Latvia: Supreme Court Senate changes case-law regarding reason of limitation of economic activity expenses to be included in calculation of corporate tax

Supreme Court Senate, in case Nr.SKA-21/2013, due to LLC “RDN” claim against the State Revenue Service of Republic of Latvia (hereinafter SRS), in the Judgment of June 12, 2013, has changed the case-law regarding reason of limitation of economic activity expenses to be included in calculation of corporate income tax (hereinafter CIT).

SRS performed Value added tax (hereinafter VAT) and CIT audit in LLC “RDN” and acknowledged that the transactions presented in the accountancy of the Applicant in fact have not been carried out, therefore LLC “RDN” without a reason increased economic activity expenses and without a reason performed deduction of pretax.

Therefore in the result of audit, with the Decision of SRS General director, for Applicant were determined additional VAT and CIT payments in the budget.

The Applicant submitted a claim against SRS in Administrative Court and requested to withdraw the Decision of SRS General director.

Regional Court (second instance court) rejected LLC “RDN” claim, holding that transactions in fact have not been carried out; the invoice of transaction was signed by the person who was not entitled for that; invoice included wrongful information regarding the actual procedure of transaction; it could not be established who obtained the Applicant’s goods. Therefore invoices are not recognized as transaction source documents within the meaning of the Law "On Accounting". LLC “RDN” appealed the Judgment.

Senate in the joint meeting of 9 senators withdrew the Regional Administrative Court judgment according to the following reasons:

[1.] The second instance court had not correctly and completely evaluated the facts of the case to conclude that the Applicant was not entitled to deduct pretax.

Law on VAT Article 10 (1) (1) establishes that only a taxable person registered in the SRS has, in a tax declaration, the right to deduct as input VAT, from the amount of tax payable into the budget, the tax amounts indicated in tax invoices received from other taxable persons regarding goods and services for ensuring their own taxable transactions, as well as the ensuring of such transactions conducted in foreign states as would have had tax imposed if they had been conducted inland.

In the Senate case law is recognized that, within the meaning of the Law on VAT, Article 10 (1)(1) in conjunction with Article 1 (9)(8),  pretax may be deducted only in accordance with the tax invoice actually carried out transaction, which complies with all the features mentioned in the provision. Therefore first must be determined whether the transaction actually has been carried out. For deduction of pretax, it is not enough that the transactions have been formatted in accordance with the requirements of law, as the transactions have actually to be carried out from their economic and legal nature, and the invoices have to reflect the transactions.

In the recent EU Court judicature in more detail is explained further actions of VAT administration and Court, in case it is found that the transaction with the person indicated in the invoice has actually not been carried out.

“However, if the tax authority from the fraud or irregularities committed by the issuer of the invoice concludes that the transaction corresponding to the invoice is considered not to have been actually carried out, this administration, for denying the deduction rights, has to prove on the basis of objective factors and without requiring of the recipient of the invoice checks, which are not its responsibility, that the recipient knew or should have known that the transaction was connected with VAT fraud, a matter which it is for the referring court to determine”. (Case C-563/11 LLC Forvards V Vs.SRS).

Therefore tax administration can not stop at the finding that the transaction counterparty actually could not perform the transaction because of lack of resources or fictional character. Also the court in its motivation can not be confined to that.

From the EU Court judicature conclusions the Senate establishes that SRS can not deny the tax payer the right to deduct pretax on the ground that the issuer of the invoice or its supplier has performed illegal activities, without objective evidences, what could prove that the tax payer knew or he had to know that the transaction, what justifies the right for deduction, was connected with the invoice issuer`s committed fraud or other linked market participant’s committed fraud.

SRS can not justify the refusal to use the right of deduction only with tax payer's counterparty illegal or fictitious nature operations, as SRS is obliged to perform the necessary tax payers' checks (Cases No.C -80 /11 and C-142/11 Mahageben §62).

[2.] The second instance court, determining whether the Applicant was entitled to present the transactions in economic activity expenses, had to verify whether the Applicant knew (or should have known) that the transaction is included in tax fraud.

The Senate has previously acknowledged that the information regarding supplier has essential importance, determining whether the tax payer correctly has calculated CIT. Just knowing a supplier, it is possible to ascertain whether the transaction of supply of goods was performed for appropriate price. If it is determined that the person indicated in invoices has not delivered the goods, there is a reason to assume that the transaction was not carried out. Concluding that the transaction was not carried out, transaction costs incurred are not related to the tax payer's economic activity.

Same source documents (transaction confirming bills) shall be taken into account in calculation of CIT and VAT, on both equally apply provisions of Law "On Accounting", Article 2 regarding authentic information disclosure in accounting, Article 7 (1) regarding entries in the accounting records only in accordance with the source documents. In both cases vital importance is whether the person, in the result of transaction, has received the goods (services), what have been used for providing the economic activity.

Therefore for successful functioning of the tax system and prevention of fraud, there is no ground to apply different criteria in respect to each tax regarding the same transactions.

Therefore, in the Senate`s view also to calculation of CIT, establishing economic activity expenses to be included, shall be applied the same approach as in EU Court judicature. If the tax authorities and later court has reason to doubt whether the transaction in fact has been carried out with the mentioned counterparty, it must be determined whether the tax payer is involved in tax fraud.

According to above mentioned the Senate departed from its previous case-law according to which reason to doubt the possibility of the transaction with the counterparty essentially excludes the possibility to present the transaction in the economic activity expenses.

Valters Gencs

Tax Attorney & Founding Partner

Gencs Valters Law Firm, Riga

Email: valters.gencs@gencs.eu Tel: +371 67 24 00 90