In its judgment of January 15, 2014, the Provincial Administrative Court (WSA) in Warsaw (case no. III SA/Wa 1928/13) ruled that a bankruptcy receiver was not required to correct input tax under the procedure set forth in Art. 89b (1) of the VAT Act (in the version which took effect on January 1, 2013) if the creditor cannot correct output tax under the “bad debt relief” procedure due to the debtor being bankrupt.
Before being declared bankrupt, the company was purchasing goods and services from its trading partners. Not all of its debts in this respect were repaid. The company’s creditors were required to report their claims in the bankruptcy proceedings. Due to having been substantiated as uncollectible – within the meaning of Art. 89a Section 1a of the VAT Act – after December 31, 2012 some of the debts involved were subject to the “bad debt relief” regulations in the version which took effect on January 1, 2013.
The bankruptcy receiver believed that he was not required to correct input VAT under Art. 89b (1) of the VAT Act in view of the company’s failure to repay its debts within 150 days of the due date, as he would have violated one of fundamental principles relating to VAT, i.e. its neutrality. The tax authorities would have collected input VAT from the creditor, who was deprived of the right to claim bad debt relief (i.e. a correction to input VAT) in view of the debtor’s bankruptcy. At the same time, as a result of the bankruptcy receiver’s correction and payment of the related tax liability, the tax authorities would have collected the same amount of tax twice. In effect, VAT would have been paid by both parties to the transaction.
The Head of the Tax Chamber in Warsaw ruled that the bankruptcy receiver was required to correct input VAT in the case at hand. He invoked the literal wording of Art. 89b of the VAT Act, which stipulates that, in a situation where 150 days pass from the due date for the payment of an invoice, the debtor is required to correct input VAT regardless of whether or not its creditor resorted to bad debt relief. To put it differently, even if the creditor was not entitled to correct input VAT due to the debtor being bankrupt, the bankruptcy receiver was still required to correct it.
The WSA in Warsaw reversed the ruling on appeal. In its opinion, the viewpoint presented by the tax authority violated the fundamental principle that VAT is a neutral tax. If implemented, the interpretation of Art. 89b of the VAT Act by the Head of the Tax Chamber would have resulted in double taxation.
The opinion presented by the WSA in Warsaw in its judgment merits full approval. The Court rightly pointed out that a correction by the bankruptcy receiver of input tax under Art. 89b of the VAT Act would have violated the key structural principle of the VAT system, i.e. that VAT is neutral, and resulted in double taxation. On one hand, the creditor would have been deprived of the right to claim bad debt relief and, by extension, of the right to correct output VAT in view of the debtor’s bankruptcy. On the other hand, the bankruptcy receiver would be required do correct input VAT and pay the related tax liability on an ongoing basis.
The controversy in this case stems from the asymmetry between Art. 89a of the VAT Act concerning a correction to output VAT by the creditor and Art. 89b governing a correction to input VAT by the debtor. Art. 89a (2) of the VAT lists the conditions which must be satisfied in order for output VAT to be corrected by the creditor. Art. 89b of the VAT Act does not contain any analogous regulation. Consequently, given the literal wording of those regulations, the debtor may be obligated to correct input VAT, despite the fact that the creditor was not entitled to correct output VAT due to the non-fulfillment of one of the conditions listed in Art. 89a (2) of the VAT Act. The judgment under consideration hands a strong argument to taxpayers in a potential dispute with the tax authorities over the double taxation of a transaction arising from the asymmetry presented above.
Moreover, it is to be hoped that the lawmakers will decide to amend the “bad debt relief” regulations and eliminate the inconsistency of the VAT Act. Otherwise, disputes between taxpayers and the tax authorities over the applicability of “bad debt relief” are bound to continue.