The Good Faith Doctrine in Value Added Tax Law

Abstract: This article examines the intersection of taxpayer good faith and the fundamental right to deduct input value added tax within the context of alleged carousel fraud schemes. Drawing upon a seminal decision rendered by the Voivodeship Administrative Court in Łódź, this analysis elucidates the evidentiary burden incumbent upon tax authorities when challenging VAT deductions and articulates the doctrinal framework governing taxpayer protection in multi-party supply chain transactions. The decision under review establishes that tax authorities must unequivocally specify whether they contest the factual occurrence of supplies or allege knowing participation in fraudulent schemes—a distinction carrying profound implications for evidentiary standards and taxpayer rights.

I. Introduction: The Good Faith Principle in VAT Jurisprudence

The concept of taxpayer good faith constitutes a cornerstone principle in disputes concerning the right to deduct input value added tax. In essence, good faith denotes that a taxable person neither knew nor, upon exercise of reasonable diligence, could have known that a transaction in which it participated formed part of a tax fraud scheme.

Pursuant to the well-established jurisprudence of the Court of Justice of the European Union and domestic administrative tribunals, a taxpayer acting in good faith retains the right to deduct input VAT notwithstanding irregularities occurring at antecedent stages of the supply chain. This foundational principle serves as a bulwark protecting bona fide commercial actors from vicarious liability for the misconduct of third parties with whom they have no privity of relationship and over whose conduct they exercise no control.

The tension between effective tax enforcement and the protection of innocent market participants presents one of the most challenging doctrinal questions in contemporary VAT law. As this analysis demonstrates, the resolution of this tension requires tax authorities to meet exacting evidentiary standards and to articulate their legal theories with precision—requirements that, when unmet, warrant judicial intervention.

II. Factual Background: The Supply Chain Under Scrutiny

A. The Taxpayer’s Commercial Operations

The appellant, a limited partnership (spółka z ograniczoną odpowiedzialnością spółka komandytowa), conducted business operations in the textile trade sector, including intra-Community transactions. The Head of the Customs and Fiscal Office initiated a customs and fiscal audit together with tax proceedings to examine the accuracy of declared tax bases and the correctness of VAT calculations for January 2017.

Upon completion of the audit, the tax authority determined that the company had overstated input tax by approximately PLN 530,000 through deductions claimed on purchase invoices that, in the authority’s assessment, failed to document genuine economic events.

B. The Alleged VAT Carousel Mechanism

The tax authority concluded that the company had participated in a VAT carousel scheme designed to defraud the treasury. The mechanics of this alleged fraud involved chain transactions featuring the characteristic participants endemic to such schemes:

• The “Missing Trader” (znikający podatnik): An entity introducing goods into commercial circulation without remitting the corresponding VAT liability
• The “Buffer” (bufor): Intermediary entities serving to legitimize transactions and artificially extend the supply chain
• The “Broker” (broker): The entity declaring cross-border sales and claiming VAT refunds

The tax authority assigned the appellant the role of broker—allegedly declaring intra-Community supplies of goods at the zero percent rate and subsequently claiming input tax refunds from the treasury.

C. The Alleged Fraudulent Scheme: From China Through Poland to Turkey

According to the authority’s findings, at the initial stage of the purported scheme, so-called missing traders introduced textiles originating from China into European Union territory. Subsequently, the goods underwent an ostensible change of origin, being introduced into Turkey as merchandise from the EU-EFTA zone. This stratagem allegedly enabled the avoidance of supplementary customs duties of twenty-eight percent while effectuating an approximately fivefold increase in declared value.

The appellate tax authority confirmed that the alleged carousel fraud was structured as follows:

• The first link comprised so-called “straw companies” (słupy)—entities possessing no tangible assets
• Subsequent links consisted of direct and indirect suppliers to the appellant, functioning as legitimizing buffers
• The appellant occupied the broker position
• Terminal links included additional buffers—one domiciled in Slovakia, another in Turkey

Significantly, the authority observed that despite declaring substantial input tax surpluses over output tax, the buffer entities in this chain never claimed refunds—a circumstance the authority interpreted as evidence of a predetermined operational schema.

