Tax

The ECJ Power Punch to
Hungarian VAT Practice

Hungarian taxpayers had faced uncertainty since 2003, when Hungary introduced the principle of “due foresight” into its VAT regime. This principle had been the main weapon of the Hungarian tax authority (NAV) against taxpayers trying to abuse VAT deduction rights. The NAV also abused this weapon, but has now been disarmed.

Where does this principle come from?

One of the cor­ner­stones of Hun­gar­i­an VAT reg­u­la­tion was that the issuer was respon­si­ble for the authen­tic­i­ty and cor­rect­ness of data in the invoice. At the begin­ning of 2003, Hun­gary made an inter­est­ing mod­i­fi­ca­tion: “The tax-relat­ed rights of the recip­i­ent of the invoice [eg the right to deduct VAT] may not be com­pro­mised if it act­ed with due fore­sight regard­ing all cir­cum­stances of the deal.” The mean­ing of “due fore­sight” was not defined in the law.

What did it mean?

In prac­tice, the prin­ci­ple meant that, despite hav­ing received a cor­rect and authen­tic invoice, the tax­pay­er was not allowed to deduct or reclaim the input VAT paid upon the invoice based on tax prob­lems of the issuer, which prob­lems often exist­ed only tem­porar­i­ly (because only alleged by the NAV but then clar­i­fied or rec­ti­fied by the issuer). In oth­er cas­es, the prob­lems of the invoice issuer were real but could not have been dis­cov­ered by the invoice recip­i­ent, or only if the recip­i­ent had exer­cised unrea­son­able and extreme care.

For exam­ple, the NAV found a lack of due fore­sight when a taxpayer’s busi­ness part­ner (sup­pli­er) did not have enough reg­is­tered employ­ees to per­form under a con­tract with the tax­pay­er, and the NAV thus declared the con­tract fic­ti­tious and did not allow the tax­pay­er to deduct/reclaim the VAT paid on the sup­pli­er invoice. The NAV took the view that the tax­pay­er should have exam­ined whether its sup­pli­er had prop­er­ly reg­is­tered all employ­ees nec­es­sary to per­form the ser­vices ordered by the tax­pay­er.

Anoth­er exam­ple of the NAV deny­ing due fore­sight by a tax­pay­er was when the tax­pay­er failed to repeat­ed­ly inves­ti­gate its long-term sup­pli­er and thus failed to dis­cov­er that the busi­ness partner’s VAT reg­is­tra­tion num­ber had been sus­pend­ed (due to a dis­pute between the sup­pli­er and the NAV in which the sup­pli­er lat­er pre­vailed) at the time when a cer­tain invoice had been issued to the tax­pay­er. Con­se­quent­ly, the tax­pay­er was not per­mit­ted to deduct VAT paid pur­suant to the invoice even though the ser­vices cov­ered by the invoice were actu­al­ly per­formed.

The prac­tice of the NAV led to the con­se­quence that the tax­pay­er received the NAV’s atten­tion and not the issuer, who might have (or was lat­er deemed to have) vio­lat­ed the tax rules. Thus, this prin­ci­ple cre­at­ed a spe­cial risk for the tax­pay­er: In cas­es when the NAV was unable to col­lect the VAT from the issuer, it relied upon the taxpayer’s lack of due fore­sight to dis­miss the taxpayer’s VAT deduc­tion claim.

Tax­pay­ers suf­fered because the deduc­tion right is a fun­da­men­tal right in any val­ue added tax sys­tem, and they were deprived of this right with­out a clear legal pro­vi­sion sup­port­ing such prac­tice. This con­se­quence was espe­cial­ly unfair giv­en that the tax­pay­er had no infor­ma­tion on, and no con­trol over, the issuer’s (often only alleged) prob­lems and fail­ure to pay the VAT.

The position of the Hungarian courts and the ECJ

The Hun­gar­i­an courts did not object to the NAV’s approach until 2011 when two coun­ty courts request­ed pre­lim­i­nary rul­ings from the ECJ on the mean­ing of “due fore­sight”. The ECJ joined the C-80/11 and C-142/11 pro­ce­dures and addressed the fol­low­ing ques­tions:

  • Must the recip­i­ent of an invoice obtain oth­er doc­u­men­ta­tion that proves that the issuer (i) was enti­tled to sell the goods or pro­vide the ser­vices or (ii) has prop­er­ly filed its tax returns? Must the recip­i­ent ver­i­fy these cir­cum­stances with­in the “due fore­sight” prin­ci­ple?
  • May the NAV refuse a deduc­tion claim of the recip­i­ent sim­ply because the issuer is unable to prove the law­ful use of sub­con­trac­tors (eg, in cas­es where the use of sub­con­trac­tors depends on their for­mal reg­is­tra­tion with a cer­tain author­i­ty)? Can the recip­i­ent be pun­ished for the issuer’s sub­con­trac­tors not being iden­ti­fi­able or their invoic­es being non-com­pli­ant, even though the issuer per­formed the ser­vices for which the invoice was issued?
  • Who has the bur­den of proof that the recip­i­ent knew about the ille­gal activ­i­ty of the issuer’s sub­con­trac­tors?

The ECJ ruled in favour of the tax­pay­er on all issues. Accord­ing to the judg­ment, the tax author­i­ty may not refuse the deduc­tion right of the recip­i­ent on the ground that the issuer or one of its suppliers/subcontractors act­ed improp­er­ly. The tax author­i­ty must prove on the basis of objec­tive evi­dence that the recip­i­ent knew or should have known that the trans­ac­tion was con­nect­ed with fraud. If the recip­i­ent obtains a prop­er invoice and the trans­ac­tion was per­formed, the NAV may not refuse the deduc­tion right because the recip­i­ent did not check the sta­tus of the issuer.

Although the ECJ’s pre­lim­i­nary rul­ing is only bind­ing on Hun­gar­i­an courts, it is like­ly to influ­ence tax col­lec­tion cas­es through­out the EU. As the ECJ has pre­vi­ous­ly explained, it expects author­i­ties of the mem­ber states to apply EU law in accor­dance with its pre­lim­i­nary rul­ings (see Kempter, Kühne & Heitz).

This rul­ing is rel­e­vant for future and past cas­es. Regard­ing past cas­es, since the rul­ing mod­i­fies the mean­ing of “due fore­sight”, it might have a retroac­tive effect by enabling pre­vi­ous­ly pun­ished recip­i­ents to request the reopen­ing of their tax cas­es. Regard­ing future cas­es, tax­pay­ers should seek advice in how to use this rul­ing for their ben­e­fit in audits by the NAV.

Although the ECJ’s preliminary ruling is only binding on Hungarian courts, it is likely to influence tax collection cases throughout the EU.

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