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Is it possible to maintain right to deduct even in chain fraud?

The Supreme Administrative Court in a recent judgment dealt with the right to deduct tax on a supply provided within a fraudulent chain of transactions. The tax administrator did not fully prove that the taxpayer knew, or could have known, that the supplier would not pay output VAT because of tax fraud.

Case No. 5 Afs 55/2020 involved a company trading mainly in Apple brand electronics in B2B mode outside the manufacturer's authorised regime. In a tax inspection for the period from August to November 2014, the tax administrator assessed additional tax on the company, on the grounds of denying them the right to deduct.

In the appeal proceedings, the tax administrator revealed chains of transactions in which the company was involved: the company purchased electronics from other EU member states and stored them in the Czech Republic. Then they sold the same electronics to other ‘ready-made’ domestic or foreign companies. Through further links of the chain, the electronics got back to the Czech Republic. However, these companies did not declare or pay output VAT and when approached by the tax administrator became uncontactable. In the ensuing litigation, the Municipal Court in Prague examined the fraudulent chain and whether there were objective circumstances that would have made the company aware of the illegal activity. The court also assessed whether the company had taken reasonable steps to detect or prevent the tax fraud. The court held that the company had deviated from common practice, had not complied with its own business terms and conditions, and could and should have known of their involvement in a fraud. The court’s arguments were the insufficient control of IMEI numbers of the phones which helps to detect the unreliable origin of the device including any link to illegal activity; the absence of contracts between the B2B contracting parties; and the issuance of tax documents before accepting the order. The company appealed against this to the SAC.

The SAC agreed with the tax administrator that in combination, the evidence may create the impression of the existence of tax fraud, but it also held that separately, the individual parts of the case can be explained. According to the SAC, merely revealing the structure and pointing out the business practices and the fact that tax was not paid in a part of the supply chain does not a priori constitute the company’s involvement in tax fraud.

The SAC concluded that company's manner of trading outside the official distribution network was legal and legitimate. The court acknowledged the company's arguments for not reviewing their business partners and not concluding written contracts (historical knowledge of partners and previous experience with them). At the same time, the court denied the tax administrator's claim that the transaction had no economic purpose, proving that the average margin on the fast-moving trades was around 2%.

The SAC found the company's cassation complaint justified and vacated the judgment of the Municipal Court in Prague. The case has been referred for further consideration. This is yet another long-running dispute between the state administration and a private entity.