Denying right to deduct VAT before entering bankruptcy compatible with EU directive?

The Court of Justice of the European Union (CJEU) has dealt with the refusal of the right to deduct VAT on taxable transactions carried out by a Romanian company before entering insolvency proceedings.

A Romanian company registered as a taxable person entered insolvency proceedings following a court order. After the declaration of bankruptcy, a tax inspection was performed at the company. The tax administrator then issued an order to pay additional tax as a result of adjustments to VAT deductions on transactions carried out before the bankruptcy was declared.

The company appealed the order to pay the tax, but the financial administration dismissed the appeal: in its opinion, once the bankruptcy had been declared, the company had ceased to carry out its economic activity. The national court upheld this conclusion, confirming the initiation of insolvency proceedings as a reason to terminate the right to deduct, since any transactions carried out during the proceedings had no economic purpose and served solely to repay debts. The court also considered it irrelevant that the sale of assets within the insolvency proceedings had been subject to VAT. The court based its conclusion on Romanian national laws.

In this context, a prejudicial question was referred to the CJEU, asking whether initiating insolvency proceedings in respect of a taxable person (entailing the liquidation of its assets for the benefit of its creditors) automatically places an obligation on that entity to adjust VAT deductions made in respect of goods and services acquired before it was declared bankrupt. In other words - shall the economic activity of the taxable person be considered terminated on the grounds of a declaration of bankruptcy?

The CJEU concluded that as long as a company continues its economic activities, it competes with other taxable persons carrying out similar transactions. Thus, to maintain the principle of fiscal neutrality, its transactions in terms of VAT should be treated in the same way as those of competing undertakings. The initiation of insolvency proceedings does not prevent the company from carrying out its economic activity. Therefore, it is not possible to automatically deny that company the right to deduct VAT.

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