When Illegal Agreements Meet VAT Law: A Landmark Polish Ruling on Tax Deduction Rights

In December 2017, Poland’s Supreme Administrative Court delivered a verdict that cut through tax-authority overreach with surgical precision: the mere illegality of a business arrangement does not, by itself, extinguish a taxpayer’s right to deduct VAT. The conspiracy may be unlawful, the court declared, but the transaction executed within it can still be perfectly taxable.

The Anatomy of a Tax Dispute

The case that landed before Poland’s highest administrative court had all the ingredients of a modern fiscal drama: an electronics distributor, a government contract for educational software, and a daisy chain of companies passing licenses for language-learning programs from hand to hand like a baton in some elaborate corporate relay race.

The Ministry of National Education had commissioned software for schools—a straightforward enough procurement, one might think. But tax authorities, peering into the transaction’s entrails, saw something darker. They invoked Article 88(3a)(4)(a) of Poland’s VAT Act, a provision that denies VAT deductions when invoices document transactions that never actually occurred.

The tax office’s bill of particulars was damning, or so it seemed:

• The invoices, they claimed, documented phantom operations—empty invoices, in the parlance of tax enforcement
• The company had knowingly participated in a transactional chain that smelled distinctly of bid-rigging
• The entire arrangement constituted an abuse of the right to deduct VAT

Adding insult to injury, the authorities slapped on an additional tax liability under Article 108 of the VAT Act—a provision requiring payment of VAT shown on invoices that don’t reflect real transactions.

Through the Courts: A Study in Judicial Reversal

The Warsaw Provincial Administrative Court sided with the tax authorities. The invoices, the lower court found, failed to reflect genuine economic activity. Documents had been backdated. The descriptions of what was supposedly being sold kept shifting. The company, in the court’s estimation, hadn’t produced credible evidence to prove the transactions were real.

The company filed a cassation appeal with the Supreme Administrative Court, challenging both the procedural handling and the substantive legal conclusions.

What happened next would reshape how Polish tax authorities approach VAT deduction disputes.

The Supreme Administrative Court’s Intellectual Breakthrough

The Supreme Administrative Court didn’t merely reverse the lower court—it dismantled the entire conceptual framework that had supported the tax authorities’ position. The court’s central holding deserves quotation in full:

“Even if it were established that the case involves bid-rigging, this does not necessarily mean that no VAT-taxable transaction occurred, nor that the right to deduct input tax was extinguished. One must bear in mind that the illegality of an agreement concluded as part of bid-rigging does not preclude the possibility that a transaction transferring license rights actually took place. What is illegal is the agreement itself—not the transaction executed within its framework.”

This distinction—between the illegality of a conspiracy and the tax treatment of transactions conducted pursuant to that conspiracy—represents a sophisticated parsing of legal categories that tax authorities had been conflating for years.

The court systematically distinguished three situations that can lead to VAT deduction denials, each requiring different proof and different analysis:

Empty invoices—documents that correspond to no actual economic event whatsoever. Here, the right to deduct never arises in the first place, regardless of the taxpayer’s intentions or good faith.

Tax fraud—where a real transaction occurred but formed part of a fraudulent scheme. In such cases, the authorities must assess the taxpayer’s good faith: did they know, or should they have known, they were participating in fraud?

Abuse of tax law—where transactions meet formal requirements but their essential purpose was obtaining a tax advantage contrary to the legislation’s aims. This requires demonstrating that tax benefits were the primary motivation for the arrangement.

The court noted, with evident frustration, that the tax authorities had never clearly established which of these categories applied to the case at hand.

The Burden of Proof: A Fundamental Rebalancing

Perhaps the ruling’s most practically significant passage concerns who must prove what in tax proceedings:

“Establishing such circumstances cannot burden the taxpayer; rather, it must burden the authorities that choose to challenge the correctness and legality of tax settlements, since their goal is to deprive the taxpayer of the right to deduct VAT.”

When issuing a tax decision denying deduction rights, the tax authority must prove:

• that no transaction occurred (the empty invoice scenario), or
• that the taxpayer knew or should have known about tax fraud, or
• that the transaction’s primary purpose was obtaining tax advantages contrary to the law (abuse of rights)

Abstract suspicions won’t suffice. As the court pointedly observed:

“The tax authorities failed to prove any form of tax fraud and did not demonstrate that the essential purpose of the transaction was obtaining a tax benefit—which is a necessary condition for finding an abuse of tax law.”

Illegal Acts in the VAT System: A Doctrinal Analysis

The ruling addresses a fundamental question about the relationship between a transaction’s legality and its tax consequences. In the Polish legal system, income from illegal sources doesn’t exempt one from tax obligations. By the same logic, an illegal act—such as bid-rigging—doesn’t automatically mean that transactions executed within its framework are tax nullities.

The practical implications are significant:

The court drew on CJEU case law, emphasizing the principle of fiscal neutrality. For VAT purposes, what matters is whether objective criteria for a taxable transaction are met—the parties’ intentions or the legality of their underlying arrangement is beside the point.

The European Dimension: CJEU Jurisprudence

The Supreme Administrative Court’s reasoning drew extensively on the Court of Justice of the European Union’s accumulated wisdom on VAT matters, weaving together multiple strands of European jurisprudence.

Neutrality and the Right to Deduct. The right to deduct input VAT constitutes a foundational principle of the VAT system and may be restricted only in exceptional circumstances. The CJEU has repeatedly emphasized that denying this right requires meeting strictly defined conditions (Collée C-146/05, Mecsek-Gabona C-273/11, Tóth C-324/11).

