© 2025 by Michael Firth KC, Gray's Inn Tax Chambers
Contact: michael.firth@taxbar.com
A10. Supply chain fiscal neutrality
FIVE PRINCIPLES
(1) Deduction of input VAT properly incurred by taxable trader
- Deduction system intended to reliable trader entirely of burden of VAT payable in the course of taxable economic activity
"[41] In that regard, it must be borne in mind that the Court has repeatedly held that the principle of fiscal neutrality manifests itself through the deduction system which is meant to relieve the trader entirely of the burden of the VAT payable or paid in the course of all his economic activities. The common system of VAT therefore ensures that all economic activities, whatever their purpose or results, provided that they are themselves subject to VAT, are taxed in a wholly neutral way (see, inter alia, Case 268/83 Rompelman [1985] ECR 655, paragraph 19, and Case C-32/03 Fini H [2005] ECR I-1599, paragraph 25 and the case-law cited)." (Malburg C-204/13)
- Traders acting in good faith not to bear the risk of supplier insolvency to public purse
"[44] That practice effectively makes such purchasers bear the risk that the vendor’s insolvency entails for actual payment of the VAT into the public purse, a risk which is, however, in principle for the public purse to take on." (UAB Ha.En C-227/21)
- Similar goods should bear same tax burden whatever length of supply chain
"[33] Finally, the Court has held that one of the principles on which the VAT system was based was neutrality, in the sense that within each country similar goods should bear the same tax burden whatever the length of the production and distribution chain (judgment of 24 October 1996, Elida Gibbs, C‑317/94, EU:C:1996:400, paragraph 20)." (Boehringer C-462/16)
- Neutrality not giving employer right to deduct input VAT on fuel supplied to employee but used for employer's business
"[55] It is true that the solution thus imposed by the wording of Article 17(2)(a) of the Sixth Directive may not appear fully consistent with the purpose of that provision and with certain objectives pursued by the Sixth Directive, such as fiscal neutrality and the avoidance of double taxation.
[56] The fact remains, however, that, in the absence of intervention by the Community legislature, the system for deduction of VAT which it has created, as defined by the Sixth Directive, does not provide any basis for a right entitling taxable persons to deduct VAT in the circumstances referred to in Article 23 of the implementing decree of 12 August 1968 or enable any detailed rules for the application of such a right to be established (see, by analogy, Case C-165/88 ORO Amsterdam Beheer and Concerto [1989] ECR 4081, paragraphs 16, 22, 23 and 24)." (Commission v. Netherlands C-338/98)
- But UKSC adopting analysis of transactions that gave non-recipient of goods equivalent right to recover on supply of services to that person
"[80] There is a legal relationship between the redeemer and LMUK pursuant to which there is reciprocal performance. In accepting points, which have no inherent value, in exchange for goods or services, the redeemer is acting in a manner which is only explicable because of its agreement with LMUK, under which LMUK will pay it for doing so. LMUK pays it for doing so because its business is dependent on redeemers accepting points in exchange for the provision of goods and services. The only economically realistic explanation of LMUK's behaviour is the value to LMUK itself of the redeemers' acceptance of points in exchange for the provision of goods and services.
[81] In these circumstances, it can in my view be said that the remuneration received by the redeemer represents the value to LMUK of the service which the redeemer provides (cf Tolsma v Inspecteur der Omzetbelasting Leeuwarden (Case C-16/93) [1994] STC 509, para 14; First National Bank of Chicago v Customs and Excise Commissioners (Case C-172/96) [1999] QB 570; [1998] STC 850, paras 26 to 29).
[82] The approach described in the foregoing paragraphs is consistent with the fundamental principle, as the Court of Justice has described it, that a taxable person is entitled to deduct the VAT payable in the course of his economic activities. The alternative approach described in paragraph 76 is not." (HMRC v. Aimia Coalition Loyalty UK Limited [2013] UKSC 15)
(2) Refund of output VAT incorrectly charged
- Neutrality requires system for supplier to correct tax improperly invoiced
"[41] In the light of the foregoing, the answer to the third question is that the principle of the neutrality of VAT, as given specific definition by the case-law relating to Article 203 of Directive 2006/112, may be relied on by a taxable person in order to contest a provision of national law that makes the refund of VAT invoiced in error conditional on the correction of the incorrect invoice, in circumstances where the right to deduct that VAT has definitively been refused and such definitive refusal results in the system for correction provided for under national law no longer being applicable." (Rusedespred C-138/12)
"[37] However, where the issuer of the invoice has in sufficient time wholly eliminated the risk of any loss in tax revenues, the principle of the neutrality of VAT requires that VAT which has been improperly invoiced can be adjusted without such adjustment being made conditional by the Member States upon the issuer of the relevant invoice having acted in good faith (see Schmeink & Cofrethand Strobel, paragraph 58, and Karageorgou and Others, paragraph 50)." (Stadeco C-566/07)
"[18] Finally, with regard to the argument put forward by the appellant in the main proceedings and the Commission to the effect that the fact of limiting the exercise of the right to deduct to taxes corresponding to the supply of goods and services calls into question the neutrality of VAT, it should be pointed out that, in order to ensure the application of that principle, it is for the Member States to provide in their internal legal systems for the possibility of correcting any tax improperly invoiced where the person who issued the invoice shows that he acted in good faith .
