Background

The judgment concerned a Hungarian taxpayer who carried out intermediation in the wholesale of foodstuffs. The respective taxpayer entered into a contract of mandate with another Hungarian company on the basis of which they entrusted the latter with the right to purchase and sell goods on their behalf. In the course of the tax proceedings, the tax authorities established that the taxpayer's suppliers had participated in carousel fraud. That finding was based, in particular, on the infringement of the provisions of Hungarian law on the safety of the food chain, and on the verification of the financial transactions of various companies involved in the supply chain.

The Hungarian tax authorities indicated that the taxpayer did not act with sufficient "due diligence" while verifying its suppliers. Additionally, one of the arguments to support their view was that the person managing the company with which the taxpayer concluded the above-said contract of mandate had previously participated in VAT fraud. In turn, the taxpayer argued that it had acted with due diligence and tried avoiding participating in VAT fraud, by, inter alia, establishing internal purchasing rules that mandated that suppliers be inspected prior to entering into a contract and that prohibited any cash payments.

CJEU's findings

In its judgment, the Court recalled its existing and extensive jurisprudence on the issue of the right to deduct VAT in the event of tax fraud, namely that:

• A taxable person may be denied the right to deduct provided that it is shown on the basis of objective circumstances that they  knew or should have known that, by purchasing the goods or services giving rise to the right of deduction, they  were  participating in a transaction related to such fraud committed by the supplier or other entity involved in the supply chain.
• A tax authority that intends to refuse the right to deduct must, however, prove the existence of VAT fraud and that the taxable person either committed this fraud themselves or at least knew or should have known that a given transaction was related to the fraud.

In addition, in the decision, the CJEU indicated the following circumstances:

First, it is sufficient to provide evidence that a taxable person knew or could have known about the fraud to claim the taxpayer's involvement in the fraud (and thus to justify the refusal of the right to deduct).

Second, however, the mere fact that the entities participating in the supply chain knew each other is not sufficient evidence to prove the taxpayer's involvement in the fraud.

Third, the tax authority may not require the taxpayer to carry out a comprehensive and thorough verification of the supplier, thus transferring to that taxpayer the obligation to carry out in-depth verification activities. In particular, the tax authorities may not generally require a taxable person wishing to exercise the right to deduct VAT to ascertain, on the one hand, whether the issuer of the invoice relating to the goods or services for which exercise of that right is sought has the status of a taxable person, has the goods in question and is able to deliver them, and whether they comply with the obligation to declare and pay VAT, in order to ensure that there are no irregularities or fraud, and, on the other hand, that they have documents confirming this.

Fourth, the tax authority cannot inhibit the taxpayer's right to deduct input VAT for the sole reason that they have failed to comply with their obligations under national or EU law relating to the safety of the food chain. In doing so, the Court acknowledged, however, that failure to comply with those obligations may be one of the elements which the tax authority may consider to establish the existence of VAT fraud and the participation of that taxable person in that fraud.

Fifth, the Court indicated that the tax authorities are entitled — when they assess the "due diligence" of a taxpayer — to consider the fact that the legal representative of the taxpayer's contractor knew about the circumstances constituting the fraud.

Practical impact on tax assessment proceedings

The discussed judgment is another decision in which the Court confirmed that the taxpayers' right to deduct input VAT may be questioned by the EU member states' tax authorities if these tax authorities prove, firstly, that tax fraud has been committed and, secondly, that the taxpayer knew or — if acting with due diligence — could have known about the existence of this fraud.

The practical problem, however, is that the CJEU has never provided comprehensive guidance on the circumstances which the tax authorities should consider when examining the existence of taxpayers' due diligence, leaving this issue to the national courts. The CJEU indicates — at most — whether certain circumstances may "independently" determine the lack of due diligence or whether they may, in conjunction with other circumstances, be an indication for the assessment of the discussed issue (determination of which is left to the national courts).

Therefore, in practice, the tax authorities and national courts of the Member States must (taking into account the general guidelines of the CJEU) independently, on the basis of the collected evidence, assess whether, in their opinion, a taxpayer acted with due diligence. 