Empty Invoices and Deduction Rights. Only input tax from invoices reflecting genuinely performed transactions gives rise to deduction rights. Fictitious transactions documented by so-called empty invoices confer no such rights (Stroy trans C-642/11, LVK C-643/11, Firin C-107/13).

The “Diligent Trader” Standard. When assessing a taxpayer’s good faith, authorities should consider whether the taxpayer took all measures that could be expected of a “diligent trader”—a standard articulated in Netto Supermarkt (C-271/06).

Abuse of Rights: A Two-Part Test. Finding an abuse of rights requires demonstrating both elements (Halifax C-255/02): (1) that the disputed transactions result in tax advantages contrary to the legislation’s purpose, and (2) that obtaining such advantages was the transactions’ essential aim.

Practical Implications for Taxpayers

During Tax Audits. During a tax audit, taxpayers should demand that authorities specify precisely on what basis they’re challenging deduction rights: Is the authority claiming no transaction occurred? Is it alleging participation in tax fraud? Is it invoking abuse of rights? Each basis requires different evidence and a different defense strategy.

When Past Returns Are Challenged. The ruling confirms that formal irregularities alone—backdated documents, errors in describing transaction subjects—don’t suffice to deny deduction rights. Authorities must demonstrate that the identified deficiencies indicate the absence of any real transaction.

In the Context of Fiscal Criminal Proceedings. Notably, criminal proceedings in this case had been discontinued. The court observed that invoking alleged bid-rigging carries insufficient weight when criminal proceedings on the same facts have been abandoned. This matters significantly for taxpayers whose fiscal criminal cases have been dropped while tax authorities attempt to challenge their returns based on identical circumstances.

Why the Lower Court’s Judgment Failed

The Supreme Administrative Court vacated the Provincial Administrative Court’s judgment for violating Article 141(4) of the Law on Proceedings Before Administrative Courts, identifying fundamental deficiencies in the reasoning:

Inconsistent factual findings. The lower court alternately claimed that transactions hadn’t occurred (the empty invoice theory) and discussed the taxpayer’s good faith (which presupposes that transactions did occur). This inconsistency made appellate review impossible.

Failure to categorize clearly. The judgment never specified whether the court considered the invoices empty, found tax fraud, or identified abuse of rights. Each classification requires different prerequisites and different evidence.

Conceptual confusion about the transaction’s subject matter. The court conflated trading in license rights with trading in license documents as physical goods—a legal error. A license is an authorization to use a work, not a document.

The ruling offers important guidance for practitioners filing appeals to administrative courts—highlighting inconsistencies in tax authorities’ argumentation can prove decisive.

Software Licenses: The Peculiarities of Trading in Rights

The Supreme Administrative Court devoted considerable attention to analyzing the legal character of transactions involving computer software. Computer programs constitute works under copyright law, and a license merely represents authorization to use them.

Key findings:

• License agreements may be concluded in any form (including orally or through implied conduct)—except for exclusive licenses, which require written form
• A license document merely confirms that a license was granted; it’s not a condition of the license’s validity
• Transferring a license document is not equivalent to concluding a license agreement

This matters for VAT classification—transferring rights to intangible assets constitutes a supply of services under Article 8(1)(1) of the VAT Act.

What This Means for Tax Authority Practice

The I FSK 352/16 ruling delineates the boundaries of tax authorities’ powers:

The Requirement of Precise Grounds. Authorities cannot rest on vague assertions that a transaction “raises concerns” or that a taxpayer “participated in a transactional chain.” They must clearly identify and prove a specific legal basis for denying deduction rights.

No Burden-Shifting. The authority, not the taxpayer, must prove the prerequisites for denial. Taxpayers needn’t prove that transactions occurred—presenting supporting documentation suffices. The burden of rebutting that documentation falls on the authority.

The Obligation to Consider Economic Substance. The Supreme Administrative Court criticized the authorities for failing to analyze the transactions’ economic rationale. When an authority claims a transaction was fictitious or constituted an abuse, it should explain what economic purpose the parties were pursuing and why that purpose indicates abuse.

The Verdict’s Lasting Significance

The Supreme Administrative Court’s December 18, 2017 ruling (I FSK 352/16) represents a significant contribution to the ongoing debate about the limits of tax authorities’ power to deny VAT deduction rights. The court confirmed that:

1. Illegal acts can still be subject to VAT—the illegality of an agreement doesn’t render transactions executed within its framework tax nullities.
2. The burden of proof rests with authorities—tax officials must prove the prerequisites for denying deduction rights; they cannot shift this burden to taxpayers.
3. Precise classification is required—authorities must clearly specify whether they’re relying on the empty invoice theory, alleging tax fraud, or invoking abuse of rights.
4. Formal deficiencies don’t automatically extinguish deduction rights—documentation errors may indicate carelessness but don’t conclusively establish the absence of real transactions.

Businesses whose VAT settlements face challenge should insist on precise specification of the grounds for denial and systematically expose gaps in the evidence assembled by tax authorities. In tax disputes concerning VAT deduction rights, this ruling provides substantial ammunition for protecting taxpayer interests.

Legal basis:

• Articles 86(1), 88(3a)(4)(a), 108(1) of the Act of March 11, 2004 on Tax on Goods and Services
• Articles 167, 168 of Council Directive 2006/112/EC of November 28, 2006 on the common system of value added tax
• Article 67 of the Act of February 4, 1994 on Copyright and Related Rights

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.