Briefing document & Podcast: ECJ C-564/15 (Farkas) – Non-application Reverse-Charge, 50% tax penalty is disproportionate

Briefing Document: Case C-564/15 (Farkas) – VAT, Reverse Charge, and EU Law Principles

1. Case Overview:

Subject: A preliminary ruling requested by a Hungarian court regarding the compatibility of Hungarian VAT regulations with EU law, specifically Directive 2006/112/EC on the common system of VAT.
Parties:Tibor Farkas: The purchaser of a mobile hangar (movable property).
Nemzeti Adó- és Vámhivatal Dél-alföldi Regionális Adó Főigazgatósága: The Hungarian tax authority.
Issue: The core dispute concerns the application of the reverse charge mechanism for VAT in Hungary, the right to deduct VAT, and the proportionality of a tax penalty imposed on Mr. Farkas.

2. Key Concepts & Legal Framework:

Value Added Tax (VAT): A consumption tax applied to the value added at each stage of production or distribution. Directive 2006/112/EC provides the framework for a common EU VAT system.
Reverse Charge System: A VAT mechanism where the responsibility for paying VAT shifts from the seller to the purchaser. This is often used to simplify VAT collection and prevent tax evasion. As stated in the main judgement, recital 42 of Directive 2006/112 states: ‘Member States should be able, in specific cases, to designate the recipient of supplies of goods or services as the person liable for payment of VAT. This should assist Member States in simplifying the rules and countering tax evasion and avoidance in identified sectors and on certain types of transactions.’
Article 199(1)(g) of Directive 2006/112/EC: This article allows Member States to apply the reverse charge mechanism to the supply of immovable property sold by a judgment debtor in a compulsory sale procedure.
Hungarian Law on VAT, Paragraph 142(1)(g): The Hungarian law extends the reverse charge mechanism to both movable and immovable property when the seller is in bankruptcy proceedings.
Principles of Equivalence and Effectiveness: EU law requires Member States to apply national procedural rules in a way that is no less favorable than for similar domestic claims (equivalence) and does not make it excessively difficult to exercise rights conferred by EU law (effectiveness).
Principle of Fiscal Neutrality: VAT system should not distort competition or economic decisions; similar transactions should be taxed in a similar way. The right to deduct VAT is crucial to ensure this neutrality. As the main judgement states, “The deduction rules thus established are intended to free the taxable person completely of the burden of the VAT accruing or paid in all its economic activities. The common system of VAT therefore ensures that all economic activities, whatever their purpose or results, provided that they are, in principle, themselves subject to VAT, are taxed in a neutral way”.
Principle of Proportionality: Any action taken by an authority should not be more than necessary to achieve its objectives. This principle is relevant to the tax penalty imposed on Mr. Farkas.

3. Facts of the Case:

Mr. Farkas purchased a mobile hangar (movable property) at an electronic auction.
The seller (a company with an outstanding tax liability) issued an invoice including VAT, and Mr. Farkas paid the VAT to the seller.
Mr. Farkas deducted the input VAT recorded on the invoice.
The Hungarian tax authority determined that the transaction was subject to the reverse charge mechanism under Paragraph 142(1)(g) of the Law on VAT, requiring Mr. Farkas to pay the VAT directly to the Treasury.
The tax authority disallowed Mr. Farkas’s VAT deduction and imposed a tax penalty.

4. The Preliminary Ruling Request:

The Hungarian court sought clarification from the CJEU on the following questions:

Is the Hungarian tax authority’s practice compatible with EU law, particularly the principle of proportionality, fiscal neutrality, and the prevention of tax evasion, given that the seller declared and paid the VAT, and Mr. Farkas deducted the VAT paid to the seller?
Is the imposition of a 50% tax penalty proportionate, given that the Treasury suffered no loss of revenue, and there was no evidence of abuse?

5. Court’s Reasoning and Judgement:

Application of Article 199(1)(g): The Court clarified that Article 199(1)(g) of Directive 2006/112/EC only applies to immovable property. Because the mobile hangar is considered movable property, the Hungarian law extending the reverse charge to movable property went beyond the scope permitted by the directive.
Right to Deduct VAT: Mr. Farkas was denied the right to deduct the VAT paid to the seller because “the VAT was not due and the payment was made in breach of a substantive requirement of the reverse charge regime”. The VAT should have been paid directly to the tax authority.
Recourse for Mr. Farkas: The Court stated that Mr. Farkas could claim reimbursement of the unduly paid VAT from the seller under national law. If such recourse is impossible or excessively difficult (e.g., due to the seller’s insolvency), the principle of effectiveness requires Hungary to provide a mechanism for Mr. Farkas to claim reimbursement directly from the tax authority.
Proportionality of the Tax Penalty: The Court stated that “the principle of proportionality must be interpreted to the effect that it precludes national tax authorities, in a situation such as that in the main proceedings, from imposing on a taxable person, who purchased an item of property the transfer of which comes under the reverse charge regime, a tax penalty of 50% of the amount of VAT which he is required to pay to the tax authority, where those authorities suffered no loss of tax revenue and there is no evidence of tax evasion, this being a matter for the referring court to determine.” Given that there was no loss of tax revenue and no evidence of tax evasion, a 50% penalty appeared disproportionate, although the final determination was left to the national court.

6. Implications:

The Farkas case clarifies the limitations on Member States’ application of the reverse charge mechanism for VAT. Article 199(1)(g) cannot be broadly interpreted to include movable property without a specific derogation.
The case underscores the importance of the principles of equivalence and effectiveness in ensuring the proper implementation of EU law at the national level.
The judgement emphasizes the principle of proportionality in relation to tax penalties. Penalties should be appropriate to the nature and seriousness of the infringement and should not be excessive.

7. Key Quotes:

“Article 199(1)(g) of Directive 2006/112 refers only to immovable property and not movable property. Therefore, the sale of movable property in an auction, such as the one at issue in the main proceedings, falls outside its scope.”
“Mr. Farkas was denied the right to deduct the VAT he paid to the seller because the VAT was not actually due to the seller under the reverse charge mechanism. He incorrectly paid the VAT to the seller when he should have been paying it directly to the tax authority.”
“…to the extent that reimbursement of the unduly invoiced value added tax by the seller to the purchaser becomes impossible or excessively difficult, in particular in the case of the insolvency of the seller, those principles require that the purchaser be able to address his application for reimbursement to the tax authority directly.”
“The Court concluded that the principle of proportionality likely precluded the imposition of a 50% tax penalty on Mr. Farkas, given the circumstances of the case.”

8. Conclusion The Farkas case is a good example of the European Court of Justice being asked to rule on the VAT implications of an unusual case. Whilst the Hungarian tax authority was technically correct that Farkas had an outstanding tax liability, the circumstances, especially the lack of tax evasion or loss of tax revenue meant that a heavy penalty was not proportionate.