Penalty quashed when you knew or should have known of VAT fraud

Tax inspectors must refuse VAT rights to businesses that knew or should have known of fraud in the supply chain, even without an explicit statutory basis. According to the Dutch Supreme Court, the absence of that basis is precisely what rules out a penalty.

Assessment and liability

The Court of Justice of the EU gives tax authorities across the EU considerable room to refuse VAT rights to businesses that knew or should have known of VAT fraud in the supply chain, such as the zero rate for intra-Community supplies or the right to deduct input VAT. Those businesses can also be held liable for the VAT debts of the fraudulent trading partner. A business that has paid too little attention to fraud signals from its trading partners can therefore face a substantial VAT claim. The European Court of Human Rights has made clear that refusing VAT rights is not a penalty within the meaning of the Convention, but a business that loses its deduction or the zero rate because it should have known of fraud certainly experiences the VAT burden as one.

The penalty

Where an additional assessment is raised because the business knew or should have known of VAT fraud, a substantial penalty on the assessed amount usually follows. That penalty is the real punishment. The inspector may impose a penalty of up to 100% of the VAT assessed:

where it is due to the intent or gross negligence of the taxable person that the tax payable on the return has not been paid, has been paid in part, or has not been paid within the period set by law.

For intra-Community supplies zero-rated in the Netherlands, the case law of the Court of Justice of the EU requires the zero rate to be refused where the supplier knew or should have known of its customers' VAT fraud. That mandatory refusal applies even where national law contains no explicit basis for it.

No statutory offence

The question then is whether the penalised offence is made out, namely that it is due to the supplier's intent or gross negligence that the VAT was not paid on time. Two positions are possible:

• A supplier who made intra-Community supplies and knew or should have known of its customers' VAT fraud wrongly applied the zero rate under the case law, and therefore failed to pay the VAT due on its return in time.
• Under the law the supplier is entitled to the zero rate, so that as a matter of statute there is no VAT payable on the return. The fact that the inspector is obliged by case law to withdraw the zero rate after the event does not change this.

In 2024 the Supreme Court took the first view, but a few months ago it departed from it. In its judgment, the principle of legality requires that a penalty may be imposed only where the VAT became due under the law and had to be paid on the return under the law. Merely withdrawing the zero rate after the event because of knowledge of the customers' fraud does not meet that test. The Supreme Court therefore quashed the penalty.

Why this matters in practice

For businesses that made zero-rated intra-Community supplies and knew or should have known of fraud in the chain, this means the following: where all the statutory conditions for the zero rate were met, Dutch VAT at 9% or 21% can still be assessed, but a penalty of up to 100% for intentionally or negligently failing to pay VAT on time may not be imposed.

In our view it is arguable that the same applies where a business is denied input VAT deduction after the event because of knowledge of fraud by its supplier or customer, even though the statutory conditions for deduction were met. Anyone facing Dutch additional assessments with penalties for knowledge of fraud in the chain would therefore do well to consider, alongside the substantive defences against the assessment, whether this judgment can get the penalty set aside.