VAT Fraud and the Role of the Tax Administrator

Introduction: Fraud and VAT

Let us examine the circumstances that are important when considering the calculation of VAT by the tax administrator after establishing that the applicant's contractors committed VAT fraud and the applicant knew or had the opportunity to know that they were participating in transactions related to VAT fraud.

Case Background: Dealings with JSC X and JSC Y

In the SACL (Supreme Administrative Court of Lithuania) case, the appellant did not collect important necessary data about the companies before concluding transactions with JSC (Joint-Stock Company) X and JSC Y. Although the appellant claims to have collected all publicly available information about the contractors, the documents in the case file show that information about the contractors (their debts to Sodra) was searched for on the website after the transactions with them had already been concluded.

Suspicious Circumstances and Document Issues

Furthermore, the tax case documents do not contain any information about the representatives of JSC X and JSC Y with whom communication took place when concluding the disputed transactions—in his explanations to the tax administrator, the applicant's owner only indicated the e-mail addresses of the contractors used to communicate with the representatives of JSC X and JSC Y, but did not indicate the names and surnames of these persons. In addition, the director of JSC X died, but documents (3 VAT invoices and 3 cash receipts) continued to be issued in his name. It should be emphasized that 41% of the amount payable for diesel fuel was paid by the applicant JSC X in cash according to 3 cash receipts issued after the death of the aforementioned person. The orders were signed by a person named Therefore, diesel fuel was sold on behalf of JSC X by other, unidentified persons, but not by representatives of JSC X, as there were no employees left in the company after the death of the director and no new director had been appointed. Thus, the SACL agreed with the tax administrator's position that it was unlikely that the applicant's owner and/or chief accountant, did not verify the identity and powers of the person who presented the documents (cash receipts) before paying a large sum of money in cash.

Court’s Assessment of the Applicant’s Conduct

The court explained that the applicant, being a professional in his field, should have noticed the shortcomings in the documents submitted by his contractors: discrepancies in VAT invoices, waybills and quality certificates, the absence of the seller's (supplier's) stamp, the name, surname, and signature of the responsible person, and the uniformity of the documents (contracts, VAT invoices, and waybills) issued on behalf of JSC X and JSC Y.

Arguments of the Appellant and Court’s Rejection

The Supreme Administrative Court of Lithuania rejected the appellant's argument that it was not obliged to make additional inquiries into the reliability of its contractors, as this had been assessed by the competent authorities (the State Tax Inspectorate when registering them as VAT payers and the relevant municipal administrations when issuing licenses), since the company cannot justify its inaction by the actions of other institutions when it failed to verify the identity of the representatives of JSC X and JSC Y and their powers to act on behalf of those companies, and did not pay attention to obvious deficiencies and discrepancies in the documents, such behavior is not characteristic of a prudent businessman and honest taxpayer.

The Supreme Administrative Court of Lithuania noted that the appellant's claims that it is unacceptable in a state governed by the rule of law that, due to the possibly negligent assessment and control of the legality and validity of the economic activities of an economic operator by state institutions, after the latter has carried out transactions related to VAT fraud, the tax liability of the fraudulent entity is transferred to a bona fide economic operator that pays all taxes on time, are abstract in nature and do not provide specific facts regarding the unlawful actions of the authorities. Furthermore, it is the direct responsibility of the appellant, not the authorities, to establish the identity of the persons acting on behalf of JSC X and JSC Y when concluding transactions and paying money.

Deductible Expenses and Fuel Purchase Costs

In addition, it should be noted that another relevant issue was decided in this case: the court of first instance, having recognized that the fuel invoiced on behalf of JSC X and JSC Y was actually delivered to the applicant and that the company incurred costs, and applying the provisions of Article 69(2) of the Law on Tax Administration, it ruled that the company was entitled to recognize the fuel purchase costs as deductible expenses and annulled the order to pay income tax, interest, and a fine.

Supreme Administrative Court’s Reassessment

In the opinion of the Supreme Administrative Court of Lithuania, the evidence in the case shows that the applicant ignored obvious signs of tax fraud and failed to take basic measures to ensure that the supply transactions did not involve tax fraud. The circumstances indicated by the appellant, namely that the transactions concluded by the company with JSC X and JSC Y covered a small part of the market for fuel purchased by the applicant, and that the company had been operating for a long time and in good faith, did not refute the circumstances established in this case that the company must have known that by purchasing the goods it was participating in a transaction involving VAT fraud.

Meanwhile, the State Tax Inspectorate disagreed with this assessment and claimed that the court had unjustifiably recognized, in the context of other established circumstances, that the expenses on the basis of which the costs were recognized could be based on documents that had no legal force; It pointed out that the court had not assessed Article 11(4) of the Law on Tax Administration. The Supreme Administrative Court of Lithuania found the State Tax Inspectorate's arguments to be well-founded and upheld the State Tax Inspectorate's appeal in this part.

