In one of its most recent judgments, the European Court of Justice (“ECJ”) was considering a dispute between a Czech VAT payer and the Czech tax administration regarding the possibility of adjusting (reducing) output VAT on debts owed by an insolvent debtor who ceased to be a taxable person. Under the Czech VAT Act, this constitutes one of the many options of applying the reduction to VAT on bad debts. The ECJ takes a rather restrained approach to the potential restriction on such VAT adjustment. In its opinion, the restriction cannot be linked with the debtor’s VAT deregistration. Restricting the adjustment is only permissible in cases when the non-payment of the debt is not yet definitive.
Judgment of the ECJ – unlawful limitation of the option to reduce VAT on bad debts
In its judgment in Case No C-127/18, the ECJ has ruled on a system error of the Czech legislature regarding an unlawful limitation of the possibility to adjust the VAT taxable amount and hence VAT itself in cases when the debtor ceases to be a taxable person.
This was the case of A-PACK CZ (“Company”). It had irrecoverable debts owed by an insolvent debtor that ceased to be taxable person and made an adjustment (reduction) to output VAT equal to the outstanding amounts. Even after an appeal, the tax administrator refused the procedure, referring to the fact that the adjustment of VAT cannot be made due to the debtor’s VAT deregistration. The company challenged the refusal, referring to the conflict of such steps with Article 90 of the VAT Directive (2006/112/EC) under which such adjustments to VAT are permitted.
According to the established practice of the European Court of Justice, Article 90 imposes an obligation on Member States to reduce the taxable amount as well as the outstanding amount of VAT whenever the taxable person does not receive a part or all of the consideration after a transaction has been concluded. According to the fundamental principle of the Directive, the taxable amount should be the consideration actually received and, as a result, the tax authorities may not collect an amount of VAT exceeding the tax which the taxable person actually received.
According to the ECJ, this procedure may only be limited in cases when the non-payment of consideration is difficult to establish or is only temporary. Permitting a wider limitation would be in contravention of the principle of the neutrality of VAT, which, according to the ECJ, means in particular that the taxable person as a VAT collector on behalf of the state is entirely to be relieved of the final burden of VAT. The limitation contained in Czech law which makes the correction of VAT subject to the condition that the debtor has not ceased to be a taxable person for the purposes of VAT, cannot be justified by the need to take account of the uncertainty as to the definitive nature of the non-payment in question. The fact that the debtor has ceased to be a taxable person may be, on the contrary, evidence of the definitive nature of the non-payment. As a result, the ECJ has held that the limitation contained in Czech law is contrary to Article 90 of the Directive.
An amendment to the Czech VAT Act came into effect on 1 April 2019. It has significantly restated the provisions governing VAT on bad debts. However, the provision in question under which adjustments may not be made to VAT on debts owed by a debtor who ceased to be a taxable person has remained in force.
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