In its latest decision, the European Court of Justice (ECJ) has ruled that the Hungarian tax authority (NAV) unlawfully refused to allow VAT deduction to taxpayers who could not have known that the invoice’s issuer was implied in tax fraud. A special twist in the so-called Signum case is that it was the court of first instance who referred the case to the ECJ, as opposed to the guidelines of Hungary’s supreme court. The decision will have a significant bearing on ongoing tax audits and tax-authority findings, especially in the agricultural and trade sectors.
In the well-publicised Mahagében and Tóth cases, the ECJ declared that the right to deduct VAT may only be denied if the tax authority can prove that the taxpayer knew, or with due circumspection ought to have known, that the parties preceding it in the sales chain had participated in tax fraud. It also stressed that the investigation as to whether the taxpayer was indeed aware of such fraud should not put on the taxpayer “tax inspection” obligations. Companies cannot be required, for instance, to check how many registered employees the vendor has, or to investigate whether the vendor possesses the means to fulfil the transaction.
In response to the above decisions, the tax authority established a new practice: if it found any irregularities at the vendor, it argued that the transaction had not been made between the parties concerned, and that the content of the invoices issued by the vendor and accepted by the buyer lacks credibility. In this way, the tax authority denied the buyer its right to deduct tax, regardless of whether it could have known anything of the irregularity.
In doing so, contrary to the earlier ECJ judgments, it once again established that the party accepting the invoice is liable for tax fraud committed at an earlier stage in the chain: in effect, NAV was demanding that parties accepting invoices perform full due diligence on the vendor. This clearly placed the taxpayers under an investigation obligation that they had neither the resources for, nor any realistic chance of, fulfilling. In its judgments passed in recent years, the supreme court also gave its blessing to NAV’s practice in this regard.
The ECJ has called a halt to the prevailing practice
In the Signum case, the details of which were published recently, one of the judges at the Hungarian court of first instance turned to the European Court of Justice, as he considered it to be against EU law for taxpayers to be denied the right to deduction on the ground that they were held culpable of omitting the already mentioned full due diligence. An interesting aspect of the case is that the court escalated the matter in a repeated procedure; in other words, the supreme court had already made it clear in the case concerned that the awareness of the party accepting the invoice is not to be examined in such cases.
In its decision, the ECJ highlighted that it is not sufficient for the tax authority to establish that the company issuing the invoice could not have performed the service. In such cases NAV must also prove that the company accepting the invoice knew, or ought to have known if it had proceeded with sufficient caution, about the infringements committed by the invoice issuer. In other words, the test of whether due circumspection was applied may not be omitted even if NAV proves that the service was not performed by the company issuing the invoice.
An important element of the decision is that proving the “state of awareness” may not be based on the absence of such checks that the recipient of the invoice should not have performed as a prudent businessman. This means that, in future, buyers acting in good faith who have ascertained that the vendor fulfils the basic conditions for operation (existing company, active tax number, representative is properly authorised to represent it, etc.) cannot be held liable for tax fraud committed at an earlier stage in the supply chain, if they were not otherwise aware of such.
Is this the end of the road?
Based on experience so far, the court’s decision is unlikely to cause NAV to desist from these types of VAT audits. The tax authority is likely to develop new weapons in its efforts to catch up in some way or other with the VAT revenues that the budget is being cheated of. The ECJ, however, has again confirmed that in the course of doing so, NAV must conduct a more thorough investigation of what the buyer knew. As a result of this, hopefully, taxpayers who genuinely act in good faith will have less to fear from VAT audits in the future. And after all, this is what NAV’s new, client-friendly approach, promised to the public, is based on.