CJEU on material and formal conditions for the right to deduct VAT

A few words about the CJEU ruling on November 21^st, 2024, ref. C-624/23, SEM Remont.

Case overview

The ruling was issued in connection with a transaction in which, in August 2020, the Bulgarian company SEM Remont contracted the Russian company Gidrostroy – Russia to carry out dredging works in the port of Varna. The contractor, not registered for VAT in Bulgaria at the time of issuing the invoices, did not charge VAT on these documents. The recipient of the service was ES BILD, an entity established by SEM Remont and EIS – Stroitelna kompania AD (the Bulgarian representative of Gidrostroy – Russia).

The decision to register the Russian company for VAT in Bulgaria was issued only in December 2020, following an audit that determined its turnover had exceeded the statutory threshold obligating registration back in December 2019. Consequently, the Bulgarian tax authorities ordered Gidrostroy – Russia to calculate and pay the outstanding tax for the period from December 2019 to December 2020. In order to settle the outstanding tax on the disputed transaction, Gidrostroy – Russia issued a memorandum, which is mandatory under Bulgarian regulations for transactions settled under the reverse charge mechanism when the supplier is not registered in the country and the obligation to settle VAT rests with the registered recipient (in this case, SEM Remont).

However, the protocol contained formal errors – firstly, the Russian company appeared both as the supplier and the recipient of services, thus the document did not provide correct information about the actual parties to the transaction. Secondly, the memorandum was submitted to the tax authority and not to the counterparty.

Once, during the audit, the tax authority asked Gidrostroy – Russia to calculate VAT for periods prior to the actual registration, its Bulgarian tax representative EIS – Stroitelna kompania entered into a loan agreement with SEM Remont for the amount equal to the VAT amount shown in the aforementioned memorandum, and the borrowed funds were effectively transferred to the Bulgarian state treasury as overdue tax.

The Bulgarian tax authority refused to recognize the memorandum as a basis to deduct VAT by SEM Remont, as the document did not meet formal requirements. In justifying the refusal, the authority also cited a Bulgarian provision according to which a VAT-liable transaction supplier who failed to file a registration application within the statutory deadline is obligated to pay VAT on that transaction but has no right to correct invoices issued in the period before the actual VAT registration. The authority also stated that the original invoices were issued for a transaction where the actual purchaser was not SEM Remont but ES BILD. Therefore, it was concluded that SEM Remont did not meet either the material or formal conditions for the right to deduct VAT.

As a result of this refusal, SEM Remont appealed to the administrative court in Varna, which had doubts about the compatibility of national regulations with EU law, referred preliminary questions to the CJEU.

CJEU ruling

The Court emphasized that the right to deduct VAT is an integral part of the system and cannot be restricted. This applies only to situations where the basic conditions for the right to deduct are met, specifically the requirement that the output VAT should be due or paid to the supplier.

In the discussed situation, the original invoices documenting the transaction were issued without VAT, and this tax was shown only at the stage of the memorandum issued by the Russian company during the tax audit. Hence, it cannot be assumed that the price agreed between the parties included VAT. The memorandum could not be, according to the CJEU, classified as an agreement between the parties due to serious formal deficiencies: not indicating the transaction parties and not delivering the memorandum to SEM Remont. Therefore, it cannot be assumed that VAT was paid by SEM Remont or was due from it. This conclusion cannot be altered by the fact that SEM Remont entered into a loan agreement with the Russian contractor’s representative for an amount equal to the input VAT on the original transaction. The loan agreement neither imposed an obligation to pay VAT on SEM Remont nor could be considered a correction invoices issued by the Russian company.

The CJEU also agreed that Bulgarian law, which does not allow the correction of incorrectly issued invoices in situations where the supplier was not registered for VAT in due time, does not violate the principles of VAT neutrality if the VAT was not actually paid by the recipient.

Significance of the ruling

It is worth noting that the factual situation described in the ruling is quite intricate and takes into account specific provisions of Bulgarian law. The CJEU’s reasoning is not entirely clear, but some general conclusions can be drawn for taxpayers.

The CJEU emphasized that fulfilling material conditions (i.e., VAT must be due or paid) is crucial for obtaining the right to deduct, of course apart from the requirement of a connection between purchases and the taxable activities of the supplier. Formal deficiencies are generally correctable, but not in situations where the essential material conditions are not met.

In this context, the Bulgarian ruling does not introduce a revolution. The view that any document (e.g., an agreement) can be considered an invoice provided it contains all information necessary to establish the fulfilment of material conditions for the right to deduct is well-established in both CJEU rulings (judgment of September 29^th, 2022, ref. C-235/21, Raiffeisen Leasing) and Polish courts (judgment of the Warsaw Administrative Court of December 8^th, 2023, ref. III SA/Wa 1473/23). The right to deduct VAT can be preserved even when the taxpayer has committed formal infringements, provided these do not prevent the provision of evidence that the material conditions have been met (as in the CJEU judgment of November 21^st, 2018, ref. C-664/16 Lucreţiu Hadrian Vădan; Polish Supreme Administrative Court judgment of October 29, 2021, ref. I FSK 1656/21).