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.