The European Court of Justice ruled that art. 17, 18(2) and (3) and 21(1)(b) of Council Directive 77/388 (‘the sixth directive’), did not preclude national legislation which laid down a limitation period for the exercise of the right to deduct, provided that the principles of equivalence and effectiveness were respected. The principle of effectiveness was not infringed merely because the tax authority had a longer period in which to recover unpaid VAT than the period granted to taxable persons for the exercise of their right to deduct. However, art. 18(1)(d) and 22 precluded a practice whereby tax returns were reassessed and VAT recovered which penalised misapprehension of obligations arising from formalities laid down in national legislation pursuant to art. 18(1)(d) and of the obligations relating to accounts and tax returns under art. 22(2) and (4) respectively, by denying the right to deduct in the case of a reverse charge procedure.

Facts

The taxpayer was an Italian limited company specialising in granulated blast furnace slag and other ingredients, in particular synthetic gypsum and ashes used for the manufacture of cement. In the tax years 2000 and 2001, the taxpayer entrusted to operators established outside Italy the transport of those materials from Italy to other member states of the European Community. In the invoices issued by those operators for services supplied to the taxpayer, they were described either as ‘chartering of the vessel’ or ‘shipping’. However, the invoices did not indicate the amount of VAT, and some of them stated that the transactions were exempt. The taxpayer therefore regarded the relevant transactions as exempt from VAT and recorded the invoices relating to those transactions only in the register of purchases and not in the register of invoices issued. The VAT relating to those transactions was therefore not mentioned in the returns drawn up by the taxpayer for the tax years 2000 and 2001.

The tax authorities took the view that the transactions in question were services in the intra-Community transport of goods subject to VAT, and that the reverse charge procedure was applicable to them, which, with the exception of one invoice, was not disputed by the taxpayer. The taxpayer had not complied with the accounting requirements relating to the reverse charge procedure because the invoices concerned had been recorded only in the register of purchases and not in the register of invoices issued.

Therefore, tax recovery notices were issued, reassessing for VAT purposes the tax returns submitted by the taxpayer for the tax years 2000 and 2001, and claiming payment of undeclared taxes and imposed penalties in respect of those taxes.

Subsequently, the authorities took the view that the taxpayer had lost its right to deduct VAT because, under national law, it had not exercised that right within a period of two years from the time the VAT became chargeable, whereas the tax authorities were still within the time-limits for recovering the VAT relating to the services concerned since notices of reassessment and recovery might be served within a period of four years calculated from the date on which the tax returns relating to disputed taxes were submitted.

The taxpayer challenged the recovery notices concerned and sought to have them annulled. The tax authorities argued that, according to EC law, the taxpayer should have invoiced itself for the transactions in question, calculated the VAT payable, and recorded the invoice in the register of invoices issued and the register of purchases so that it would have had a VAT credit for the purposes of deducting the input tax calculated. The court stayed the proceedings and referred to the ECJ for a preliminary ruling.

Issue

Whether art. 17(6), (7) and 22(7), (8) of the sixth directive justified the national legislation which, where the reverse charge procedure applied, made the exercise of the right to deduct VAT subject to compliance with a limitation period which was shorter than that available to the tax authority for recovering tax.

Decision

The European Court of Justice (Third Chamber) (ruling accordingly) said that a limitation period the expiry of which had the effect of penalising a taxable person who had not been sufficiently diligent and had failed to claim deduction of input tax by making him forfeit his right to deduct, could not be regarded as incompatible with the sixth directive, in so far as that limitation period applied in the same way to analogous rights in tax matters founded on domestic law and to those founded on Community law (‘principle of equivalence’); and that it did not render virtually impossible or excessively difficult the exercise of the right to deduct (‘principle of effectiveness’).

As regards the principle of equivalence, it did not appear from the file, nor had it been argued before the court, that the limitation period provided for in the national legislation did not comply with that principle.

With respect to the principle of effectiveness, a two-year time-limit could not, in itself, render the exercise of the right to deduct virtually impossible or excessively difficult, since art. 18(2) allowed member states to require that the taxable person exercise his right to deduct during the same period as that in which it arose.

The fact that a limitation period began to run as regards the tax authority at a date subsequent to the date from which the limitation period applicable to the right to deduct of a taxable person began to run did not infringe the principle of equality. Accordingly, a limitation period, such as that in the present case, did not render impossible or excessively difficult the exercise of the right to deduct merely because the tax authority had a longer period in which to recover unpaid VAT than that accorded to the taxable person for the exercise of such a right.

In accordance with the reverse charge procedure introduced by art. 21(1)(b) of the sixth directive, the taxpayer, as the recipient of services supplied by taxable persons established abroad, was liable to input tax, although it could, in principle, deduct exactly the same amount of tax so that no tax was due to the Exchequer. However, where the reverse charge procedure was applicable, art. 18(1)(d) authorised the member states to establish the formalities with which the taxable person had to comply in order to be able to exercise his right to deduct.

Furthermore, according to art. 22(2) and (4), every taxable person was to keep accounts in sufficient detail for VAT to be applied and inspected by the tax authority and to submit a return which had to set out all the information needed to calculate the tax that had become chargeable and the deductions to be made. In order to ensure that every taxable person complied with those obligations, art. 22(7) authorised member states to take the necessary measures for that purpose, including in the case of the reverse charge procedure.

A reassessment and recovery practice, which penalised 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 went further than was necessary to attain the objective of ensuring the correct application of such obligations within the meaning of art. 22(7), since Community law did 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 misapprehension of those obligations. That practice also went further than was necessary for the correct collection of the tax and for the prevention of evasion within the meaning of art. 22(8), since it might even lead to the loss of the right to deduct if the reassessment of the tax return by the tax authorities was made after the expiry of the limitation period available to the taxable person in which to make the deduction.

Articles 17(6) and (7) of the sixth directive were not applicable to a situation such as the present, since they governed the existence of the right to deduct itself and not the procedure for exercising it. Moreover, art. 17(6) applied only to expenditure which was not strictly business expenditure, such as luxuries, amusements or entertainment, whereas it was common ground that no such expenditure was involved in the present case. Furthermore, member states could not avail themselves of art. 17(7) unless they had first used the consultation procedure provided for in art. 29.

European Court of Justice (Third Chamber).

Judgment delivered 8 May 2008.