Tax Partner at RSM Poland
You must have already heard about the principle of good faith and due diligence in the context of value added tax (VAT). This issue has been addressed many times by the courts, both Polish and the Court of Justice of the European Union (CJEU), which means that taxpayers quite often have disputes with tax authorities in this respect.
The Ministry of Finance has also recently issued the “Methodology of evaluating due diligence compliance of buyers of goods in domestic transactions". You can read more about this in a series of articles on our blog entitled: How to verify the contractor to avoid being involved in a tax fraud (read here). Nevertheless, the tax authorities continue to interpret the concept of “good faith” somewhat differently from e.g. the CJEU or some formations of the court in Polish administrative courts. In this context, the ruling of the Provincial Administrative Court in Wrocław of 10 July 2018 file ref. No. I SA/Wr 256/18 deserves particular attention, as the court relied very extensively on both the EU and Polish case-law in its reasoning. I highly appreciate the competence standard of this ruling; hence I am going to use it as a starting point for further discussion.
In the analysed case, a company involved in scrap metal trading would first purchase and then sell steel products and copper cathodes. The purchase was made primarily through domestic transactions. The taxpayer applied a VAT rate applicable to such transactions, i.e. 23%, and at the same time had the right to deduct the input tax from the purchase invoices. A large part of these goods was generally sold to contractors registered on the territory of European Union Members States other than Poland. Thus, the sale was made on terms and conditions of the intra-community supply of goods, and the company was entitled to apply the 0% rate VAT. As a result, the company generated a large surplus of input tax over output tax on a regular basis. On the one hand, the company was a taxpayer trading so-called sensitive goods, being in the spotlight for years, and on the other hand, the sales structure and the rules and principles of intra-EU transactions taxation generated a large surplus of the input tax over the output tax consistently and regularly.
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In a tax audit concerning VAT in the period from October 2012 to June 2013, the tax authority decided that the company did not have the right to deduct the input tax nor to apply the 0% rate of VAT under the intra-community supply of goods. The head of the tax office has established that the goods traded by the company were used in a tax fraud at earlier stages of their marketing, and the fraud consisted in extorting VAT. According to the tax authority, the taxpayer failed to exercise due diligence and did not act in good faith; the company should have known that the transactions it concludes at later stages are part of a tax fraud. When considering the appeal, the second instance authority approached the case the same way; as a result, the case was brought to court.
When considering the complaint, the Provincial Administrative Court in Wrocław disagreed with the position of the tax authorities and repealed the decision appealed against by the taxpayer. The reasoning included a detailed analysis of the method of the adduction of evidence and the concept of good faith. On the day of publishing this article, the issued ruling is not final and binding yet; however, it must be noted here that preparing a sensible last resort appeal is going to be quite a challenge in this case.
To start with, the Court referred to the fact that the right to deduct the input tax is not a tax relief but a fundamental taxpayer’s right. The common value added tax system requires VAT to be harmonised. This means that on the territory of each Member State, taxation rules and principles are the same for similar goods and services. One of these principles is the neutrality of taxation, according to which the taxpayer shall not be charged with this tax and shall not benefit from it as a result of settlements the taxpayer makes. The right to deduct the input tax is a tool that serves this principle. It is necessary to guarantee tax neutrality, because the economic burden of VAT is not placed on the VAT payer, but on the final consumer (who is not a taxpayer) purchasing a given commodity (good or service) for the purpose of (private) consumption. In other words: the economic burden of the tax is transferred to the final purchaser, as it is the expenditure the final consumer incurs on the purchase of goods and services that is subject to VAT.
Let us illustrate this with an example. Company A purchased steel products (garage cabinets) from Company B in order to use them for taxable activities, including, among others, the retail sale of these goods to a person who is not running any business. This consumer pays a gross price to Company A: the price includes VAT that is charged to the consumer. Company A must transfer it to the tax office, but the company may also deduct the amount of VAT it has paid to their supplier (as VAT is not supposed to be a burden for Company A). Thus, the tax office is only going to receive the difference, as from the perspective of Company A this is someone else’s money, i.e. the amount of VAT financed by the consumer. Thus, the purchase of goods entitles Company A to deduct the input tax shown on the purchase invoice. In the subsequent stage of marketing, Company A as a VAT payer is under obligation to pay the tax, yet the funds for this payment will be received from the customer being the consumer. Company A merely transfers the tax collected from the purchaser and included in the price of goods to the tax office, and deducts the amount it has paid to another taxpayer (their supplier).
The Court pointed out that, just like the right to deduct the input tax, the application of the 0% VAT rate for the intra-community supply of goods is not a benefit (hence not a relief), but merely a constitutive element of the value added tax. The intra-community supply of goods is a specific instance of the supply of goods that involves applying the 0% VAT rate by the supplier, with the right to deduct the input tax being preserved. The 0% VAT rate (exemption with the right to deduction) can only be applied if:
- the right to control the goods as the owner has actually been transferred to the purchaser;
- the goods have been physically transferred between EU Member States.
If the supplier furnishes all evidence attesting their right to apply the regime of the intra-community supply of goods, the authority cannot deprive them of the right to apply the 0% tax rate. With such a settlement methodology, the taxation is actually transferred to another EU Member State, where the final consumption of the supplied goods will most probably take place. Since consumption expenditure is subject to VAT, the revenue from this tax is due to the Member State on the territory of which the consumption takes place. The application of the 0% rate is thus technical in nature, which is incredibly important for correct VAT settlement within the European Union.
Unfortunately, the aforementioned constitutive features of VAT are deliberately abused by dishonest taxpayers who organise fraud schemes aimed at extorting VAT. Therefore, the tax authorities must remember to examine the case thoroughly and with due consideration for essential facts before they impose any limitations of the right to deduct the input tax or apply the 0% VAT rate for the intra-community supply of goods. The fundamental constitutive features of the value added tax should be considered at all times, and one cannot follow the assumption one bad apple spoils the barrel. There is no room for collective responsibility here, at least for two reasons:
- punishing taxpayers for other people’s mistakes is not justified (as they do the job of tax administration to a large extent when it comes to tax settlement),
- to perform their fraud effectively, fraudsters use honest taxpayers as a smokescreen: it automatically precludes punishing the latter, as they did not know and could not have known anything about the fraud.
This aspect is going to be discussed further in the next article of our series.
Summing up: what we would like to draw your attention to in our entire series dedicated to good faith is the fact that value added tax does not have to be as complicated and difficult to recover as it may seem from the perspective of disputes with the tax authorities. The underlying assumption of the common VAT system is that it guarantees the total neutrality of this tax, and it can be limited only in exceptional circumstances, i.e. if the taxpayer himself commits a tax fraud or if he does not commit a tax fraud himself but does not act in good faith when purchasing goods or services. The risk management in this field can be effective: it simply must be based on well-implemented in-house procedures. The taxpayers are offered a helping hand by the courts, both the Court of Justice of the European Union and domestic administrative courts. Tax authorities cannot take the path of least resistance and compensate their indolence in prosecuting fraudsters by way of harassing honest taxpayers. In the next article of our series I will discuss the premises of good faith that have been presented by the courts and should be taken into account when establishing such in-house procedures.
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