Good faith as a determining factor in the tax on goods and services

An analysis of the protection institution of a taxable person acting in good faith is extremely important for the settlement of the economic operator with the tax, in particular in the event of a tax check on the determination of a tax liability.

The scope and methodology of the protection of the rights of a person acting in good faith are presented in this paper on the basis of the provisions of the Civil Code, the Code of Commercial Companies, Tax Ordinance, Income Tax Act and the provisions of the VAT Act.

In practice, the application of tax law can be very important because, in certain situations, good faith can exempt the taxpayer from liability in the event of an unconscious breach of tax law standards or involvement in business transactions with unfair parties.

I. The Concept of Good Faith

The design of the concept of good faith is known from the times of Roman law. The Romans used this concept only in a situation that involved the circulation of certain legal relations, namely, it was a measure of moral behavior in social systems.

Good faith was also defined as mutual respect and trust between the parties, being the backbone of the principles of fairness and justice.

The practical approach of the Roman lawyers to the problems analysed resulted in a reference to good faith being made to solve a specific legal problem rather than a systematic approach to this principle in general terms[1].

This concept began to be applied in the area of tax law relatively recently. There is no doubt that the development of the importance of the concept of good faith and due diligence was due to the case-law of the Court of Justice of the European Union.

The TEU has repeatedly stressed the importance of this institution in the area of value added tax, in particular in examining the right to deduct input tax or the right to apply the exemption for exports of goods and intra-Community supplies of goods[2].

The development of the doctrine concerning the protection of a taxable person acting in good faith with regard to deduction of input tax started the judgment in the Optigen and Others cases. 3 . In subsequent judgments, the Court clarified and developed the scope of this clause[4].

The development of the Court of Justice's jurisprudence line was linked to a number of criminal offences in tax settlements, including the so-called "VAT carousels", which unfortunately occurred on a wide scale also in Poland.

Analyzing the question of good faith or due diligence shows us that this construction occurs quite point-blank in Polish tax law. However, it should be stressed that Polish civil law makes wide use of due diligence structures[5].

In the science of civil law, good faith is placed among the elements of the facts as a so-called mental state, and thus some subjective attitude of the person on whom this attitude may depend the formation, change or cessation of the legal relationship[6].

Under the Commercial Companies Code, we have regulations on due diligence, which are exonerative conditions, which exclude the responsibility of persons managing commercial law companies. Such regulations are included, among others, under Article 293(2) , Articles 299(2) and 483(2) KSH.

In an attempt to determine the core of the protection institution of a taxable person acting in good faith, it would be worth looking into the case law and civil law doctrine.

The literature often highlights the fact that there is no uniform, commonly used pattern of actions that meet due diligence, but that it should be determined taking into account the general care required for the relationship.

Legal regulations containing protection structures of a taxable person acting in good faith can also be found in Tax Ordinance, according to Article 112(1): „The purchaser of an undertaking or an organised part of an undertaking shall be jointly and severally liable to the taxpayer for the tax arrears incurred by the date of acquisition of the business unless, with due care, he could not have known of those arrears.’ 7 .

The need to settle the tax obligation with good faith is recognised by the Court of Justice of the European Union. From this point of view, although good faith is not a normative concept of tax law, it finds its application in the VAT system[8].

It follows from the caselaw of the Court that in good faith only a taxable person who did not know or, with due care, could not know that he was involved in a transaction involving an abuse or fraud of value added tax[9]. Participation in such transactions, in view of the risk that is incompatible with the application of the provisions of the common system of value added tax, should call into question the right to implement a specific VAT mechanism[10]. However, it follows from the caselaw of the Court that the right to exercise a certain power (e.g. the right to deduct) should only be deprived of the taxable person who committed the offence himself or who knew or should have known that he was involved in the offence or abuse. Such a taxable person, acting in bad faith, must be disenfranchised by the provisions of the common system of value added tax. The powers to which the unconscious taxpayer should retain the right can be divided from the point of view of substantive VAT regulation into the following groups:

• • the right to deduct input tax,
• • application of the rate 0%,
• • exports of goods outside the territory of an EU Member State,
• • the joint and several liability of the taxpayer for the obligations of the counterparty,
• • correction of the tax wrongly shown on the invoice,
• • the application of the margin procedure.

Regardless of the area of application, the jurisprudence effect of the concept is intended to achieve a specific VAT mechanism. An unconscious participant in fraud or abuse, showing his good faith, cannot lose the right to apply certain mechanisms. The concept of good faith is therefore intended to offset the consequences of a fraudulent or abusive transaction in the supply chain of an unconscious taxpayer[11]. It is therefore intended to support the structurally guaranteed neutrality of this tax.

