Highgate Law & Tax: failure to allow VAT deductions can put a business on the back foot. Peter Varga’s statement for HOSPODÁRSKE NOVINY

In practice, there are several reasons for not granting the right to deduct VAT. The standard ones are that the entity on the invoice did not make the supply, it has not been proven that the supply was made, there was an unjustified tax advantage or there was tax evasion. Or a combination of these. Either way, the tax authorities disproportionately often act in a reckless manner and, worse, contrary to the current case law not only of the CJEU but also of the Slovak courts. And while the taxpayer may eventually be able to seek justice, the tax administrator’s decision is enforceable and therefore enforceable.

Why can the failure to recognise a VAT deduction have devastating consequences?

Imagine a trading company that buys goods worth €1,000,000 + VAT per year and then sells them for €1,100,000 + VAT. The gross margin is thus EUR 100 000 . If the tax authorities were not to allow the company to deduct the VAT (i.e. EUR 200 000), this would be an amount significantly in excess of the gross margin. Add to this the company’s other costs, and the non-recognition of the VAT deduction could be liquidating for the company.

Although the company can seek justice in court, until the court decides, this decision of the tax administrator is in most cases enforceable. And this entails in larger companies, for example, the loss of ratings against partner companies or the repayment of bank loans. And if the business as an individual is liable for the bank loan, the private assets of the company owner may also fall victim.

What are the common mistakes of the tax administrator?

In practice, we encounter several mistakes. These include simple procedural errors, such as the signature on the tax inspection report. Simple at first sight, but in the end, even such things can win a tax dispute. More complex and, above all, more dangerous are these oversights:

The supplier has not made delivery on the invoice

While the tax administrator does not dispute that the delivery did not take place, it does dispute whether the delivery was made by the supplier on the invoice. Did the supplier have employees? Which persons at the supplier made the delivery? If the delivery is of goods, did the supplier have a sufficiently large warehouse? For how long a period was that warehouse available?

Often these are requirements that are objectively outside the sphere of disposal of the audited tax entity. How is the taxable person to prove whether his supplier had employees and a sufficiently large warehouse at the time?

Such an approach of the tax administrator is contrary to the case law of the Court of Justice of the EU as well as the Constitutional Court of the Slovak Republic. The burden of proof of the tax subject is not absolute and such requirements are manifestly disproportionate. In so far as the tax authorities do not dispute the existence of the supply, the right to deduct VAT cannot be denied on the sole ground that it appears to the tax authorities that the supplier did not have sufficient material and personnel or that the transaction does not make economic sense to the tax authorities. This defence is supported by relatively recent court decisions and is therefore often disregarded by tax authorities in practice.

Devasion or tax fraud

It is common for a tax administrator to attempt to burden a healthy audited taxpayer with fraudulent conduct by one of the supply or purchasing partners in the chain. In other words, if someone in the chain has failed to pay VAT, it is the controlled tax entity that is supposedly liable to compensate the State.

However, the case law of the CJEU is clear on this point too. It is not enough for the tax authorities to raise doubts that the taxpayer being audited may have participated in fraudulent conduct. The tax administration must prove that the taxable person concerned knew or was obliged to know that fact. This jurisprudential view is sufficiently settled and should be automatically applied by tax administrations in tax proceedings. And if it is not, a court should be able to identify it and overturn the tax administrator’s decision.

Confusion of terms

A very common phenomenon is also the confusion of terms in the tax administrator’s reasoning. The use of the terms ‘undue tax advantage’ and ‘tax evasion’ or ‘tax fraud’ in the same reasoning is confusing. Each of those terms involves a different procedural position of the taxpayer under scrutiny. Therefore, if the tax administration is unable to formulate its line of argument clearly, the fairness of the proceedings is affected and the taxpayer concerned is prevented from making an effective legal defence in such a case. And this argumentation may be successful before the court.

Proof that delivery has taken place

In some proceedings, the tax authorities argue that the existence of the supply has not been proven. The burden of proof in this case lies on the shoulders of the taxable person. The taxable person should be able to prove that the supply actually took place. On the other hand, the taxable person cannot reasonably be expected to discharge that burden of proof absolutely and such proof must be beyond reasonable doubt. Unrealistic and cumbersome requirements by the tax authorities to prove the existence of, for example, supplies of services by means of detailed minutes of meetings, protocols or official records are frequent.

What should be the operational preventive defence?

If taxpayers want to avoid VAT irregularities during tax audits, one option is to be extremely diligent and check their suppliers and customers in detail. One of the main principles is not to do business with businesses that have a record of amounts owed to any of the public authorities. At the same time, caution should be exercised with newly established business partners, partners with minimal share capital and those with no employees or high turnover. Clients are advised to always verify suppliers as well as customers through public registers for larger deliveries and to record this information in separate records. Such steps can significantly help in arguments in tax proceedings.

What should be the systemic defence?

Setting the right corporate structure for the business. This includes, in particular, elements of protecting assets and values that may be threatened by tax proceedings, as well as protecting the owners of the companies themselves. However, caution must be exercised in such structuring. For example, in situations where the Financial Administration is already circling over the tax entity, the transfer of assets and business to another company needs to be dealt with not only through the lens of transfer pricing, the legal opposability of such transfers, but also criminal law. Therefore, it is important to set up the corporate structure of the business in advance.

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