Over the last decade, the number of precedents and cases from arbitration courts involving the tax authorities challenging an offset of input VAT has dramatically increased.
Following the introduction of Article 54.1 to the Tax Code, which deals with anti-abuse rules, the tax authorities and courts have started rejecting deductions of input VAT from ‘bad-faith suppliers’ (companies usually created for a short period of time with the aim of benefitting from tax evasion schemes) even if the goods, work or services have been supplied or provided.
After a long silence, in its Determination No. 307-ES19-27597 of May 14 2020, the Supreme Court gave its view on whether a company loses its right to claim its input VAT for offset if its supplier has signs of being a so-called ‘bad faith supplier’. The Supreme Court reconfirmed that the right to recover VAT does not necessarily depend on a supplier’s good faith provided that there was an actual supply and the taxpayer acted in good faith.
This follows from a case when the tax authorities undertook a field tax audit of SPTB Zvezdochka JSC, covering the company’s activities in 2013, 2014 and 2015. As a result, the tax authorities rejected the company’s right to seek an offset of input VAT charged by its supplier, SK Logistic LLC, and instead claimed additional VAT from Zvezdochka, along with related tax fines. This was because, in the authorities’ view, the supplier was acting in ‘bad faith’. The tax authorities conclusion was based on the following arguments:
The supplier did not have economic resources to fulfil its contractual obligation;
The supplier did not have fixed assets to provide the services envisaged by the contract;
The average number of employees was one person;
Invoices and consignment notes had been signed by a non-authorised person;
The supplier’s costs and input VAT were almost equal to its revenue and output VAT; and
No due diligence had been performed by the taxpayer on the supplier.
The Court of First Instance supported the company, but the Court of Appeal and Cassation rejected the lower court’s decision and supported the tax authorities on the basis that the company’s supplier did not pay VAT and thus did not transfer to the treasury the funds which could be used by the purchasers to recover the VAT. The company continued litigating with the authorities and took the case to the Supreme Court, which rejected the previous court rulings and supported the company.
The Supreme Court supported the company, stating that the right to recover VAT does not depend on the good or bad faith nature of the taxpayer’s suppliers, provided that the goods, work or services were actually supplied (provided) to the taxpayer. The court ruled that a taxpayer’s right to recover its input VAT does not depend on whether its suppliers paid VAT, the financial position of those suppliers or the way they conduct their business activities.
According to the determination, the tax authorities can deny the offset of input VAT on the basis of the following grounds:
The supply of goods, work or services never happened;
It is proven that the transaction in question was aimed at tax evasion; or
The taxpayer did not aim at tax evasion but knew or should have known that tax evasion was the aim of its direct or indirect supplier.
If the taxpayer was not engaged in tax evasion or did not know, nor should have known, about such tax evasion but acted with the reasonable due care, the refusal to offset input VAT would mean that the taxpayer was being penalised for the misconduct of others.
In the judges’ view, due care should include a review of not only contractual terms and conditions but also a contractor’s business reputation, solvency, the risk it may fail to perform its obligations, the availability of the required resources and its capacity (production facilities, technical equipment and qualified personnel), and whether they have relevant experience.
Furthermore, due care should depend on the materiality of the relevant transaction. In significant transactions (for instance, those concerning real estate), the taxpayer should perform due diligence on the history of a seller’s relationship with its prior owners, etc. The source of this information would be the supplier’s financial and tax reports.
As such, the determination has provided guidance which did not previously exist on how a taxpayer can demonstrate that it acted in good faith. Though the determination covers years when Article 54.1 of the Tax Code, which deals with anti-abuse, was not yet in effect, it is going to be interesting to see how court practice on this issue will develop.
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