Principles of Tax Law: Substance Over Form

It is important to note that the Supreme Administrative Court of Lithuania stated that the court of first instance had applied the principle of substance over form in calculating the tax, which, inter alia, provides that in cases where a taxpayer makes a mistake in drawing up accounting documents and submitting a tax return, as well as in other cases where the taxpayer's activities do not comply with the formal requirements of legal acts but their content corresponds to the circumstances to which taxation is linked by tax laws, the tax shall be calculated by applying the relevant provisions of the aforementioned tax laws (Article 69(2) of the Tax Administration Law). Thus, the aforementioned principle is a general principle of tax law which is applied in accordance with other tax law provisions.

The Supreme Administrative Court of Lithuania emphasized that the practice of the Supreme Administrative Court of Lithuania has noted that "the fact that the accounting documents (in this case, VAT invoices) on which the taxpayer's right to deduct certain expenses from gross income when calculating income tax is based do not reflect the actual content of the economic operation per se (in itself) allows for the presumption of a legal fact that a person, relying on these accounting documents (VAT invoices) and the data recorded therein, cannot recognize (justify) expenses that reduce income tax. In such a case, the taxpayer, similarly to proving his right to deduct VAT on the basis of the relevant VAT invoices, must provide evidence (prove) of the legal facts which entitle him to deduct the expenses – the type, quantity, value of the goods (services) purchased, the seller of the goods (service provider) and other circumstances related to the incurrence of expenses in earning income.

The explanations provided and case law are considered very important in practice, as they are binding on both the State Tax Inspectorate and entities when fulfilling their tax obligations.

The “Missing Traders” Case

In another Supreme Administrative Court case, a dispute arose after the VAT tax administrator determined that JSC X and JSC Y had committed VAT fraud, and that the applicant knew or should have known that it was participating in transactions related to VAT fraud and the increase of deductible expenses based on VAT invoices issued in the name of JSC X and JSC Y.

The Supreme Administrative Court of Lithuania stated that the court of first instance had correctly identified the applicable law in the case when it found that the applicant knew or should have known that the transactions it had concluded with JSC X and JSC Y were part of a VAT fraud chain.

It noted that the case had undoubtedly proven that JSC X and JSC Y had committed VAT fraud by acting as "missing traders," i.e. they forged documents (VAT invoices, diesel quality certificates), unidentified persons acted on their behalf, and the VAT declared in the VAT invoices issued to the applicant was not declared and/or paid for the period in question. When assessing whether the applicant knew or had the opportunity to know that it was participating in transactions involving VAT fraud, the evidence must be assessed as a whole and not separately, as is done in the appeal.

The Supreme Administrative Court of Lithuania stated that the case proved that both JSC X and JSC Y were newly established companies with no marketing activities demonstrating minimal real activity, no assets, no place of business that would inspire confidence, practically no real human resources and activities (trade in diesel fuel) that were not declared as their activities. These circumstances are immediately apparent to an experienced market participant, Therefore, before deciding to purchase fuel from new business partners, the applicant should have been particularly cautious with regard to JSC X and JSC Y, but, as can be seen from the case file, the appellant did not even establish the identities of the persons representing the suppliers.

Addendum: Legal Provisions on Accounting

In addition, it should be noted that in fraud cases, the court also points out that Article 11(4) of the Law on Accounting provides that expenses recognized as costs may only be based on legally valid documents that must contain all the mandatory accounting information specified in the laws and regulations governing accounting. may be based only on legally valid documents that must contain all the mandatory accounting document details specified in the legislation governing accounting. In addition to these details, the documents supporting the expenses recognised as costs must also contain other additional details specified by the Government of the Republic of Lithuania or its authorised institutions. The Supreme Administrative Court of Lithuania noted that these legal provisions are important not only for a specific entity, but also for the tax and economic environment in general, i.e. they ensure that all participants in economic transactions fulfill their tax obligations and that illegal activities, such as those in this case, trade in contraband or stolen diesel fuel or diesel fuel sold without paying the required taxes, and cannot be ignored by absolutizing the principle of the primacy of content over form.

Furthermore, in the present case, company S recorded in its accounting records economic transactions which did not take place between the economic operators indicated under the conditions specified. Company S also included monetary amounts in its expenses on the basis of accounting documents that had no legal force, i.e., it recorded business transactions in its accounting records that did not take place between the specified economic entities under the specified conditions. The circumstances of the case show that Company S does not have accounting documents that would reveal the true content of the disputed business transactions—the actual parties to the transactions, the persons representing them, the origin of the diesel fuel, etc. In the absence of the actual content, there are no grounds for applying the principle of substance over form.