As will be discussed in the following paragraphs, the practice across the various EU member states in this regard is not uniform.

Practice of the local tax authorities in selected EU member states

Poland

The Polish tax authorities and — often — the Polish administrative courts approach the discussed issue in a very restrictive manner. Administrative courts' case law in Poland is not uniform, and sometimes even contradictory (for example, in some cases, it is indicated that personal meetings with a supplier prove that a taxpayer should have guessed that they were concluding transactions with a tax fraudster; in other cases, it is indicated that the lack of personal meetings proves failure to exercise due diligence). 

The actual burden of proof is also often reversed in the meaning that it is often the taxpayer who is expected to prove that they acted with due diligence. Furthermore, verification activities that go beyond "standard" commercial verification are typically expected (e.g., close monitoring of average market prices, personal visits to the counterparty, checking whether the supplier is in the possession of goods it delivers, detailed verification of data in commercial registers in order to verify the counterparty's trading history). 

The situation was only seemingly improved by the Minister of Finance's general explanations (methodology) issued in 2019 indicating what circumstances should be taken into account when examining the due diligence (which include a list of recommended formal actions to be taken, such as verification of the contractor in the taxpayers' database, verification of concessions and permits, and verification of the so-called "transaction criteria"). 

In practice, as a rule, it is assumed that a taxpayer failed to act with due diligence. There are a few cases in which the tax authorities admitted the existence of due diligence on the part of the buyer of goods.

Hungary

Hungarian tax authorities and administrative courts take a very similar approach to the Polish approach; nevertheless, looking at the development of jurisprudence, there is definitely an ease in the burden of proof from the taxpayers' perspective. Hungary has a decade-long history in VAT fraud cases brought to the CJEU. In those cases, the CJEU often provided very specific guidance regarding the circumstances that may or may not be considered when denying the right to deduct VAT. Hence, it is now crystallized jurisprudence that the right to deduct cannot be denied because "in addition to that invoice, that taxable person is not in possession of other documents" (C-80/11 and C-142/11), because "the national accounting rules were not complied with" (C-610/19), or because "the supply chain which led to those purchases was not economically justified" (C-611/19). The CJEU's recent judgment cited above provides additional guidance on what taxpayers should review in the course of their business activities.

Nevertheless, as the general VAT rate in Hungary is 27%, tax evasion is still a significant issue and both the tax authorities and administrative courts take a very strict approach in case they suspect that any party in a supply chain committed tax fraud.

Belgium

Following landmark CJEU cases on VAT fraud, the Belgian VAT law has been adapted to deny the right to deduct to a taxable person who "knew or should have known" that the VAT due, in the supply chain, would not be paid as a consequence of VAT fraud (Article 79, §2, paragraph 2 of the Belgian VAT Code). Further, a joint and several liability was implemented in the Belgian VAT law for taxable persons who "knew or should have known" that the non-payment of VAT, in the supply chain, is "committed or will be committed with the intention of evading the tax" (Article 51bis, §4 of the Belgian VAT Code). 

The condition "knew or should have known" often gives rise to discussions. The Belgian tax authorities generally take a very strict approach in case they suspect that any party in a supply chain committed VAT fraud. 

Numerous case laws have dealt with such issues. The local courts have provided some guidance on the circumstances in which it can be considered that a taxable person "knew or should have known" that they were involved in a VAT (carousel) fraud. In particular, the fact that products/services are sold at "abnormally low prices" is sufficient to conclude that a taxable person "knew or should have known" that they were involved in VAT fraud (as confirmed by the Supreme Court, Cass. 18 June 2009).

The above shows that the Belgian tax authorities have some serious legal weapons with which to combat VAT fraud. Any taxable person should exercise due diligence when suspecting VAT (carousel) fraud since (i) they could be held jointly and severally liable and (ii) their right to deduct input VAT might be denied.  