The jurisprudence of the Court of Justice of the European Union, which introduced to the ground a tax on goods and services not known to that law the notion of good faith and due diligence, did not develop a "tax" definition of these terms nor did it refer to their meaning under private law. The Court consistently points out that:

1. the right to deduct is conferred on the taxable person, unless it is demonstrated in the light of objective conditions and without requiring the taxable person to make arrangements which he is not obliged to know or should have known that the supply involved a VAT offence 12 ;
2. the determination of the measures which, in a particular case, may reasonably be expected of the taxable person who intends to exercise the right to deduct VAT, in order to ensure that his transactions do not involve a prior-stage criminal offence, depends primarily on the circumstances of the case under consideration.[13].

Also in the case law of the Court of Justice itself, as well as the Polish administrative courts, it does not make the nature and source of the concept of “good faith” of the subject of in-depth consideration.

Polish administrative courts mainly in the initial stage of resolving the type of disputes in question stressed that the use of the concept of "good faith" should remain a domain of private law alone.[14].

On this basis, the possibility of ruling on a tax obligation on the basis of civil law institutions was denied, but this analysis found no development[15]. The Court of Justice, in turn, does not state in any of its judgments the substance and origin of the notion of good faith in private law.

In In fact, in the opinion issued in one case, the Ombudsman explained that the ‘principle of good faith’ applied by the Court of Justice derives from the design of this tax, not from private law, but that, in view of the context of the statements, this attention must be directed at the objective and the need to apply it, not at the source and nature of the concept of ‘good faith’ itself.

16 .

In the national doctrine, due diligence in VAT should be assessed in the context of published 27 April 2018 a document prepared by the Ministry of Finance and National Tax Administration.

The document entitled ‘The methodology for assessing the due diligence of purchasers of goods in domestic transactions’ explains that ‘to assess whether it is appropriate to challenge the taxpayer’s right to reduce the amount of tax due by the amount of input tax, it is crucial to assess whether, in a particular case where VAT fraud was found, the taxpayer should have known that he was involved in a transaction involving fraud or abuse of VAT’.

17 .

It also states that ‘if the taxable person is not sufficiently careful when entering into a transaction, and thus ignores objective circumstances indicating that the transaction may be intended to infringe a law or fraud, then the right of that taxable person to deduct input tax should be challenged. [...] In addition, examples have been presented of actions that the taxpayer should contribute to verifying the circumstances of the transaction in order to demonstrate due diligence when deciding to enter into a transaction with the counterparty concerned’ 18 .

The good faith of the buyer the legislator seems to take into account in the area of the institution of joint and several liability.

In the light Article 105a(1) The VAT Act of the purchaser may be held jointly and severally liable with the entity making the supply for its tax arrears in the proportion of the tax payable on the supply if, in addition to exceeding the threshold amount ‘(...), the purchaser knew or had reasonable grounds to believe that the total amount of tax due to the supply of those goods to him or its part would not be paid to the tax office’.

At the same time, the taxpayer points to circumstances of bad faith Article 105a(2) VAT Act[19].

III WSA and NSA case law line In the judgment of the General Court of 16 May 2018, VIII SA/Wa 940/17, it was pointed out that due diligence was the state of the taxpayer's awareness and, consequently, the possibility of predicting the taxpayer's participation in activities leading to an undue refund.

In that judgment, the CSA also indicated where the action of the taxpayer should be regarded as having been committed ‘in bad faith’.

“In order to act “in bad faith”, the taxpayer does not need to be aware that he or she is in violation of the law, but also if, under the circumstances in question, he or she can and should anticipate such a condition (in the form of negligence).

In other words, “in bad faith” is the one who knows (has positive knowledge) about the actual and actual reality, and who does not have such knowledge due to his negligence. The existence or lack of good faith is therefore a fact rather than a legal standard.’

In the judgment of 10 July 2018, No reference no. I SA/Wr 351/18, The Provincial Administrative Court in Wrocław stressed that the exclusion of the taxpayer from the right to deduct input tax may only take place on the basis of objective grounds that the taxpayer knew or could have known that he was involved in fraudulent proceedings.

The tax authority, in making the thesis on the informed participation of the taxpayer, must prove it. It is the task of the tax authorities to carry out checks, not to transfer this obligation to the taxpayer.

Therefore, the tax authority cannot require the taxable person to conduct in-depth investigations or the issuer of an invoice for the goods or services on which the taxable person deducts the input tax is a fair taxable person.

It is reasonable to expect the taxpayer to take reasonably justified measures in the course of the economic turnover (the so-called proportionality principle).

The tax authority, when refusing the deduction of VAT by the taxable person, should retrospectively reproduce the picture of the taxpayer's awareness of the date of the transactions in question.

The mere fact that a counterparty is cheating cannot automatically generate the conclusion that the taxpayer was aware of its involvement in the VAT fraud procedure.

Furthermore, in the course of the free assessment of evidence, the tax authority should take into account the fact that even a prudent taxpayer may not have discovered tax fraud, because the fraudster was so deeply imprisoned.

In particular, in a situation where the taxpayer, despite undertaking an in-depth verification of the counterparty, did not discover that the purpose of the counterparty was to extort VAT.

Supreme Administrative Court in judgment of 18 May 2018, No reference no.

