, did not take place, and that the applicant recorded in the accounts transactions that did not actually take place. Since the applicant knew or should have known of the VAT fraud (i.e. the actions of the above-mentioned companies in creating as large a chain of transactions as possible with companies which do not actually carry out their activities and which do not pay VAT), the Court of First Instance was justified in upholding the conclusions reached by the Inland Revenue and the Commission that the applicant was dishonest in its dealings in the dispute, and that it did not take any interest in the availability of the contractors to carry out the services at issue.

Moreover, in the same case, the Supreme Administrative Court, in its reply to the applicant's appeal that the inspection had revealed deficiencies in the documents supporting the economic transactions only from the initial recipient of the service and from the individual final performers of the service, with whom the Company had no direct legal relationship, stressed that the disclosure of the chain of VAT fraudulent transactions is relevant for the assessment of the applicant's participation and/or knowledge or potential knowledge of that participation. The Board of Appeal noted that the companies did not provide packaging services to the Company, i.e. the content of the economic transactions is not as set out in the disputed VAT invoices. The original service providers of the chains of transactions did not carry out any real activity at the time of the disputed transactions and did not carry out the packaging of the goods referred to in the VAT invoices in their name under the conditions and circumstances set out in the invoices. The totality of the circumstances established by the STI with regard to the actions of the original service providers and the Company's contractors who purchased services from those companies substantiates that the applicant's contractors, together with the suppliers of the original transaction chains, committed VAT fraud by issuing only formal sales and purchase documents without actually performing the services.

Therefore, in the end, the Chamber of Judges finds that the evidence collected in the case and duly assessed by the Court of First Instance confirms the defendant's findings that the applicant infringed Article 58(1)(1) and Article 64(1) of the Law on VAT, by deducting input VAT on the basis of VAT invoices issued in the name of companies, which are not of any legal force. The tax administrator has duly discharged the burden of proof and has gathered sufficient evidence to prove that the applicant is not entitled to deduct VAT on the basis of the VAT invoices issued in the name of companies.

What facts are relevant to deny the right to deduct input VAT

The article goes on to examine in detail the situation in which VAT is charged where the tax authorities have established that the company's contractors have committed VAT fraud and the company knew or had reason to know that it was involved in transactions involving VAT fraud.

It is these situations that are the most challenging for accountants, as there are many evaluative considerations that determine the appropriate assessment. So let's look at what the tax authorities and the courts have been assessing in recent case law.

In a completely new case, the dispute concerned VAT after the tax authorities had established that UAB X and UAB Y were committing VAT fraud and that the applicant knew or should have known that it was involved in transactions involving VAT fraud and that it had increased the allowable deductions on the basis of the VAT invoices in the names of UAB X and UAB Y.

The Supreme Administrative Court held that the Court of First Instance, in finding that the applicant knew or ought to have known that his transactions with UAB X and UAB Y were part of a VAT fraudulent scheme, correctly identified the law applicable to the case.

It pointed out that the case proved beyond doubt that UAB X and UAB Y had committed VAT fraud by acting as 'missing traders', i.e. by falsifying documents (VAT invoices, diesel quality certificates), by acting on behalf of unidentified persons and by failing to declare and/or pay the VAT deducted from VAT invoices issued to the applicant in the VAT return for the period at issue. In assessing whether the applicant knew or should have known that it was involved in transactions involving VAT fraud, the evidence must be assessed in its entirety and not in isolation, as is the case in the appeal.

The Supreme Administrative Court stated that it was proved in the case that both UAB X and UAB Y were newly established companies, with no marketing, assets, trustworthy place of business, practically no real human resources, and carrying out activities (diesel trading) which were not declared as their activities. These circumstances are immediately apparent to an experienced market operator and the applicant should have been particularly careful with regard to UAB X and UAB Y before deciding to purchase fuel from new business partners, but, as can be seen from the file, the appellant did not even establish the identities of the persons representing the suppliers.

Another relevant recent ruling of the Supreme Administrative Court is a recent one, where the assessment of VAT is at issue when the tax administration has established that the Applicant's contractors have committed VAT fraud and the Applicant knew or had the possibility to know that he was involved in transactions related to VAT fraud.

Let us consider what circumstances are relevant in the context of a VAT assessment where the tax authorities have established that the Applicant's contractors have committed VAT fraud and the Applicant knew or had the possibility to know that it was involved in transactions involving VAT fraud.

In this situation, the appellant did not gather the necessary relevant information about the companies before entering into the transactions with UAB X and UAB Y. Although the appellant claims to have gathered all publicly available information on the counterparties, it is clear from the documents in the case file that the information on the counterparties (their debts to Sodra) was searched for on the website already after the conclusion of the transactions with them.

Moreover, the documents of the tax case do not contain any information on the representatives of UAB X and UAB Y, with whom communication was made during the conclusion of the disputed transactions - the owner of the applicant in his explanations to the tax administration only indicated the e-mail addresses of the contractors, which were used to communicate with the representatives of UAB X and UAB Y, but did not indicate the names of these persons. Moreover, the director of UAB X had died, but the documents (3 VAT invoices and 3 cash receipt orders) continued to be issued in his name. It should be noted that the applicant paid 41 % of the amount payable for the diesel in cash to UAB X on the basis of 3 cash-in-kind orders issued after the death of that person. The orders were signed by the person. Consequently, the diesel was sold on behalf of UAB X by other, unidentified persons, but not by representatives of UAB X, as the company was not staffed after the death of the director and no new director was appointed. Thus, the Supreme Administrative Court upheld the position of the tax administration that it was unlikely that the owner and/or the chief accountant of the applicant did not verify the identity and authority of the person who delivered the documents (cash receipt orders) before paying a substantial amount of money in cash.

Moreover, the applicant, as a professional in his field, should have noted the deficiencies in the documents submitted by the contractors: discrepancies in the VAT invoices, the waybills and the quality certificates, the absence of the seller's (supplier's) seal, the absence of the name and signature of the person responsible, the uniformity of the documents (contracts, VAT invoices and consignment notes) in the name of JSC X and JSC Y.

The Supreme Administrative Court rejected the appellant's argument that it was not obliged to additionally inquire into the reliability of the contractors, as this had been assessed by the competent authorities (the State Tax Inspectorate when registering them for VAT purposes, the municipal administrations of the cities of Vilnius and Kaunas when issuing the licences), since the company cannot justify its failure to act on the basis of the actions of other authorities when it did not itself verify the identity and authority of the representatives of UAB X and UAB Y to act on behalf of those companies, and when it did not take note of the obvious deficiencies and inconsistencies in the documents, such behaviour is not characteristic of a prudent businessman and a conscientious tax payer.

The Supreme Administrative Court noted that the appellant's claims that it is intolerable in a state governed by the rule of law that, as a result of the State authorities' possibly negligent assessment and control of the legality and reasonableness of an economic operator's economic activity, when the latter carries out transactions involving VAT fraud, the tax liability which the fraudulent operator failed to discharge is transferred to an honest economic operator who pays all taxes on time, are of an abstract nature, and do not contain any specific facts concerning the unlawful actions of the authorities.   Moreover, it is the appellant's direct responsibility, and not that of the authorities, to establish the identities of the persons acting in the name of UAB X and UAB Y in the context of the transactions and the payment of money.

These are all important considerations for businesses to be aware of in order to preserve their right to deduct VAT.