VAT penalties and the principles of proportionality and neutrality. Towards an EU “harmonized” criterion?

On April 15, 2021, the European Court of Justice (ECJ) issued its judgment in the Grupa Warzywna (C-935/19) case. This case refers to the always controversial issue of VAT penalties.

A Polish company named Grupa Warzywna purchased a real estate that was used for more than 2 years. The seller of the real estate issued an invoice charging VAT. Grupa Warzywna submitted a refund claim for the VAT on the real estate purchased.

The Tax Authority rejected the claim on the basis that the sale of the real estate should have been VAT exempt. According to the Tax Authorities, Grupa Warzywna was not entitled to deduct the input VAT on the supply. Even is the Company corrected its VAT return accordingly and decreased its deductible VAT amount, the Tax Authority levied a penalty of 20% on the VAT amount of the purchase, arguing that the VAT deduction originally declared was unjustified.

The company did not agree with the approach from the Authorities and finally a question was referred to the ECJ asking whether a penalty like the one imposed by the Polish Authorities was compatible with EU Law.
The ECJ´s reasoning is clear and direct, stablishing the basis of what might be considered a common EU sanctioning criterion.

There is an absence of harmonization through EU legislation in the field of penalties as they do not form part neither from the EU VAT directives, nor from the VAT regulations.
The above means that the power to impose penalties is entirely within the competence of the Member states, who have freedom to qualify, quantify and impose the penalties they consider appropriate. However, two pillars of the EU law must always be well respected, namely, the principle of proportionality and the principle of VAT neutrality.

Respect for the principle of neutrality takes the form of allowing VAT taxpayers the right to deduct the input VAT amounts incurred while carrying out activities subject to VAT This right can only be restricted in very specific situations such as fraudulent behaviors. Therefore, penalties that restrict or eliminate this right would not be in accordance with EU Law.

On the other hand, the principle or proportionality is crystalized in several arguments like for example that penalties must not go beyond what is strictly necessary for the objectives pursued. The nature and the degree of seriousness of the infringement which that penalty seeks to sanction must be considered. As a summary it can be said that they cannot be disproportionate to the gravity of the incident, especially when no VAT revenue loss is suffered.

In the Grupa Warzywna case, the Company committed an error based on a wrong assessment of the VAT treatment of a certain transaction. However, the penalty did not make any difference whether the purpose was fraudulent, whether the error generated tax revenue loss or whether any other special circumstances were considered or not. For all these reasons, the ECJ concluded that said penalty was breaching the EU principle of proportionality.

According to the above, one can say that VAT penalties indistinctly imposed without considering the special circumstances of each case are contrary to the principle of proportionality and consequently, they are not aligned with EU Law.

Member States must consider the particularities of each single case, especially, the behavior of the taxable persons and if there has been good or bad faith, before imposing a penalty.
The ECJ establishes a series of limits within which all Member States must move when it comes to penalties in the field of VAT. These penalties, if imposed without respecting these limits, will be increasingly questioned. Therefore, in order to avoid expensive and long legal proceedings for taxable persons, the legislation of Member states should always take these limits into account.

All the above reasoning can be considered as consolidated through a series of ECJ´s judgments like for example the following cases:

C-210/91; C-110/99; C-262/99; C-181/04; C-502/07 K-1; C-188/09; C-385/09; C-424/12; – C-272/13; C-183/14; C-564/15; C895/19.

Undoubtedly, at present, it is not possible to speak of harmonization in the field of sanctioning law and realistically, it is likely that this full harmonization will not exist in a near future. However, in light of the different ECJ case law, one can glimpse some sort of “soft” harmonization which is materialized in the safeguard of two major principles of VAT: the principle of VAT neutrality and the principle of proportionality. The sanctioning regime of each Member state must always respect both of them. It is arguable whether this happens in practice