III. The Administrative Decision: Denial of Deduction Rights

By tax decision issued in January 2020, the authority:

• Determined the company’s input tax surplus eligible for refund at PLN 109,559 (rather than the declared amount exceeding PLN 639,000)
• Assessed an additional tax liability of PLN 529,728 (representing one hundred percent of the disallowed input tax)
• Found that the company had overstated intra-Community supplies by more than PLN 2.3 million

The authority held that invoices issued by the appellant’s supplier failed to document genuine economic transactions and therefore could not constitute a basis for VAT deduction under Article 88(3a)(4)(a) of the Polish VAT Act. Critically, however, the authority failed to conduct a comprehensive analysis of the taxpayer’s good faith—an omission that would prove dispositive.

IV. The Judicial Challenge: Appeal to the Administrative Court

The company lodged an appeal to the Voivodeship Administrative Court, raising inter alia the following grounds:

• Violation of the principle of legality through reliance upon speculative inferences
• Conduct of proceedings in a manner undermining taxpayer confidence in tax authorities
• Erroneous factual determinations and transgression of the bounds of free evidentiary evaluation
• Failure to conduct evidentiary proceedings directed toward assessing the taxpayer’s due diligence and good faith

V. The Court’s Analysis: Good Faith as a Shield for Deduction Rights

The Voivodeship Administrative Court in Łódź, by judgment of October 27, 2020 (Case No. I SA/Łd 162/20), annulled the contested decision, identifying fundamental errors in the tax authorities’ reasoning concerning the assessment of taxpayer good faith.

A. The Presumption of Declaration Accuracy

The Court invoked the legal presumption enshrined in Article 21(2) of the Tax Ordinance and Article 99(12) of the VAT Act:

“The tax liability, the amount of tax difference refund, the amount of input tax refund, or the tax difference referred to in Article 87(1), shall be accepted in the amount resulting from the tax declaration, unless the tax authority determines it at a different amount. Accordingly, the burden of rebutting legal presumptions rests upon the tax authority.“

B. The Dual Prerequisites for Input Tax Deduction

The Court identified two fundamental requirements for input tax deduction in domestic transactions:

1. The taxable person must possess a VAT invoice
2. The taxable person must have obtained actual control over the goods (or the service must have been genuinely performed)

C. Taxpayer Good Faith and the Standard of Due Diligence

The Court articulated the governing principle concerning good faith and the right to VAT deduction:

“Protection of the taxpayer’s right should be ensured where the taxpayer neither knew nor, upon exercise of due diligence, could have known that at earlier stages of the transaction chain the system of VAT charges and deductions had been compromised.”

Of particular significance, the Court expressly held that the standard of diligence required is “reasonable” rather than “heightened” or “extraordinary”:

“A taxable person cannot be expected to undertake measures characteristic of tax authorities.”

This formulation carries substantial practical import: a commercial enterprise need not conduct investigative proceedings concerning its counterparties nor verify the entirety of the supply chain. Adherence to customary commercial prudence appropriate to the relevant sector and scale of operations suffices to establish good faith.

D. The Rejection of Collective Responsibility

The Court drew upon the established jurisprudence of the Court of Justice of the European Union, observing:

“The mere determination by tax authorities that irregularities occurred at earlier stages of the supply chain does not automatically warrant the disallowance of transactions involving the appellant. Pursuant to CJEU case law, no doctrine of collective responsibility applies in this context, as such an approach would prove manifestly unjust to entities unknowingly drawn into fraudulent schemes and could precipitate the insolvency of numerous bona fide enterprises.”

Citing the seminal CJEU judgment of January 12, 2006, in Optigen and Others (Joined Cases C-354/03, C-355/03, and C-484/03), the Court emphasized that each transaction within a supply chain must be evaluated independently, and the character of any particular transaction cannot be altered by antecedent or subsequent events.