Spain

Rather than a restriction on the right to deduct input VAT, the Spanish VAT Act contains a specific tax liability provision for taxpayers participating in any fraudulent VAT transaction. In particular, those recipients who should know or should reasonably presume that the VAT has not been passed or remitted by the seller to the tax authorities, will be considered as VAT liable. The recipient should reasonably presume that VAT has not been paid when it is paying a "notoriously abnormal price."

A notoriously abnormal price shall be understood to mean: (i) that which is significantly lower than that corresponding to said goods under the conditions in which the operation was carried out; or (ii) that which is significantly lower than the purchase price of said goods by the person who has delivered them.

The context must be carefully analyzed by tax authorities, examining any available document and other transaction carried out in the same economic sector with a high degree of similarity with the one analyzed, in order to quantify the normal market value of the goods existing at the time of the operation.

Czech Republic

There is no official guidance issued by the Czech tax authorities that would provide some level of confidence in respect of what kind of compliance measures implemented by taxpayers should be sufficient to prove "good faith." On the other hand, it cannot be said that, in general, the Czech tax authorities are overaggressive with shifting the responsibility for tax fraud to the taxpayers who purchased goods from an entity involved in the tax fraud (excluding cases whether the purchaser clearly knew about the tax fraud of course). And if they did so, the courts usually side with the taxpayers (unless the taxpayers participated in the tax fraud). 

That was also the case in one of the decisions of the Czech Supreme Administrative Court from January 2018 (the Vyrtych case), in which the court clearly stated that (i) the tax authorities should have reasonable requirements in respect of what kind of information a taxpayer should know or verify about their suppliers, (ii) the tax authorities should take into account all information and measures implemented by the taxpayers and (ii) it is the tax authorities who should prove that a taxpayer could or should have known about a tax fraud committed in the supply chain. 

Therefore, what is usually recommended to taxpayers in the Czech Republic is to gather information about their suppliers (e.g., to review (i) the validity of the VAT ID number, (ii) whether the taxpayers are not considered as unreliable tax payers, (iii) whether the person signing contracts is the authorized person, etc.) should stand up in court. So far, the Czech courts seem to have reasonable requirements in respect of proving "good faith." 

The Netherlands

There are no official guidelines in the Netherlands that provide for a safe haven in case a taxable person finds itself in a chain in which VAT fraud is committed. The Netherlands follow the 'knew or should have known' criterion introduced in the landmark CJEU case Kittel v. Recolta. The tax inspector has the burden of proof when accusing the taxable person of being aware or that they should have been aware that VAT fraud was committed in the supply chain. The Dutch Supreme Court has held, in a national landmark case regarding VAT fraud (HR 19 January 2018, case 16/06245), that the tax inspector must establish the following (cumulative) elements prior to refusing the right to recover input VAT:

1. How the supply chain in question was structured and what place the taxable person in question occupied in that chain.
2. In which link(s) of that chain VAT fraud was committed and what that VAT fraud entailed.
3. On what grounds it must be considered that the taxable person knew or should have known that the VAT fraud took place in that chain.

In academic literature, it is argued that 'should have known' can be seen as similar to the principle of 'gross neglect.' This means that 'should have known' can be explained as negligence bordering on intent or gross carelessness. As has been previously held by the Dutch Supreme Court (HR 19 December 1990, case 25/301), the mere circumstance that a taxable person has acted carelessly does not mean that this carelessness automatically qualifies as gross negligence.

In practice, there is a limited number of carousel fraud cases in Dutch case law. Therefore, it seems that the practice of the authorities is not very strict or aggressive.

