Supreme Administrative Court Ruling on Allowable Deductions for Foreign Documents

Introduction

The article reviews the recent case law of the Supreme Administrative Court on how costs are recognised as allowable deductions for the purposes of corporate income tax when companies hold foreign documents. This is particularly relevant in the context of the increasing number of international business transactions. 

Conditions for Allowable Deductions under Lithuanian Law

The extended panel of judges of the Supreme Administrative Court of Lithuania (SACL) has clarified the conditions for allowable deductions by stating that, with the exception of the exceptions provided for in the Corporate Income Tax Law (individual cases), only such costs of an entity which meet the following conditions that must exist together (cumulative) are recognised as allowable deductions: (1) the costs must be actually incurred; (2) the costs are incurred in the course of the entity's commercial or productive activities; (3) the commercial or productive activities in which the costs are incurred are for the purpose of generating and/or producing income or other economic benefits; (4) the costs must be incidental to the activities in which the entity incurs the costs; and (5) the costs must be necessary to generate the entity's income or economic benefits.

Case Study: Recognition of Costs Based on Foreign Documents

Meanwhile, in a new case, the Supreme Administrative Court (SAC) discusses costs as allowable deductions under foreign documentation. Let's look at what the court has revealed.

In this case, the Court stated that the tax authorities had established during the audit that the LTD had purchased marketing services from an Estonian company and had also purchased intermediary (marketing) services from an Estonian company (, and had attributed these costs as allowable deductions in the calculation of the taxable profit for the relevant tax periods. The company's main activity is the processing, preserving and production of meat and meat products.

Court’s Evaluation of Documentary Evidence

Here, the Court disagreed with the applicant's position that the company had provided the tax authorities with all the available evidence, had provided detailed explanations on the nature and content of the brokerage services, on the specific features of the market in which the company operates, and had prepared analyses and summaries of the results of its activities, but that the tax authorities had formally evaluated the evidence provided by the company, had unduly overemphasised the importance of the information provided by the foreign tax authorities, and had failed to take into account the fact that the information provided by the foreign tax authorities also confirms the provision of the service.

In order to shed light on the practical assessment of the documents, it should also be mentioned that the Court found from the content of the invoices and the service acceptance documents submitted in the case that the service acceptance documents were signed by more than one person. The acts signed by natural person X include the name of natural person X, whereas the others contain only signatures which are visually different from the signature of natural person X and which do not allow for identification. Thus, the acts of acceptance of services were not signed by the same person. The acts of acceptance of services were signed by the representative of the Estonian company, natural person X, although the signatures are different in many cases. The invoices do not bear the signature of the supplier. The commercial director signed on behalf of the purchaser of the services, LTD. The company explained the situation by stating that the invoices were issued directly from the electronic system and received by e-mail; it did not provide information on who exactly issued the invoices. The Commercial Director signed on behalf of the company (purchaser of the services).

The Role of Substance Over Form in Tax Assessment

Finally, the Company's Commercial Director stated in her initial explanation: she was in constant contact with the customers mentioned in the Act, as our company does not have the manpower resources and the fact of delivery of the products, the proper unloading cannot be fully controlled by the in-house export manager, and an external service was hired to supervise such deliveries.  It oversees the transit of the products and the settlement of payments. The deeds were drawn up on the basis of the work done by the representative with the buyer in question. The Court agreed with the tax authority's assessment that the explanation should be viewed critically, since the company's employees are generally more aware of the quality of the movement of goods and other features of the company's operations and transactional policies than an external user. Moreover, as established by the Tax Inspectorate, the company had paid a salary to the export manager, whereas the Estonian company (data not published) had been paid ten times that amount during the same period. According to the Court, the company could have hired additional export managers for that amount.

Thus, the Court recalled in the case that costs are recognised on the basis of documents drawn up by foreign entities or natural persons if the substance of the transaction can be determined from those documents.

Requirements for Supporting Documents

This case was supplemented by another case from the Supreme Administrative Court. The situation was that fuel was actually supplied to an undertaking (the applicant) on the basis of invoices issued in the name of LTD X and LTD Y, and that this undertaking incurred costs. However, as the documents in question were defective, a tax dispute arose between the company and the tax authorities.

Implications for Taxpayers and Authorities

This case leads to a very important conclusion:

the accounting documents (VAT invoices in the present case), which are the basis for the taxpayer's right to deduct certain costs from gross income for the purpose of calculating corporation tax, do not reflect the actual content of the economic transaction, and in themselves give rise to the presumption of a legal fact that a person cannot recognise (justify) costs that reduce the amount of corporation tax on the basis of these accounting documents (VAT invoices) and the data recorded therein.

How should this relatively new interpretation in case law be understood and how does it affect the practice of the tax authorities? Let's see.

The ruling of the Supreme Administrative Court, which concluded the dispute, explains that the court of first instance followed the principle of substance over form in tax assessment, which provides, inter alia, that in cases where a taxpayer makes a mistake in the preparation of accounting documents and in the submission of a tax return, as well as in other cases where the taxpayer's activity does not comply with the formal requirements of the legislation, but its content corresponds to the circumstances to which the tax laws relate taxation, the tax shall be calculated by applying the relevant provisions of the said tax laws (Art. 69(2) of the Law on Taxes and Taxation).

Conclusion

Expenditure on the basis of which costs are recognised can only be based on documents which have the force of law and 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 rules are important not only for the entity concerned, 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.