[19] The answer to the first question should therefore be that the right to deduct provided for in the Sixth Council Directive, 77/388/EEC, of 17 May 1977 does not apply to tax which is due solely because it is mentioned on the invoice." (Genius Holding BV C-342/87)
See further T4. VAT shown on invoice.
- Not required to permit adjustment where no longer possible to cancel deduction granted
"[61] By contrast, as was the case in Genius Holding, where the risk of any loss of tax revenues has not been wholly eliminated, the Member States may make the possibility of adjusting VAT which has been improperly invoiced conditional upon the issuer of the relevant invoice having acted in good faith. As the national court has stated, if it transpires that it is no longer possible to cancel a deduction granted in respect of the addressee of the invoice and the issuer of the invoice has not acted in good faith, he may be held responsible for the shortfall in tax revenues in order to ensure tax neutrality." (Schmeink & Cofreth C-454/98)
(3) Cannot collect output tax from both supplier and customer, and refuse customer deduction
- Where customer and supplier mistakenly thought reverse charge applied
"[42]It follows from the foregoing considerations that the answer to the third and fourth questions referred is that the principle of the neutrality of VAT must be interpreted as precluding a national provision which permits the tax authorities to refuse to grant the supplier of services a refund of the VAT which the supplier has paid, when the recipient of those services, who has also paid the VAT in respect of the same services, is refused the right of deduction on the ground that that recipient did not have the corresponding tax document, any adjustment of tax documents being precluded under national law where a definitive tax adjustment notice exists." (GST C-111/14)
(4) No double taxation
"[40] In that regard, it should be recalled that it follows from the Court’s case-law that the principle of fiscal neutrality inherent in the common system of VAT precludes the taxation of a taxable person’s business activities leading to double taxation (see, to that effect, judgments in Puffer, C‑460/07, EU:C:2009:254, paragraph 45 and 46, and Klub, C‑153/11, EU:C:2012:163, paragraph 42)." (NLB Leasing C-209/14)
- Taxation of intra-EU acquisition and exemption of dispatch intended to avoid double taxation
"[24] Thus, any intra-Community acquisition that is taxed in the Member State where the dispatch or intra-Community transport of goods ends under the first subparagraph of Article 28a(1)(a) of the Sixth Directive has, as a corollary, an exempted supply in the Member State in which that dispatch or transport began under the first subparagraph of Article 28c(A)(a) of that directive (Case C‑245/04 EMAG Handel Eder [2006] ECR I‑3227, paragraph 29).
[25] It follows that the exemption of an intra-Community supply corresponding to an intra-Community acquisition enables double taxation and, therefore, infringement of the principle of fiscal neutrality inherent in the common system of VAT, to be avoided." (Teleos C-409/04)
- No deemed supply on withdrawal of business asset that did not give rise to input recovery
"[46] Taxation of the item in such a situation, where it does not create an entitlement to deduction of residual tax, would lead to double taxation contrary to the principle of fiscal neutrality inherent in the common system of VAT, of which the Sixth Directive forms part (see, with regard to heading (a) of the second subparagraph of Article 6(2) of the Sixth Directive, Kühne, cited above, paragraph 10, and Case C-193/91 Mohsche [1993] ECR I-2615, paragraph 9)." (Bakcsi C-415/98)
- No effective double taxation of goods supplied under loyalty scheme
"[85] As the Court of Appeal pointed out, if the provision of goods or services by redeemers were treated as a taxable supply to the collector (other than to the extent to which any monetary consideration might be paid by the collector), the tax authorities would receive not only VAT on the amount received by LMUK for supplying the right to receive those goods and services, but also VAT on the amount which LMUK must pay to satisfy that right. If, on the other hand, the consideration paid by LMUK to the redeemers is regarded as the consideration for the supply of a service to LMUK (a service which encompasses the provision of goods and services to collectors), the tax authorities will still receive VAT from LMUK on the difference between the value of the supplies which it makes in the course of its business (ie its receipts from the supply of the right to receive such goods and services) and the value of the supplies which it receives for the purposes of that business (ie the cost to LMUK of satisfying that right). The tax authorities will thus recover VAT on the value added by the taxable transactions entered into by LMUK, taking the issue and redemption of points as a whole. That conclusion is in accordance with the basic principle of VAT." (HMRC v. Aimia Coalition Loyalty UK Limited [2013] UKSC 15)
- No double taxation where VAT charged on lease and sale of the property following lessee default if separate supplies
"[44] It follows from the foregoing considerations that the principle of fiscal neutrality must be interpreted as not precluding, first, a leasing service relating to immovable property and, second, the sale of that property to a person who is a third party to the lease agreement, being taxed separately for VAT purposes, where those transactions cannot be regarded as forming a single supply, which is a matter for the referring court to determine." (NLB Leasing C-209/14)
(5) Taxation in the place of consumption
- Zero-rating of export to apply if substantive conditions met even if some formal conditions not met