VI. The Critical Deficiency: Absence of Good Faith Analysis

The most consequential defect in the tax authorities’ approach consisted in the internal inconsistency of the decision’s reasoning and the failure to comprehensively examine the company’s good faith. The Court observed:

“The authority, focusing its examination upon stages of commerce preceding the taxpayer’s acquisition of goods and the subsequent intra-Community supplies to [the Slovak purchaser], assessed in general terms that the taxpayer did not act in good faith in these transactions. The authority stated that, in its view, the taxpayer knowingly participated in the described scheme. However, this position was not connected with a comprehensive analysis of the taxpayer’s good faith in relation to its domestic suppliers.“

A. The Imperative of Legal Clarity: “Empty Invoices” Versus Carousel Fraud

The Court underscored that the authority had invoked Article 88(3a)(4)(a) of the VAT Act (concerning invoices documenting transactions that did not occur—so-called “empty invoices”) while simultaneously arguing that the company participated in VAT carousel fraud. These two legal bases, however, entail fundamentally different evidentiary requirements:

Alternative I—Empty Invoices (Article 88(3a)(4)(a)): Where the authority maintains that supplies to the company did not actually occur, it bears the burden of proving this proposition. The mere demonstration of irregularities at an earlier stage of commerce does not preclude the possibility that goods were in fact delivered from another source. In this scenario, the taxpayer’s good faith is immaterial—only the factual occurrence or non-occurrence of the supply is relevant.

Alternative II—VAT Carousel Fraud (Knowing Participation): Where the authority alleges participation in a carousel fraud scheme, it must demonstrate the absence of taxpayer good faith—either actual knowledge of participation in the fraudulent scheme or failure to exercise due diligence. This scenario necessitates examination of the taxpayer’s good faith conduct, counterparty verification procedures, and the authenticity of precautionary measures implemented.

“It is not the function of an administrative court exercising legality review over a tax decision to select between two alternative theories for disallowing input tax deductions advanced by the appellate authority. The reasoning of a tax decision must be clear, precise, and unequivocal in identifying the factual findings the authority adopts on the basis of the totality of evidence compiled in the case file.”

VII. The Evidentiary Paradox: Evidence of Actual Supply

Of particular significance, the Court observed that analysis of the evidentiary record led to conclusions directly contradicting the authority’s determinations:

“Examination of this question leads rather to the opposite conclusion—that goods did exist and were the subject of supply, inasmuch as they subsequently constituted the subject of intra-Community supplies to purchasers within European Union territory.”

Moreover, the documentary record established that the impugned textile supplier:

• Was, at the date of the disputed supplies, an actively operating VAT-registered taxable person
• Had recorded the challenged invoices in its accounting documentation
• Had declared and settled the corresponding output tax

These circumstances indicate that the company possessed reasonable grounds for maintaining good faith regarding the reliability of its counterparty.

VIII. The Framework for Good Faith Assessment

The Court directed the authority, upon remand, to conduct a comprehensive good faith analysis encompassing:

1. Unequivocal specification of the basis for challenging the deduction—whether the objection concerns empty invoices (where good faith is immaterial) or carousel fraud participation (where good faith is determinative)
2. Correct identification of the legal basis for the determination
3. Comprehensive examination of taxpayer good faith in relation to all counterparties
4. Analysis of due diligence measures—counterparty verification and circumstances that might have aroused suspicion
5. Assessment of the authenticity of precautionary procedures implemented by the company (with respect to both purchases and sales)

IX. Doctrinal Principles: Good Faith and VAT Deduction Rights

The Łódź Administrative Court’s judgment affirms fundamental principles protecting taxpayers acting in good faith in tax disputes concerning VAT:

A. The Presumption of Taxpayer Good Faith

The tax authority bears the burden of rebutting the presumption of declaration accuracy and demonstrating the absence of good faith. Generalized assertions of fraud participation are insufficient—specific findings supported by concrete evidence are required.

B. Individual Transaction Assessment

Irregularities involving other participants in the supply chain do not automatically establish the absence of good faith on the part of a given taxpayer nor justify denial of VAT deduction rights.