I FSK 1308/16, points out that in order to deprive the taxable person of the right to deduct input tax, it is not necessary to demonstrate that the taxable person was aware that he was involved in abusive transactions, it is sufficient to demonstrate that he could or should have provided for such transactions.

Where the goods have been delivered to the buyer and it has been shown on the case that the goods could not be supplied by the issuer of invoices, in order to deprive the taxable person of the right to deduct the input tax resulting from such invoices, it should be shown that the taxable person was aware or could have foreseen that the transactions constituted an abuse.

In turn in the judgment of the Supreme Administrative Court of 5 December 2013, No reference no. I FSK 1687/13, The Court indicated that the tax authority should take the attitude of the company to the individual counterparties whose transactions have been contested and assess the importance of good faith.

Proper diligence will be demonstrated by maintaining the right to deduct input tax.

The tax authority should take into account, in respect of each of the counterparties, the elements such as the establishment and implementation of cooperation by the company, the circumstances accompanying the supply itself, the payment for them, etc., and indicate in which element the company failed to comply with the standards of careful action, which it could and should have avoided, which should have caused it reasonable concern and why.

IV Good faith in income tax

Unfortunately, compared to the protection of a taxable person acting in good faith under the Services Goods Tax Act, we see some solutions that are detrimental to the taxpayer in income tax. The taxpayer’s good faith in any situation will not be free from liability for tax obligations, which in practice may result in an increase in tax liability. This concept is confirmed uniformly by the jurisprudence of the Polish administrative courts, among others in the judgment of the WSA dated 18 April 2019 inCatowice:

„Legal construction of revenue costs is included under Article 15(1) Act dated 15 February 1992 on corporate income tax (Journal of Laws of 2021, items 255, 464, 794, 868 as amended), according to which the cost of obtaining revenue is the costs incurred in order to obtain revenue or to preserve or secure the source of revenue, except for the costs listed above under Article 16(1) This bill. In order for an expenditure to be included as revenue costs, it must be cumulatively two conditions: the purpose of the expenditure should be to achieve income, and that expenditure must not be included in a specific under Article 16(1) the cost catalogue laws which cannot be included in the cost of obtaining revenue.

Tax payers are required to properly document the cost of obtaining revenue. The possibility to charge a particular expenditure to the cost of obtaining revenue exists not only in the case of demonstrating its relationship with the source of revenue, but also requires proof that the expenditure has actually been incurred and the related purchase (service, goods) made.” 20 .

A similar argument was also raised by the Provincial Court in Wrocław in the judgment dated 24 June 2016:

„From the regulatory point of view under Article 14(1) the Corporate Income Tax Act it does not matter whether the taxable person is guilty (intentionally or due to a lack of care for his own business interests) or whether the innocent has settled the costs of obtaining revenue on the basis of unreliable accounting evidence. In order to assess the reliability of the tax accounts and to determine the appropriate method for determining the tax base, the reasons for the calculation of the costs of obtaining the revenue of expenditure resulting from invoices not reflecting actual sales are invalid. It is necessary to demonstrate the origin of the goods that a specific expenditure can be counted as revenue costs’ 21 .

The Supreme Administrative Court also expressed its support to the common concept of good faith and tax obligations dated 20 August 2019:

„Furthermore, it is necessary to agree with the Court of First Instance’s view that the provisions of the Income Tax Act on individuals do not make the right to consider expenditure as a cost of obtaining income dependent on the taxpayer’s due diligence. Good faith must not be used as a basis for recognising as a cost of obtaining expenditure documented by invoices which do not reflect actual transactions’ 22 .

IV Summary

It seems reasonable to extend the introduction of institutions for the protection of the rights of a taxable person acting in good faith in the field of tax law.

Only in a few situations can we expect the tax authority to take account of the question of good faith and thus to exercise, for example, the right to deduct or not to impose undue tax sanctions.

Of course, Polish taxpayers rely in tax disputes on the established line of the TEU (as well as administrative courts), protecting the right to deduct charges of a taxable person acting in good faith, but the statutory clause in this respect would increase this protection[23].

This is necessary in view of the increasing number of proceedings challenging the right to deduct input tax from taxable persons purchasing goods/services from tax fraudsters.

It is also worth noting that the failure to take account of the taxpayer's actions in good faith may result in infringements by tax authorities of general tax rules. Unfortunately, often a non-taxable entity is not a direct supplier that is known to the buyer, but an entity at the previous stage of the transaction.

With the introduction of such a clause in the laws governing the scope of the obligation, consideration should also be given to clarifying the conditions of good faith (due diligence).

Despite such attempts on judicial grounds, it is unfortunately possible to observe a practice questioning the deduction of input tax despite doubts about the buyer’s awareness.

The tax authorities sometimes assume that any doubts about the circumstances of the transaction must be explained to the detriment of the taxpayer, which results in the deprivation of the right to deduct. The use of this clause also requires extreme caution, as tax fraud often cites the benefits of it.

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