"[20] It should also be noted that, according to the case-law of the Court, Article 138(1) of the VAT Directive requires Member States to exempt from VAT supplies of goods which satisfy the conditions listed in that article. In addition, according to the same case-law, formal requirements cannot undermine the vendor’s entitlement to exemption from VAT where the substantive conditions for an intra-Community supply are satisfied. Similarly, the principle of fiscal neutrality requires that an exemption from VAT be allowed if the substantive requirements are satisfied, even if the taxable person has failed to comply with some of the formal requirements (see, to that effect, judgment of 9 February 2017, Euro Tyre, C‑21/16, EU:C:2017:106, paragraphs 23, 32, 35 and 36). In that context, it should be stated that there are only two situations in which the failure to meet a formal requirement may result in the loss of entitlement to an exemption from VAT. In the first place, the principle of fiscal neutrality cannot be invoked for the purposes of an exemption from VAT by a taxable person who has intentionally participated in tax evasion which has jeopardised the operation of the common system of VAT. In the second place, non-compliance with a formal requirement may lead to the refusal of an exemption from VAT if that non-compliance would effectively prevent the production of conclusive evidence that the substantive requirements have been satisfied (judgment of 9 February 2017, Euro Tyre, C‑21/16, EU:C:2017:106, paragraphs 38, 39 and 42)." (Flo Veneer C-639/24)
"[32] It should be noted that, since it is also common ground that there was no consumption of those apples in the territory of the European Union, it cannot be held that the supplier made a supply in the national territory.
[33] The exemption provided for in Article 146(1) of the VAT Directive is intended to ensure that the supplies of goods concerned are taxed at the place of destination of those goods, namely the place where the exported products will be consumed (judgment of 28 March 2019, Vinš, C‑275/18, EU:C:2019:265, paragraph 23 and the case-law cited).
[34] Accordingly, when the substantive requirements have been satisfied, the principle of fiscal neutrality requires the VAT exemption to be granted even if certain formal requirements have been omitted by the taxable persons (judgment of 17 December 2020, BAKATI PLUS, C‑656/19, EU:C:2020:1045, paragraph 72 and the case-law cited).
[35] It follows from the foregoing that the classification of a transaction as a ‘supply of goods’ within the meaning of Article 146(1)(a) and (b) of the VAT Directive cannot be refused on the ground that the dispatch or transport outside the European Union was carried out without the supplier’s knowledge and was established by the tax authorities and not by the supplier itself." (W C-602/24)
LIMITS
- Does not apply where transaction is for free and so outside the scope of VAT
"[42] The principle of fiscal neutrality does not apply therefore to a situation such as that at issue in the main proceedings, where, as is apparent from paragraphs 35 and 36 of this judgment, the provision of the client base for the use of a partnership free of charge is not a transaction falling within the scope of VAT." (Malburg C-204/13)
- Query whether principle is complied with where structuring a transaction in a different way could have resulted in deduction
"[46] That conclusion is supported by the fact that, as the German Government notes, the provision of the client base for use free of charge cannot be treated in the same way as other courses of action legally possible under national law, which under that law would have permitted an entitlement to deduct but which, of his own volition, Mr Malburg did not choose. Contrary to the national legislation at the origin of the dispute which gave rise to Polski Trawertyn, which did not allow the applicant for a deduction to benefit from the application of the principle of fiscal neutrality, it therefore appears, though it is for the referring court to determine, that the national legislation at issue in the main proceedings does not preclude, in principle, the implementation of the principle of fiscal neutrality in a situation such as that at issue in the main proceedings, which is characterised by the fact that the applicant could have made use of other options." (Malburg C-204/13)
Fraud
- Neutrality may not be relied on by persons who participated in fraud
"[43] Second, the principle of fiscal neutrality cannot be relied on for the purposes of an exemption from VAT by a taxable person who has intentionally participated in tax evasion which has jeopardised the operation of the common system of VAT. According to the Court’s case-law, it is not contrary to EU law to require an operator to act in good faith and to take every step which could reasonably be asked of him or her to satisfy him or herself that the transaction which he or she is carrying out does not result in his or her participation in tax evasion. If it were concluded that the taxable person concerned knew or ought to have known that the transaction he or she carried out was part of a fraud committed by the person acquiring the goods and that he or she has not taken every step which could reasonably be asked of him or her to prevent that fraud from being committed, he or she would have to be refused the exemption (judgment of 17 October 2019, Unitel, C‑653/18, EU:C:2019:876, paragraph 33 and the case-law cited)." (W C-602/24)
"[78] Turning to fiscal neutrality and ICSL's objection that deregistration would systematically undermine the right to deduct, the short answer is that, like legal certainty, these principles must give way to the inherent nature of the Halifax abuse principle, as applied in the Kittel line of cases. The CJEU said this in Italmoda at [48] in relation to input tax and VAT refunds:
"… the central function of the right of deduction provided for in Article 17(3) of the Sixth Directive, in the VAT mechanism designed to ensure complete neutrality of the tax, does not preclude that right from being refused to a taxable person in the event of participation in fraud... Similarly, the specific function of the right to a VAT refund, intended to ensure the neutrality of VAT, cannot preclude that right from being refused to a taxable person in such a situation."
