European Legal Review, vol. I 2011 – VAT Deduction for Goods or Services Prior to VAT Registration – Mission (Im)Possible?

As a consequence of the Court of Justice Judgment in Ecotrade case the new provisions of Art. 73a and 180a pertaining to the right to deduct in cases of self-charging VAT were introduced in the Bulgarian VAT Act. The new piece of legislation practically entitled the recipients of such taxable supplies to deduct the tax without any limitations in time even if some formal requirements are not met as long as sufficient information about the supply is available in the accounts of the taxable persons and the supply is not concealed. Besides, the financial penalty for the failure to self-charge VAT in such instances was drastically reduced in comparison with the cases where the person liable to tax is the supplier. Thus, if the general penalty could reach up to 100% of the VAT not charged by the supplier, in the case of selfcharging of VAT the penalty is only 5% of the VAT which was not self-charged on time by the recipient.

The connection between the legislative amendment to the Bulgarian VAT Act and the Judgment in joined cases C-95/07 and C-96/07 Ecotrade SpA was clearly underlined in the grounds to the Bill for amendment of the VAT Act where it was pointed out that the introduction of Art. 73a aims at harmonizing the Bulgarian VAT legislation with the European Court of Justice case-law (cases C-95 and C-96 of 2007) because of the established practice of the Bulgarian revenue authorities during tax audits to assess tax on the taxable person while denying at the same time the corresponding right to deduct, which runs contrary to the Court of Justice case-law and is detrimental to taxable persons.

Time limits for submitting the inventory and exercising the right to deduct 

The abovementioned Judgment of the Court of Justice in joint cases C-95/07 and C-96/07 Ecotrade bears significance to one more related issue – are the 7-day deadline for submitting the inventory and the 3-month time limits for deducting VAT compliant with the principle of effectiveness if they render the right to deduct virtually impossible or excessively difficult?

The paradox here lies in the fact that in a number of national judgments on taxable persons’ appeals the principle of effectiveness is often construed and invoked not in favour of the taxable persons but in support of the compliance of the national limitation periods with the EU law9 by actually citing only the first part of the principle definition concerning the admissibility of the limitations without going further to interpret the essence of the principle and whether the particular limitation period is adequate or it could render the exercise of the rights provided under the EU law virtually impossible or excessively difficult.

In this respect, it would be of particular importance for the development of the case-law on this issue how the Court of Justice would rule on the questions submitted for preliminary ruling in relation to administrative court case No. 14721/2010 by the Supreme Administrative Court which essentially asks whether the three-month VAT deduction period is compatible with Directive 2006/112/EC provisions.

I dare hope that if the Court of Justice finds that the limitation period is contrary to the principle of effectiveness, at least the unjustly short 7-day period for submitting the inventory of goods and the three-month period for VAT deduction for supplies acquired before the VAT registration would be re-considered. Even if the obligation to submit an inventory is not entirely repealed at this stage, the taxable persons would benefit enormously from at least a longer and more adequate limitation period.

Statute of limitations regarding right to deduct as a penalty for failing to meet the VAT registration and inventory filing deadlines

The preliminary ruling referred to the Court of Justice related to administrative case No. 14721/2010 touches on another very important issue concerning the permissibility of a penalty for incompliance with formal requirements which amounts to denial of VAT deduction.

In fact, the Court of Justice has already ruled on this question in its Judgment in joint cases C95/07 and C-96/07 Ecotrade where it has adjudged that a reassessment and recovery practice which penalises non-compliance on the part of the taxable person with the obligations relating to accounts and tax returns by a denial of the right to deduct, clearly goes further than is necessary to attain the objective of ensuring the correct application of such, since Community law does not prevent Member States from imposing, where necessary, a fine or a financial penalty proportionate to the seriousness of the offence in order to sanction a failure to comply with those obligations.

In the particular case of deducting VAT on assets acquired before the VAT registration the Bulgarian VAT Act very explicitly stipulates that if the inventory of assets is not submitted within the 7-day time-limit, the right to VAT deduction is not only precluded but it is deemed   that it has never arisen. This way, one absolutely formal and unnecessary requirement could lead to denial of VAT deduction amounting to tens or hundreds of thousands leva because of the ignorance of the taxable person or the tight deadlines for submitting the inventory.

Unfortunately, the tax assessment practice is full of further examples of misuse of the denial of VAT deduction as the universal penalty for all kinds of infringements which are in their large part formal and not concerning the substantive requirements for enjoying the right to VAT deduction. The taxable persons are often denied VAT deduction for infringements which are not attributable to themselves but to their suppliers – e.g. if an invoice is issued outside the prescribed time-limit or the invoice contains VAT while the supply is exempt according to the revenue authorities, etc.

In such cases, beside from the fact that the penalty is borne by the recipient of the supply instead of the perpetrator, the state budget is in practice unjustly enriched because not only does the state not recover the VAT to the recipient of the supply but it also keeps the tax paid effectively by the supplier. Ant this holds true notwithstanding the numerous penalties set forth in the Bulgarian VAT Act which could be imposed on the supplier who is in default without any detriment to the recipient.

Another common ground for VAT deduction denial is the general limitation on the right to deduct when the VAT was charged unlawfully. In the absence of a definition of the concept of unlawfully charged VAT virtually any case could be reduced to this general presumption without even invoking any particular infringement. We have witnessed recently too many examples where supplies are determined as not having actually taken place even if the persons are not related and there is objective evidence for the supply.