Watch out for irregularities to avoid losing the input VAT deduction or VAT exemption - BMF circular letter dated 15 June 2022

In a circular letter dated 15 June 2022, the German Federal Ministry of Finance (BMF) clarified section 25f of the German VAT Code (UStG), which provides for the denial of input VAT deduction and certain VAT exemptions if the entrepreneur knew or should have known that his or her turnover was involved in tax evasion or a similar offence. The BMF has very specific ideas about when an entrepreneur should be suspicious of something and take further steps.

Since 2020, there have been new rules on the denial of input VAT deduction and VAT exemptions

Since 1 January 2020, section 25f German VAT Code explicitly regulates what had previously only resulted from ECJ case law. If an entrepreneur knew, or should have known, that he/she was involved in a transaction providing or receiving a supply in which the supplier or another party was involved in VAT evasion or obtaining an unjustified input VAT deduction within the meaning of section 370 of the General Fiscal Code (AO) or in damage to VAT revenue within the meaning of sections 26a, 26c German VAT Code, the input VAT deduction and certain tax exemptions are to be denied.

The entire supply chain must be examined

The BMF clarified that tax offences must be considered in all upstream and downstream sales stages of a chain of supplies. This alone is a considerable hurdle because the entrepreneur is often only aware of his/her own source of supply and his/her own customer. For business policy reasons, upstream or downstream parties are usually not disclosed. 

What should you know (or have known)?

Above all, the indeterminate legal concept of "having to know" causes considerable difficulties. This can only mean that the entrepreneur is expected to be alert to certain irregularities, but the difficulty lies in defining what is considered “irregular”. Isn’t this dependent on the particular industry and open to individual interpretation, depending on the person’s background and expertise? The BMF, however, felt up to the task and prepared a catalogue of examples containing indicators that should alert an entrepreneur that something is amiss. If an entrepreneur detects any of these indicators, they are expected to take action to clarify and document these. If the entrepreneur fails to take these measures or if the measures cannot dispel the doubts, yet he/she nevertheless enters into or continues the business relationship, the tax authorities will assume that they either "knew” or "must have known".  The complete catalogue is available in the circular letter, which can be found here (in German) - and the key points are highlighted below.

The following circumstances should obviously raise suspicions for any entrepreneur - but here, too, adhering to tax authority expectations requires a great deal of investigative effort and a high degree of vigilance for every employee involved in the company:

  • A third party defines the conditions for a business
  • The price offered is below the market price
  • Multiple runs of goods
  • Cash payments are not customary in the industry
  • Delivery of goods to the specified address does not seem possible

Some of the clues mentioned, however, seem particularly problematic - either because they are common nowadays and often do not indicate anything wrong, or because they are very difficult to check:

  • The contact persons in the company change frequently
  • The persons involved lack professional experience and industry knowledge
  • The purpose of the company entered in the commercial register does not match the business it is conducting
  • The scope of supplies offered does not align with the company’s size
  • Website without imprint

Uncertainty: What actions can be reasonably required?

Even if the BMF attempts to provide more legal certainty with regard to what indicates an irregularity, it remains completely unclear what measures "can reasonably be required of the entrepreneur" to dispel the doubts.

Difficulties regarding criminal tax law

A prerequisite for the applicability of section 25f German VAT Code is that one of the aforementioned tax offences actually exists within the chain of supplies, whereby both objective and subjective elements of the offence must be fulfilled. A criminal conviction or a fine is not required for this; the tax office concerned should assess this independently. Given the complicated German criminal tax law, disputes are inevitable here. If a criminal proceeding has been initiated, the tax office will probably nevertheless await its outcome, so entrepreneurs can expect such proceedings to take a considerable time. 

Caution: Section 25f of the UStG is a tax law provision and does not itself say anything about the criminal liability of persons involved. However, if the tax office determines that a person knew or should have known that his/her turnover was involved in a tax offence, a criminal investigation will likely be initiated against that person.

Tax CMS, training, attribution of third-party knowledge

In any case, companies should include all the BMF’s indicators in their tax compliance management system and train all their affected employees accordingly. With regard to tax audits, it will be crucial that the measures taken are well documented.

It should also be noted that the employees' "knowledge”/"need to know" is attributed to the entrepreneur. Especially in large companies with many employees, the question arises as to whether this can apply without restriction because it is almost impossible to control. Nevertheless, it is advisable to ensure a seamless, auditable flow of information and, if necessary, to set up a reporting system for irregularities.

(Dated: 05. July 2022)