Burden of proof for shortages ascertained
In its judgment No. 1 Afs 327/2017, the Supreme Administrative Court (SAC) dealt with an additional assessment of value added tax on shortages recognised during stock takings. The judgement provides insight into how shortages are viewed by the Czech tax administration, and how the burden of proof is distributed. What should taxpayers watch out for?
In the case in question, a tax administrator denied a taxpayer’s entitlement for VAT deduction on invoices issued under an advertising contract, and also assessed additional output VAT on shortages recognised on stock taking of inventories. The SAC eventually admitted the taxpayer’s entitlement for deduction but confirmed the additional VAT assessment on shortages.
From the perspective of the VAT Act, a shortage, i.e., an unsupported loss of goods in stock, is viewed as a taxable supply, therefore subject to VAT. Unsupported shortages do not include cases where inventories were provably stolen or destroyed, or where employees were ordered to compensate the missing inventories. Furthermore, according to Czech Accounting Standards, shortages do not include natural shrinkage and technical or technological losses occurring in the manufacturing, purchasing or sales process (retail shrinkage); in these cases, the taxpayer has to issue an internal policy stipulating the usual shrinkage rate. It is always up to the taxpayer to prove the stated facts.
In the case in question, the taxpayer recognised stock-taking differences at the end of 2010 and 2011, and accounted for them as shortages. According to the interpretations of the legislation applicable at the time, these should have been subject to additional output VAT. However, the taxpayer declared that the recording of the differences in account 549 (shortages over the standard) had been incorrect as they should have been recorded in account 504 (goods consumed) because they involved shrinkage within the standard stipulated by an internal policy and as such were not subject to VAT. Therefore no additional output VAT should be assessed.
To the tax administrator, the taxpayer submitted an internal policy stipulating the rate of natural losses and shrinkage in retail. However, the tax administrator determined from the information obtained from the taxpayer and its website that the taxpayer actually carried out a wholesale activity, which was not at all specified in the submitted policy. The tax administrator then requested the taxpayer to define what portion of the shrinkage occurred in retail, and what in wholesale. The taxpayer did not provide the information. The SAC concluded that the taxpayer failed to carry the burden of proof and confirmed the assessment of additional output VAT. The judgement shows the importance of properly drafted internal policies stipulating the amount of justifiable shrinkage of inventories.