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Monday, August 8, 2011

Court of Justice detects flaw in Hungarian VAT system

The European Court of Justice decided in its judgment in Case C-274/10 that the Republic of Hungary has failed to fulfil its obligations under Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax - by requiring taxable persons whose tax declaration for a given tax period records an ‘excess’ within the meaning of Article 183 of to carry forward that excess or a part of it to the following tax year where the taxable person has not paid the supplier the full amount for the purchase in question, and
– because, as a result of that requirement, certain taxable persons whose tax declarations regularly record such an ‘excess’ may be required more than once to carry forward the excess to the following tax year,
More precisely, Hungary has exceeded the limits of the freedom available to the Member States under Article 183 which allows the Member States to lay down conditions for the refund of a deductible VAT excess.

What is this about? One way of VAT fraud is when the seller does not pay the VAT which is claimed by and refunded to the buyer. In these cases sometimes the buyer does not pay the seller. The first Orbán government decided that one way to counter this is not to enable actual payment of the VAT reclaimed if the buyer did not pay the seller. The amount can be deducted from VAT payable, the excess being carried over to the next period (which can be the next month, the next quarter or the next year, depending on the amount of VAT payable by the company over the previous year – exceptions to shorten the period are difficult to get), Thus, companies having one big purchase (usually investing) can in some cases have to wait a year or more till the get the VAT back.
This of course addressed only a marginal aspect of the problem as in VAT fraud it is often the seller which then vanishes with the money. This regulation put actually investors and leasing companies (who invest in goods and thus have immediately a claim to reimbursable VAT to lease them out where their income comes over time) and also their lessees (who only pay in installments and were thus not able to get even the VAT of the first large installment repaid) in a difficult position. After a discussion between the Ministry of Finance and the Leasing Association the problem was partially solved (in this case reimbursement can be made if the amount of the VAT is paid which leaves only lessees who pay a first installment below 20/% out in the cold).
The complaint of sellers, which could also be the basis of the rule, namely that if they do not receive the payment, it is difficult to pay the VAT (and thus this rule could improve payment discipline) could actually have been solved based on Article 66(b) of the Directive which allows that a Member States makes VAT chargeable, in respect of certain transactions or certain categories of taxable person no later than the time the payment is received. However, the Republic of Hungary has not claimed to have made use of that possibility (point 50 of the judgment).
The Court of Justice found that this rule infringes the fiscal neutrality of the VAT system: "such conditions must enable the taxable person, in appropriate circumstances, to recover the entirety of the credit arising from that excess VAT. This implies that the refund is made within a reasonable period of time by a payment in liquid funds or equivalent means, and that, in any event, the method of refund adopted must not entail any financial risk for the taxable person" (point 45 of the judgment).

It must be noted that no deadline has been set for changing this rule. It is also clear that the main problem highlighted by the Court was that there was no assurance that the tax will be recovered and when it can be recovered (the taxable person may have to carry forward the excess several periods giving rise to an uncertainty and a long delay).
Point 55 of the judgment states: "In that regard, it must be borne in mind that the carrying forward of a VAT excess over several tax periods following that in which the excess in question arose is not necessarily irreconcilable with the first paragraph of Article 183 of Directive 2006/112 (see, to that effect Enel Maritsa Iztok 3, paragraph 49). However, given that the national legislation at issue provides for tax periods from one month to a year in length, it may create a situation in which certain taxable persons, do not, because of the repeated carry-over of an excess, obtain a refund of that excess within a reasonable period."

So the consequence is not - as it is hinted by several articles in the news - that the amount of VAT has to be repaid immediately to everybody who has an outstanding claim, but the time to refund has to be limited to a reasonable and foreseeable extent and the conditions have to be in accordance with the VAT directive.

Of course, from this moment on, VAT subjects can request the refund of their excess VAT in their first VAT return. The judgment of the Court gives them the assurance that they are acting correctly. Although in general, European directives are not directly applicable, the member states have to transpose them into their national legislation and the national legislation is applicable, the judgment of the Court of 19 January 1982 in the case 8/81, (Ursula Becker v Finanzamt Münster-Innenstadt) enables direct applicability of the directives if the provisions of a directive "appear, as far as their subject matter is concerned, to be unconditional and sufficiently precise, those provisions may, in the absence of implementing measures adopted within the prescribed period, be relied upon as against any national provision which is incompatible with the directive …". And this can be done by all those who still have recoverable VAT which has not been paid to them based on the provision of the Hungarian VAT law which was annulled by the Court. If they do not request it, however, then they have to wait till the Hungarian Parliament modifies the tax law - ideally the modification should contain transitional provisions on the cases in progress.

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