In its judgment No. 7 Afs 45/2021 – 57 of 27 February 2023, the Supreme Administrative Court (SAC) ruled in favour of our client, whom we represented in a value added tax assessment case, where the tax administrator denied the right to deduct taxable supplies received (JET A-1 aviation kerosene) due to the tax administrator’s claim that these supplies were affected by VAT fraud, which our client knew or should have known about. 

The dispute related to the question whether or not the tax authorities as a whole sustained the burden of proof in relation to proving the existence of circumstances indicating the existence of VAT fraud in the resale of aviation kerosene in a chain identified by the tax administrator.

According to the case law of the Court of Justice of the European Union (CJEU) and the SAC, the term “VAT fraud” refers to situations, in which one of the parties does not remit the tax collected to the Treasury and the other deducts it in order to obtain an advantage, which is contrary to the purpose of the Sixth Directive because the transactions performed do not correspond to normal commercial conditions. Thus, VAT fraud is not any non-payment of tax, but only one, the purpose of which is to obtain an unjustified tax advantage, which can be inferred from the fact that the transactions carried out do not correspond to normal commercial conditions.

The burden of proof with regard to proving the existence of VAT fraud and the participation of the tax entity in it rests exclusively on the tax administrator, who, in order to deny the right to deduct the tax, is obliged to prove:           1) the existence of missing tax within the proven fraudulent chain, 2) the existence of objective circumstances indicating the taxpayer’s knowledge of the fraudulent conduct, 3) the fact that the taxpayer did not take relevant measures to eliminate its participation in the VAT fraud. Without simultaneous proof of all aspects, it is not possible to refuse to grant entitlement to the deduction claimed by the taxpayer in the tax return.

Although the area of VAT fraud has already been quite richly judged by the CJEU and the SAC, tax authorities often disregard this constant case law and misinterpret the term “VAT fraud”, which can be illustrated by the recent case of our client.

In the case at hand, the tax administrator based its allegation of tax fraud on the fact that the tax entity was integrated into a chain of corporations reselling fuel and during these transactions in the chain, tax neutrality was violated when one of the corporations stopped fulfilling its tax obligations, became non-contactable and did not pay the assessed tax, which, according to the tax administrator, fulfilled the condition for the existence of VAT fraud in the sense of missing tax for one of the links in the chain of corporations. Already during the tax audit, as well as in the subsequent appeal proceedings, we consistently argued in detail that the existence of tax fraud was not proven by the tax administrator. Since our argumentation was not successful with the financial administration, we had no choice but to appeal to the Regional Court in Prague (RC).

The RC upheld our reasoning when it held that it was not sufficient merely to find that the fuel was traded in a chain of companies in which one of them became uncontactable, ceased to fulfil its tax obligations and failed to pay the tax assessed. Failure to pay tax must, at the same time, be the result of conduct intended to abuse the VAT system and not the result of a mere business failure or other excusable reason.

Specifically, the RC then stated that the findings of the tax administrator in this case indicated that the corporation, for which the tax administrator identified the missing tax, had paid its tax obligations in the normal manner until March 2011 and filed tax returns until January 2013. The former managing director of the company then testified in 2017 that the Czech accounts of the company should have been blocked in March 2011. However, the tax administrator did not investigate this fact further, even though the inability to dispose of the funds may have been a natural explanation for the failure to pay the tax obligations. On the contrary, according to the RC, the facts found substantially weakened the tax administrator’s conclusion that the company’s failure to pay the tax was motivated by fraudulent conduct.

The Appellate Financial Directorate lodged a cassation complaint against the judgment of the RC, as it disagreed with its conclusions. However, in the above-mentioned judgment, the Supreme Administrative Court dismissed the appeal and agreed with the RC that the tax authorities had not reliably proved that the first condition necessary for the denial of the right to deduct on the grounds of involvement in a fraudulent chain had been met, i.e. the existence of circumstances indicating tax fraud or proving the fraudulent nature of the actions of the entities in the chain aimed at extracting an undue advantage.

The SAC explicitly stated that: “First of all, however, the conclusion that the absence of tax was fraudulent cannot be based on unsubstantiated speculation about the illegality of the supplier’s conduct, if the complainant has not even indicated the precise reason why the accounts of Gloria Vendor were blocked. The circumstances attesting to the fraudulent nature of the transactions under examination cannot be conjectured but must be proved.”

The Supreme Administrative Court also confirmed that in the case at hand the tax administrator did not sustain its burden of proof to prove the existence of tax fraud, and therefore the assessment of tax to our client was incorrect and unlawful.

Thus, it can be summarised that, even in accordance with this recent judgment of the Supreme Administrative Court, it applies that the denial of the right to deduct tax constitutes an exception to the rule that the taxpayer is entitled to deduct tax. The tax authorities should therefore treat this option with caution and proceed only and exclusively in situations that show clear signs of fraudulent behaviour. The burden of proving sufficiently that the missing tax was caused by fraudulent conduct aimed at unlawfully obtaining a tax advantage rests solely on the tax authorities. Only after the tax authorities have reliably proven this first condition is it relevant to consider whether or not the taxpayer knew or could have known about the tax fraud and whether or not it took sufficient measures to prevent its participation in the VAT fraud.

Author: Lenka Kočerová, Jaroslava Půtová