Last reviewed 27 September 2012

Henrietta Clarke reports on two cases before the European Court of Justice concerning the deduction of VAT.

European Court of Justice judgment

In June 2012, the European Court of Justice (ECJ) ruled that the deduction of VAT cannot be refused, in principle, because of irregularities committed by the issuer of the invoice. However, that deduction must be refused if the taxable person knew, or ought to have known, that the transaction relied on as a basis for the right to deduct was connected with fraud.

Case studies

Under the 2006 VAT Directive, undertakings may, as a general rule, deduct the amount of input VAT which they have already paid at the time of acquiring goods or services. They must hold an invoice duly drawn up for the supply of those goods or services.

This ECJ judgment concerned two joined cases from Hungary. Hungarian law requires taxable persons to act with all due diligence to satisfy themselves as to the propriety of transactions that give rise to VAT.

Mahageben kft

The first case concerned a Hungarian undertaking, Mahageben kft, which sought to deduct from the amount of tax for which it was liable the tax it had paid to its supplier. The supplier issued invoices for delivery of the goods and paid to the public exchequer the VAT which Mahageben had paid to it. Mahageben, in turn, exercised the right to deduct. However, after an inspection of the supplier’s premises, the Hungarian tax authority took the view that invoices submitted by Mahageben did not reflect the genuine circumstances of those deliveries and refused Mahageben the right to deduct VAT. The tax authority also criticised Mahageben for failing to satisfy itself as to the status of its supplier and failing to check whether the supplier had complied with its statutory obligations in respect of VAT.

Peter David

In the second case, Mr David carried out, under a works contract and through subcontractors, a variety of construction works and wanted to deduct VAT that he had already paid to the subcontractors. The Hungarian tax authority, however, refused to allow him to deduct that tax because of the improper acts of those subcontractors.

The judgment

The Court pointed out that the right to deduct provided for by the directive, being an integral part of the VAT scheme, may not, in principle, be limited. However, the Member States may refuse to allow the right to deduct where it is established, on the basis of objective evidence, that that right is being relied on for fraudulent or abusive ends. It is for the tax authority, however, to establish that the taxable person was aware, or ought to have been aware, of the existence of such fraud. It is also for the tax authority to carry out the necessary inspections of taxable persons to detect VAT irregularities and fraud, and to impose penalties.

In these particular cases, the Court found that the transactions relied on as a basis for the right to deduct were, in fact, carried out and that the corresponding invoices included all the information required by the directive, so the conditions needed to exercise the right to deduct were fulfilled.

In those circumstances, the Court ruled that the directive precludes the practice of the Hungarian tax authority of refusing to allow a taxable person to deduct VAT paid because of improper acts on the part of the issuer of the invoice that forms the basis on which deduction is sought, and in the absence of proof that the taxable person was aware, or ought to have been aware, of fraud committed earlier in the chain of supply.

The directive also precludes a national practice whereby the tax authority refuses the right to deduct on the grounds that the taxable person did not satisfy himself that his commercial partner was in compliance with his statutory obligations.