The European Court of Justice has issued a preliminary ruling in the case of value-added tax (VAT) deductions for supplies that a company paid for, but which tax authorities believe were not in fact received.

Tax authorities in Bulgaria had refused deductions made by a company named Bonik for the supply of wheat from two suppliers, and the Administrative Court in Varna referred a number of questions to the ECJ.

Tax authorities investigated Bonik in 2009, including checks on two suppliers and in turn on their three suppliers. These checks were unable to prove that Bonik's suppliers had had sufficient quantities of wheat to supply Bonik; one of the suppliers was not found to be at its given address, and did not provide documentation asked for by the authorities. The authorities therefore concluded that the supplies had not been received by Bonik. The court in Varna, however, established that Bonik had paid properly-documented invoices submitted by the suppliers, and that Bonik appeared to have in turn made supplies of the same quantities of wheat. The authorities did not claim that Bonik had acquired this wheat from elsewhere.

According to the court in Varna, Bulgarian legislation does not make the right to deduct VAT conditional on proof of the origin of goods, but some Bulgarian courts and the tax authorities do require proof that preceding supplies have been carried out before the right to a deduction is allowed.

The ECJ was asked to consider questions around whether lack of supply is the same thing as tax evasion, and whether a customer’s right to make a VAT deduction should be affected by "fraud or irregularities" by other links in the supply chain. According to the ECJ's ruling, in order for the VAT deduction to be disallowed, there has to be "objective evidence that the taxable person knew, or should have known, that the transaction relied on as a basis for the right of deduction was connected with VAT fraud committed upstream or downstream in the chain of supply." In such a case, involvement in a transaction involving VAT fraud would make a company "a participant" in the fraud, whether or not it profited.

Whether Bonik indeed knew, or should have known, of such a connection is now for the court in Varna to determine.