The European Court of Justice ruled that where a recipient of a supply of goods was a taxable person who did not and could not know that the transaction concerned was connected with a fraud committed by the seller, art. 17 of Council Directive 77/388 (the sixth directive) precluded a rule of national law under which the fact that the contract of sale was void – by reason of a civil law provision which rendered that contract incurably void as contrary to public policy for unlawful basis of the contract attributable to the seller – caused that taxable person to lose the right to deduct the VAT he had paid. It was irrelevant in this respect whether the fact that the contract was void was due to fraudulent evasion of VAT or to other fraud. By contrast, where it was ascertained, having regard to objective factors, that the supply was to a taxable person who knew or should have known that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT, it was for the national court to refuse that taxable person entitlement to the right to deduct.

Facts

References were made in connection with two sets of proceedings concerning the Belgian tax authorities’ refusal to allow the right to deduct the VAT paid on transactions allegedly connected with ‘carousel’ fraud. In each case the tax authorities decided that the taxpayer had knowingly participated in a VAT ‘carousel’ fraud intended to recover one or more times amounts of VAT invoiced by suppliers for the same goods and that the supplies effected to the company were fictitious. For those reasons, the tax authorities refused to allow the right to deduct the VAT paid on those supplies.

In each case the national court referred to the ECJ for a preliminary ruling on the interpretation of art. 17 of the sixth directive.

Issue

Whether, where a recipient of a supply of goods was a taxable person who did not and could not know that the transaction concerned was part of a fraud committed by the seller, art. 17 of the sixth directive precluded a rule of national law under which the fact that the contract of sale was void under civil law, which rendered the contract incurably void as contrary to public policy for unlawful basis of the contract attributable to the seller, caused that taxable person to lose his right to deduct that tax.

Decision

The European Court of Justice (Third Chamber) (ruling accordingly) said that the sixth directive established a common system of VAT based, inter alia, on a uniform definition of taxable transactions. An analysis of the definitions of ‘supply of goods effected by a taxable person acting as such’ and ‘economic activities’ showed that those terms, which defined taxable transactions for the purposes of the sixth directive, were objective in nature and applied without regard to the purpose or results of the transactions concerned.

Requiring the tax authorities to carry out inquiries to determine the intention of the taxable person would be contrary to the objectives of the common system of VAT of ensuring legal certainty and facilitating the measures necessary for the application of VAT by having regard, save in exceptional cases, to the objective character of the transaction concerned. A fortiori, it would be contrary to those objectives to require the tax authorities, in order to determine whether a given transaction constituted a supply by a taxable person acting as such and an economic activity, to take account of the intention of a trader other than the taxable person concerned involved in the same chain of supply and/or the possible fraudulent nature of another transaction in the chain, prior or subsequent to the transaction carried out by that taxable person, of which that taxable person had no knowledge and no means of knowledge. The question whether the VAT payable on prior or subsequent sales of the goods concerned had or had not been paid to the Treasury was irrelevant to the right of the taxable person to deduct input VAT. The principle of fiscal neutrality prevented any general distinction between lawful and unlawful transactions.

Consequently, the mere fact that conduct amounted to an offence did not entail exemption from tax; that exemption applied only in specific circumstances where, owing to the special characteristics of certain goods or services, any competition between a lawful economic sector and an unlawful sector was precluded. However it was common ground that that was not the case with either the computer components or the vehicles at issue in the main proceedings. Thus it was apparent that traders who took every precaution which could reasonably be required of them to ensure that their transactions were not connected with fraud, be it the fraudulent evasion of VAT or other fraud, had to be able to rely on the legality of those transactions without the risk of losing their right to deduct the input VAT.

It followed that, where a recipient of a supply of goods was a taxable person who did not and could not know that the transaction concerned was connected with a fraud committed by the seller, art. 17 precluded a rule of national law under which the fact that the contract of sale was void, by reason of a civil law provision which rendered that contract incurably void as contrary to public policy for unlawful basis of the contract attributable to the seller, caused that taxable person to lose the right to deduct the VAT he had paid. It was irrelevant in this respect whether the fact that the contract was void was due to fraudulent evasion of VAT or to other fraud.

By contrast, the objective criteria which formed the basis of the concepts of ‘supply of goods effected by a taxable person acting as such’ and ‘economic activity’ were not met where tax was evaded by the taxable person himself. Preventing tax evasion, avoidance and abuse was an objective recognised and encouraged by the sixth directive. Community law could not be relied on for abusive or fraudulent ends. Where the tax authorities found that the right to deduct had been exercised fraudulently, they were permitted to claim repayment of the deducted sums retroactively.

It was for the referring court to refuse entitlement to the right to deduct where it was ascertained, having regard to objective factors, that the taxable person knew or should have known that, by his purchase, he was participating in a transaction connected with fraudulent evasion of VAT, and to do so even where the transaction in question met the objective criteria which form the basis of the concepts of ‘supply of goods effected by a taxable person acting as such’ and ‘economic activity’.

European Court of Justice (Third Chamber) Judgment delivered 6 July 2006.