Invalidity of a transaction vs. deduction of VAT

27 October 2023 | Knowledge, News, Tax Focus, The Right Focus

According to the Supreme Administrative Court (Naczelny Sąd Administracyjny, NSA), a taxable person may not be deprived of the right to deduct VAT simply because a legal transaction is invalid from a civil law perspective. In this article, we will try to explain the NSA’s decision and what it means for taxpayers.

Right to deduct VAT

On 7 September 2023 (I FSK 897/19), the NSA ruled that transactions that are invalid under civil law due to non-compliance with form requirements may be subject to VAT. The NSA pointed out that it is the economic aspect of the transaction that is decisive, and not compliance with civil law.

The current NSA judgment is a consequence of the CJEU judgment of 25 May 2023 (C-114/22). In the latter, the Court of Justice stated that that authorities may not refuse the right to deduct VAT on the grounds of the fictitious nature of an economic transaction or a breach of civil law, unless they prove that certain conditions are met, i.e. that the transaction is to be regarded as fictitious or, in the case of a transaction actually carried out, that it is the result of VAT fraud or an abuse of the law.

Decision of the Revenue Administration Chamber on a contract concluded ‘with oneself’

The case concerned a lease entered into between a limited liability company and a married couple who owned a plot of land. Crucially, the spouses have joint ownership of assets and, at the same time, are the sole shareholders of the company and, as members of the Management Board, with the sole power to represent the company.

The Director of the Revenue Administration Chamber (Izba Administracji Skarbowej, IAS) noted that the building permit had been issued in favour of natural persons who were both the owners of the land and the sole shareholders of the company. In addition, the Director of the IAS noted that the source of financing for the transaction was the own funds of the shareholders of the company, who were also the owners of the land, and that the transaction itself did not make economic sense. Therefore, he denied the company the right to deduct input tax.

In our opinion, the tax authorities’ refusal of the right to deduct input VAT is based on two grounds. First, the authorities argued that the lease agreement, having no economic sense, was contrary to the rules of social conduct, since the company, while bearing the cost of leasing the property, would not receive any remuneration for the construction of the building, which was an investment of the spouses. As a second argument, the authorities contested the lease agreement, pointing out that it had been concluded with ‘oneself’.

Invalid civil law transactions may have VAT consequences

As a basis for denying the right of deduction, the authorities referred to Article 88(3a)(4)(c) of the VAT Act, which states that taxable persons may not reduce the amount of tax due if an invoice issued confirms activities to which Articles 58 and 83 of the Civil Code apply – in the part relating to those activities. Article 58 of the Civil Code provides for “nullity” in cases where a legal transaction is contrary to the law, is intended to circumvent the law or is incompatible with the rules of social conduct. Article 83 of the Civil Code, on the other hand, defines a legal transaction that is deemed to have been made under false pretences.

The NSA rightly pointed out that the issue of deducting VAT on transactions affected by a legal defect under civil law has been the subject of CJEU case law. Moreover, the NSA’s reasoning was based on a CJEU judgment (C-114/22), according to which taxable persons cannot be deprived of the right to deduct input VAT merely because a transaction is considered to be fictitious and invalid under national civil law and not at the level of EU legislation.

The operative part of the CJEU judgment was based on the principle of neutrality, which is a fundamental principle of the common VAT system. The CJEU pointed out that, in order to deny taxable persons the right to deduct input tax, the authorities must prove that the transaction in question was carried out in connection with fraud or abuse. According to the CJEU, it is one thing to abuse a right in order to obtain a tax advantage under VAT and another to carry out a transaction that is invalid under national law. Therefore, if the transaction has in fact been carried out, the authorities cannot deny the right to deduct input tax.

In addition, it is for the tax authority to prove that a taxable person has committed fraud and that the transaction itself is the result of such fraud. Only if the tax authority proves that the transaction is artificial or does not reflect reality within the meaning of EU legislation is it entitled to deny the taxable person the right of deduction.

From the perspective of VAT regulations, it is not the civil law conformity of a transaction that is decisive, but its economic aspect – a transaction that is invalid under civil law may have VAT consequences and thus a taxable person may be entitled to deduct input VAT, provided that the goods or services purchased have been used to carry out taxable transactions.

What does this mean for taxable persons

The NSA’s judgment confirms the changing trend in case law initiated by the CJEU. This may lead to a change in the provisions of the VAT Act. The key question, however, is what form this change may take.

There are two scenarios: either the lawmakers develop new definitions of the terms “fictitious transaction” and “transaction invalidity” for the purposes of tax regulations, or refer to the definition contained in EU legislation.

Nevertheless, it should be borne in mind that each case is different and requires detailed analysis. Our tax team can provide full assistance in this area.

Any questions? Contact us:

Jakub Dittmer

Jan Janukowicz

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