On February 12^th, 2018, the Supreme Administrative Court (further only SAC) delivered a judgement that is very important for the tax area and angered a big number of experts.

The SAC defended the company Vyrtych a.s. based in Židněves in Mladá Boleslav District which is engaged in manufacture of lighting fixtures. The Financial Administration has not allowed this company the right to deduct tax because of an alleged involvement in a fraudulent chain.  The SAC enunciated in the grounds of the judgment that it is absolutely unacceptable for the Tax Administration to impose tax on any one participant in a chain of any length, or to focus on the payer where the tax will be most easily enforced.

With this judgement the SAC revoked the decision of the Municipal Court in Prague. According to the SAC, the Vyrtych company met all the conditions for the right to deduct. The court also said that the Financial Administration has not provided clear evidence of the company having known about any fraudulent activity or of the company’s involvement in such activity, or of a lack of precaution on the company’s side upon closing the deal.

In order to understand the context, we must go back a few years. In 2010, the Court of Justice of the European Union sent a message to all the member states about how to successfully fight fraudulent evasion of value added tax (further only VAT).

Within the European judicature, the sign of fraud is one of the participants not paying the tax and the other deducting it. According to the SAC, it is not possible to consider “any one” of the participants in the chain to be “the one” and “the further one”. One must always look for ties connecting a missing payment of tax, asking for the right to deduct, and any awareness about the potential for fraud.

Judge Matyášová stated in the grounds of the judgment that: “If this is not followed, it would create inadmissible grounds for objective tax responsibility of any subject involved in a marketing chain, and for responsibility for the movement and fate of goods.

The decision of the SAC is now being analysed by the Financial Administration. According to the SAC, the Financial Administration must allow the deduction of value added tax (VAT) to the Vyrtych company, which the Administration suspected of tax fraud. The SAC ruling further states that it is not possible to conduct controls of business partners in a chain limitlessly and to “conclude extensively that it is an infinitely long chain of persons”.

The grounds of the judgment state that there was no evidence of the company being in bad faith:

“The fact that the tax is not paid by a certain participant in the chain does not allow for a refusal of deduction to another participant that gains a chargeable event in good faith and does not or cannot know about the illegal practices of another payer or payers”, stands in the judgment.

Based on the specific circumstances of this case, the SAC concluded that there are no grounds for refusal of deduction for this company because the Financial Administration had not collected enough evidence to prove conscious participation of the tax subject in any fraudulent activity or lack of caution upon closing the deal.

The judgment further states: 

“The links between the participants as presented in the court files do not prove that the complainant was in bad faith. Therefore, the complainant cannot be attributed the activities of other tax subjects with which the complainant had no commercial ties.”

“The SAC is of the conviction that the request of the European judicature to verify the credibility of business partners in a marketing chain cannot be limitlessly extended.”

“There was no evidence that the complainant was not in good faith in this respect.”

“One cannot extensively conclude that one is dealing with an infinitely long chain of persons and that a taxable person, that had the chargeable event, should be aware and cautious extensively and without limit in regard to this chain.”

Analysis of the judgement

The bone of contention of this judgment lies in the rule on the right of deduction, the principle of fiscal neutrality, abuse of rights, and also in conscious involvement of the tax subject in a fraudulent chain.

In practice, the right to deduct is

• conditioned by meeting the obligations given by the legislation, or
• denied if the right of deduction is fraudulent or applied in an abusive manner.

It was the participation in a transaction fraudulent in regard to VAT that the Financial Administration attributed “without justification” to the complainant.

In accordance with the judicature, VAT deduction cannot be acknowledged, if VAT fraud was committed in the marketing chain prior to the delivery of goods to the complainant and the complainant is aware of this fraudulent activity.

The solution of this dispute lied mainly in the presenting of evidence supporting subjectivity of the complainant, i.e. the complainant knew about the fraudulent activity, or could have known; and in the assessment of how non standard the the business transaction was, i.e. the objective circumstances.

The Municipal Court blamed the complainant for the way they obtained the Development centre during the selection process. They said the complainant behaved in an incautious manner, without appropriate care and diligence, and consciously ignored the non-standard circumstances during the course of the trade for the purposes of VAT tax evasion and violation of tax neutrality.

The SAC revoked the decision of the Municipal Court

According to the SAC:

• the absence of good faith of the complainant and the objective circumstances must be proven without any doubt
• the evidence must logically and in correlation set grounds for suspicion about the dishonest activity linked to the purchase of the property
• it is not allowed for the evaluation of evidence to be conducted purposively by highlighting the evidence incriminating the complainant and by omitting the evidence that plays in the complainant’s favour.

According to the SAC, the complainant shall not be blamed for activities which happened ex post. Neither can one deduct insufficient caution from these activities.

Therefore, the SAC concluded that within the marketing chain burdened by tax evasion one cannot sensu stricto consider “any one” of the participants of the chain to be “the one” and the further ones.

When investigating a fraudulent activity, one must always look for a causal link between the non-payment of tax and the claim for tax deduction and the knowledge of potential fraud in order to evade tax between the subjects. Protection of payments into the public budget can be legitimized, however, the Financial Administration must choose its measures in accordance with the law and with the principle of proportionality.