One of the most frequent areas of dispute between the tax authority and taxpayers relates to the conditions under which a taxable entity participating in a chain transaction can deduct the VAT passed on to it. The tax authority (NAV) was recently struck another blow in the tussle when the Supreme Court, in a precedent-setting ruling, took issue with the tax authority’s practice of regularly reclassifying the participants in chain transactions as agents. What’s more, the Curia’s ruling goes significantly further, and questions in general the tax authority’s right to reclassify the transactions of taxable entities on a whim.
NAV has very broad powers to classify a transaction for the purposes of taxation, based on its actual economic content. This reclassification does not affect the business or civil-law aspects of the relationship between the parties, but it can entail a serious additional tax and penalty payment obligation.
One of the “favourite” areas for reclassification is VAT, and specifically chain transactions. Chain transactions are where a product is sold several times in succession, but in spite of this only a single shipment takes place. In this case, the product is shipped directly from the first seller in the chain to the last buyer in the chain.
Usually what happens here is that the last buyer has a need for a given quantity and quality of product, and wants to purchase it from a trader. If the trader does not have a product (in sufficient quantity) that meets the requirements, then he in turn will try to obtain it from tried and tested partners in the market. For reasons of cost-effectiveness, it isn’t in the interests of the intermediate participants to store the goods and then ship them on themselves. So accordingly, the end seller, who actually has possession of the product, is typically instructed to ship the goods directly to the buyer who originally placed the order. In this way, the intermediate trader has no actual physical contact with the goods; indeed, usually he does not even know precisely who arranged the transportation of the goods and on whose instructions.
For a long time now, NAV has “pounced” on these transactions, even if no tax evasion has taken place. One popular finding in such cases is that the intermediate participants were not acting as “real” traders, but they only “brought together” the buyer and the seller. So the transaction is reclassified for the purposes of VAT, and the intermediate participants are no longer regarded as seller and buyer, but merely as agents.
But while an intermediate merchant actually buys and sells the products, an agent only provides an agency service, and is not itself entitled to issue a sale-of-goods invoice to the “customer”. In this case, therefore, NAV refuses the right of the given buyer to deduct VAT, on the grounds that they bought a service, not a product, from the party they were dealing with. It also refuses the right of VAT deduction at the “agent”, saying that it did not purchase the product, but merely brokered a deal between the buyer and seller.
The Supreme Court steps in
Recently, in a precedent-setting ruling, the Supreme Court also took a position in the case. The court concluded that, in the course of chain transactions, the intermediate participants cannot be regarded as agents simply because they do not come into physical contact with the goods, and because they do not perform the transportation themselves. The Supreme Court also stated that, for the purposes of VAT, in order for a sale of goods to take place it is not necessary to physically take possession of the product, and neither does the single shipment mean that the intermediaries are agents and not sellers. In these cases, therefore, the tax authority is required to produce other evidence to support the reclassification of the intermediate participants as agents.
And there’s more
At the same time, the decision of the Supreme Court does not only relate to chain transactions, but also to reclassification for VAT purposes in general: the court has declared that NAV’s right of reclassification for VAT purposes is far from being unlimited; the tax authority may only exercise it if doing so is essential in order to prevent tax evasion or to ensure the accurate collection of taxes. And in most of the cases involving VAT (since the VAT is only a “pass-through” item for most of the entities involved), there is no difference in the overall tax impact between the basic and the reclassified transaction. This means that reclassification as an agent does not result in an overall higher VAT liability; all that happens is that in one case the intermediate participant pays tax on the “price mark-up”, and in the other, on the “commission”.
Another important consequence of the judgement of the Supreme Court is that the amount of the VAT cannot be demanded twice by the tax authority in the event of reclassification as an agent. It is not possible, therefore, to deny the “agent’s” right of tax deduction on the one hand, and then, citing only the fact that the invoice was issued, to also demand the full amount of VAT payable on the product sale. This finding by the Supreme Court, in itself, could serve as a formidable defence in many tax-authority procedures where the simple reclassification of transactions results in a multiple VAT payment obligation.