[79] More generally, and as noted at [41] above, the CJEU had also referred at [46] of its decision in Italmoda to paragraph 51 of the Advocate General's opinion in that case, which stated that:
"neutrality of tax may not be reasonably relied upon by taxable persons who have wilfully or through negligence participated in fraud."" (Impact Contracting Solutions Ltd v. HMRC [2025] EWCA Civ 623, Falk LJ)
- No risk of fraud re export zero-rating if goods have left the territory
"[45] Moreover, the Court has already held that, in circumstances where the conditions for the export exemption laid down in Article 146(1)(b) of the VAT Directive, in particular, the requirement that the goods concerned leave the customs territory of the European Union, are satisfied, no liability to pay VAT arises in respect of such a supply and, in those circumstances, there no longer exists, in principle, any risk of tax evasion or loss of tax which could justify the transaction concerned being taxed (judgment of 17 December 2020, BAKATI PLUS, C‑656/19, EU:C:2020:1045, paragraph 82 and the case-law cited)." (W C-602/24)
EFFECT
- A principle of interpretation
"[43] Moreover, as the Court has already held, the principle of fiscal neutrality is not a rule of primary law but a principle of interpretation, to be applied concurrently with the principle on which it is a limitation (Case C‑44/11 Deutsche Bank [2012] ECR, paragraph 45). It does not therefore allow the scope of the deduction from output VAT to be extended in the face of an unambiguous provision of the Sixth Directive. As regards the case which gave rise to Polski Trawertyn, it was clear that the application of the national legislation at issue did not allow either the future partners of the partnership to be created or that partnership to rely successfully on the principle of neutrality." (Malburg C-204/13)
- May be relied on against a provision of national law that is inconsistent with neutrality
"[38] So far as concerns the possibility of relying on the principle of the neutrality of VAT against a Member State, it must be noted, first of all, that that principle is a fundamental principle of the common system of VAT as governed, inter alia, by Directive 2006/112 (see to that effect, inter alia, Stadeco, paragraph 39, and the case-law cited).
...
[40] According to case-law, the principle of the neutrality of VAT may, if necessary, be relied on by a taxable person against a provision of national law, or the application thereof, which fails to have regard to that principle (see, to that effect, Case C-306/06 Marks & Spencer [2008] ECR I-2283, paragraph 34). In circumstances such as those set out in paragraph 35 of this judgment, since the principle of the neutrality of VAT, as given specific definition by the case-law relating to Article 203 of Directive 2006/112, places an unconditional and sufficiently precise obligation on the Member State concerned, it may be relied on against a provision of national law that fails to have regard to that principle." (Rusedespred C-138/12)
- Treatment to be allowed if substantive conditions met even if formal conditions not met
"[34] Accordingly, when the substantive requirements have been satisfied, the principle of fiscal neutrality requires the VAT exemption to be granted even if certain formal requirements have been omitted by the taxable persons (judgment of 17 December 2020, BAKATI PLUS, C‑656/19, EU:C:2020:1045, paragraph 72 and the case-law cited).
[35] It follows from the foregoing that the classification of a transaction as a ‘supply of goods’ within the meaning of Article 146(1)(a) and (b) of the VAT Directive cannot be refused on the ground that the dispatch or transport outside the European Union was carried out without the supplier’s knowledge and was established by the tax authorities and not by the supplier itself." (W C-602/24)