C. Reasonable, Not Extraordinary, Diligence

Commercial enterprises may be expected to exercise customary commercial prudence appropriate to their sector, but not to undertake measures characteristic of tax authorities or investigative agencies. The good faith doctrine does not require taxpayers to conduct forensic investigations.

D. Clarity of Legal Theory

Tax authorities may not construct their arguments “in the alternative,” simultaneously invoking mutually inconsistent legal bases. The authority must clearly specify whether it challenges the factual occurrence of supplies or alleges knowing participation in fraud.

X. Practical Guidance: Demonstrating Good Faith to Preserve Deduction Rights

Commercial enterprises engaged in international trade should implement due diligence protocols enabling demonstration of good faith should a tax audit arise:

A. Pre-Transaction Counterparty Verification

• VAT status verification through the VIES system (for EU counterparties)
• Consultation of the VAT Taxpayer Register (the “White List”)
• Confirmation of registration data (commercial registers)
• Verification of registered office and authorized representatives

B. Transaction Documentation

• Preservation of evidence of actual movement of goods (transport documents, delivery protocols)
• Archiving of commercial correspondence
• Documentation of the manner in which business relationships were established

C. Commercial Terms Analysis

• Attention to atypical circumstances (unusually favorable payment terms, absence of security for substantial transactions)
• Comparison of prices against market conditions
• Verification that cooperation terms are customary for the sector

D. Internal Procedures

• Implementation of written counterparty verification protocols
• Training of personnel responsible for procurement
• Regular updating of counterparty information

XI. The Imperative of Professional Representation in VAT Disputes

In circumstances involving customs and fiscal audits or proceedings concerning VAT deduction rights, professional representation in tax disputes assumes critical importance. Experienced counsel can assist in:

• Demonstrating taxpayer good faith and adherence to due diligence standards
• Identifying procedural errors committed by tax authorities (as illustrated in the instant case)
• Effectively challenging inconsistent reasoning advanced by tax authorities
• Preparing appeals to administrative courts in the event of adverse determinations

As the judgment under analysis demonstrates, even in cases involving suspected carousel fraud participation, successful challenge of tax authority decisions and vindication of input tax deduction rights remains achievable—provided that the taxpayer’s good faith is properly established.

XII. Conclusion

The Łódź Administrative Court’s decision represents a significant contribution to the jurisprudence governing the intersection of good faith doctrine and VAT deduction rights. The judgment establishes several propositions of enduring significance: first, that tax authorities must articulate their legal theories with precision, distinguishing clearly between challenges to the factual occurrence of supplies and allegations of knowing participation in fraud; second, that the standard of diligence expected of taxpayers is reasonable commercial prudence, not investigative rigor; and third, that the burden of establishing the absence of good faith rests squarely upon the tax authority.

For commercial enterprises operating in complex supply chains, the decision underscores both the importance of implementing robust compliance procedures and the availability of meaningful judicial protection when tax authorities fail to meet their evidentiary burdens. The good faith doctrine, properly understood and applied, serves as an essential safeguard ensuring that the legitimate commercial activities of bona fide market participants are not collaterally impaired by the fraudulent conduct of remote third parties.

Robert Nogacki

Founder and Managing Partner of Skarbiec Law Firm, recognized by Dziennik Gazeta Prawna as one of the best tax advisory firms in Poland (2023, 2024). Legal advisor with 19 years of experience, serving Forbes-listed entrepreneurs and innovative start-ups. One of the most frequently quoted experts on commercial and tax law in the Polish media, regularly publishing in Rzeczpospolita, Gazeta Wyborcza, and Dziennik Gazeta Prawna. Author of the publication “AI Decoding Satoshi Nakamoto. Artificial Intelligence on the Trail of Bitcoin’s Creator” and co-author of the award-winning book “Bezpieczeństwo współczesnej firmy” (Security of a Modern Company). LinkedIn profile: 18 500 followers, 4 million views per year. Awards: 4-time winner of the European Medal, Golden Statuette of the Polish Business Leader, title of “International Tax Planning Law Firm of the Year in Poland.” He specializes in strategic legal consulting, tax planning, and crisis management for business.