Germany

In June 2022, the German Ministry of Finance published a decree concerning the German VAT Act, which determines that an entrepreneur who knew or must have known that his supplies were part of a fraudulent supply chain has neither a right to deduct input VAT nor the right to apply VAT exemptions if certain conditions are met. In respect of "due diligence/good faith", the decree contains, inter alia, the following:

1. An entrepreneur who has taken all measures that may reasonably be required to ensure that their transactions do not result in any VAT evasion or any damage to the VAT revenue may in principle rely on the correct tax treatment of these transactions without running the risk of losing his right to deduct input VAT or to apply VAT exemptions. 
2. Insofar as irregularities, in particular VAT evasion, are apparent —when entering into either new or existing business relationships — the entrepreneur must take further appropriate measures (e.g., obtain information) and also document this appropriately. If the entrepreneur fails to comply with this or cannot dispel any doubts by the measures taken, and nevertheless enters into or continues the business relationship, it shall be presumed that the entrepreneur knew or must have known.
3. Indications shall exist, for example, if:
   • The entrepreneur is requested or solicited by a third party to participate in transactions where the third party sets the framework conditions for the sales transaction (e.g., mediation of participants, specification of purchase or sales prices, payment terms or delivery or service routes).
   • The financing of the purchase of goods is only possible after the sale of goods has taken place.
   • (Offered) multiple runs of goods are detected.
   • The entrepreneur is offered goods or services at a price lower than the market price.
   • A cash payment that is not customary in the industry or an unusual payment processing method is used.
   • The companies change their contact persons frequently.
   • The parties involved lack professional experience and knowledge of the industry. 
   • The parties involved repeatedly change their place of business. 
   • There are doubts as to the accuracy of the information provided by the parties involved (e.g., due to deviating statements of the purpose or the address of the company in the Commercial Register).
   • The purpose of the company, as stated in the Commercial Register, does not correspond to the actual purpose of the company.
   • The entrepreneur is offered a quantity of goods or a scope of services that is unusual for the size of the company in the industry (e.g., unusually high quantities despite the fact that the company is newly established). 
   • The parties involved do not have sufficient means of contacting the company (e.g., website without imprint, telephone number or email address). 
   • Unusual performance conditions exist (e.g., the services are provided by or to a company that is not involved in the supply. 
   • The entrepreneur can determine through accessible sources of information (e.g., internet research) that the delivery of the goods to the delivery address specified by the customer does not appear possible.

The German tax authorities have taken an aggressive approach in the past and — to be able to collect lost VAT from fraudsters' (e.g., missing traders') business partners — regularly assumed either downright intent of the fraudster's business partners or at least that the business partners should have known about the intentions for VAT underpayments. Even in cases where business partners had been able to demonstrate decent review activities (including VAT IDs, review of lease contracts and certificates of residence), the authorities typically took the position that these activities (likewise) indicated that something must have been wrong. It has so far been very difficult for business partners in Germany to convince the authorities (based on their reviews of their business partners, or lack thereof) that they could not have known about the intended VAT fraud in cases in which it later turned out that a fraudulent company had indeed been involved in the supply chain and underpaid VAT.

In turn, German courts have typically followed the wording of the evolving CJEU's case law on VAT fraud, and applied these rules to the individual cases with varying individual assessments. So far, though, no general guidance provided by the German courts that would go beyond these case-by-case assessments has been published. 

Summary

As indicated above, from the examples of various member states, despite the numerous and extensive jurisprudence of the CJEU on the right of tax authorities to challenge the right to deduct VAT in the event of tax fraud: 

1. To date, there is no comprehensive and consistent guidance on the circumstances which should be taken into account when assessing the existence of good faith and "due diligence" of the purchaser of goods and services (the CJEU has usually addressed individual circumstances rather than providing comprehensive guidance).
2. The practice of tax authorities in different member states is not uniform, ranging from very restrictive to those characterized by rationality and balancing the interests of the state treasury and local taxpayers. As it seems, it would be reasonable to expect the unification of this issue at the EU level (e.g., by means of explanations or clarification of circumstances that may constitute a lack of "due diligence" at the level of EU law).

Jurisdiction contacts

Belgium - Olivier van Baelen

Czech Republic - Eliska Kominkova

Germany - Ariane Schaaf

Hungary - Gergely Riszter

Netherlands - Rik van Duijvenvoorde; Frits Pasch

Poland - Piotr Tatara

Spain - Ana Royuela