SEPTEMBER 17, 2024

By Neeraj Prasad, IRS (C&IT)

IN a recent ruling EU Court of Justice has held Poland's split payment fraud regime is in consonance with EU Vat principles and directives.

Background:

In 2019, Poland introduced a special 'split payment' mechanism in order better to be able to combat value added tax (VAT) fraud. This mechanism provides, in connection with the supply of certain goods and services, that the price owed under civil law is to be paid into two different accounts. While the net price is to be paid into an ordinary account belonging to the taxable supplier of goods or services ('the taxable person'), the VAT is to be transferred to a separate VAT account belonging to the taxable person, which can be used only to pay tax liabilities. This required customers to remit the VAT element of their payments into dedicated VAT bank accounts of their vendors. These accounts have limited features; essentially may only be used by the vendor to settle their VAT liabilities. Over 150 types of high-risk goods and services are included in the split payments rules. This includes: construction; steel; electronics; fuels; non-ferrous metals; and gold.

The Polish 'split payment 'Law:

-Article 106e(1)(18a) of the (Law on the tax on goods and services) of 11 March 2004 (), as amended ('the Law on VAT'), provides:

'Invoices on which the total amount due exceeds 15 000 [Polish zlotys (PLN)] or the equivalent of that amount in a foreign currency and which cover the supply to a taxable person of goods or services listed in Annex No 15 to that law, shall contain the statement 'split payment mechanism' …'

- Article 108a of that law provides:

'1. Taxable persons who have received an invoice showing the amount of tax may apply the split payment mechanism when paying the amount due arising from that invoice.

1a. When making payments for purchased goods or services listed in Annex No 15 to that law and evidenced by an invoice whose total amount due exceeds PLN 15 000 or the equivalent of that amount in a foreign currency, taxable persons shall be required to apply the split payment mechanism.

2. The split payment mechanism consists of:

(1) paying the amount corresponding to all or part of the amount of the tax arising from the invoice received into the VAT account;

(2) paying all or part of the amount corresponding to the net sales value arising from the invoice received into a bank account or a credit union account for which a VAT account is maintained, or by otherwise settling that invoice.'

- Article 108b of that law provides:

'1. At the request of the taxable person, the Director of the Tax Office shall authorise, by decision, the transfer of the funds held in the VAT account indicated by the taxable person to the bank account or credit union account, indicated by the taxable person, for which account that VAT account is maintained.

3. The Director of the Tax Office shall issue a decision within 60 days of receipt of the request.

5. The Director of the Tax Office shall refuse, by decision, the transfer of the funds held in the VAT account:

(1) in the event of tax arrears on the part of the taxable person and payment arrears referred to in Article 62b(2)(2)(a) of the (Law on Banking), of 29 August 1997 [(Dz. U. of 1997, No 140, item 939), as amended; ('the Law on Banking')], where the amount of those funds corresponds to those arrears with late payment interest at the date of the decision;

(2) when there are reasonable grounds for concern that:

(a) the tax liability relating to the taxes and liabilities referred to in Article 62b(2)(2)(a) of [the Law on Banking] will not be enforced, in particular where the taxpayer persistently refrains from paying the taxes due or takes measures consisting of the disposal of assets which may hinder or frustrate the fulfilment of tax obligations, or

(b) arrears of taxes and liabilities referred to in Article 62b(2)(2)(a) of [the Law on Banking] arises, or an additional tax debt, is established.

The Law on Banking

- Article 62b(2) of the Law on Banking, provides:

'The VAT account may be debited only:

(2) for the purposes of payment:

(a) into the account of the Tax Office of:

- [VAT], including [VAT] on imported goods, additional tax and late payment interest on [VAT] or on the additional tax,

- corporation tax and the payment on account for that purpose, together with late payment interest on corporation tax or on the payment on account for that purpose,

- personal income tax and advance payment for that purpose, together with late payment interest on personal income tax and on payment on account for that purpose,

- excise duty, advance payment of excise duty, daily payments and late payment interest on excise duty and advance payment of excise duty,

- customs duties and late payment interest thereon,

Poland was required to seek a derogation from the European Commission for its split payment rules. The European Commission granted Poland authorization to implement this derogation from standard VAT Directive provisions. Thereafter, the European Court of Justice by the Commission was asked to determine if this was reasonable, which that it was proportionate.

In its judgment of Syndyk Masy Upadlosci A v. Poland (C-709/22) on September 12, 2024, the Court evaluated whether Poland's implementation of the split payment mechanism aligns with Council Directive 2006/112/EC (the VAT Directive) and the EU's principle of proportionality, especially regarding the prioritization of tax creditors. The Court held that the mechanism complies with the VAT Directive and serves as a proportionate measure to mitigate VAT fraud, as it applies solely to electronic bank transfers exceeding a specified monetary threshold. Pursuant to Article 395(1) of the VAT Directive, EU member states are permitted to introduce derogatory measures that simplify VAT collection or prevent tax evasion and avoidance.

In this very matter the insolvency administrator had requested the transfer of funds from a VAT account to the estate of a taxable person in insolvency proceedings that began in January 2019. However, the tax authorities denied this request, citing outstanding VAT and income tax liabilities greater than the requested amount.

The EU Court of Justice ruled this that Polish tax authorities may restrict insolvency administrators' access to VAT accounts established under the split payment mechanism, as this limitation is deemed a proportionate measure to combat VAT fraud. The ECJ stated that: It further falls to be clarified whether EU law contains any rules on the ranking of claims to VAT in the insolvency proceedings relating to the taxable person. Priority access on the part of the State might follow from the fact that the VAT, which the taxable person collects from the consumer, is to be passed on first and foremost to the State and is not meant to benefit the taxable person's other creditors.

With these innovative measures Poland's VAT Gap has been shrinking for a number of years, and collection has been improving.

What lessons this Polish measure & consequent ECJ ruling offers to us? The GST law has specific provisions to deal with tax collected and not deposited (Section 76 of CGST-2017) and is also a prosecutable offence (Section 132 of CGST-2017). Similar measures can be adopted for specific sector /categories of tax payers, specifically covering individual entities who have a track record of non-filing of returns and consequent non-payment of duty, also those who have been booked for collecting gst and not depositing the same. There is an important lesson here in context to the interplay of IBC (2017) and GST, in IBC proceedings there is no demarcation to assess what amount has been collected as GST, the entire receivable becomes subject to the waterfall mechanism as laid down in the IBC provisions, with government tax interest taking a hit and being clubbed as just another operational creditor. If we have a split payment mechanism like Poland the amount in the tax account can be segregated from the IBC proceedings and on which only Government can have a claim. For this measure to be effective in context to IBC proceedings, those who have been categorised as wilful defaulters by the financial institutions, would have to be covered under the "split payment" account mechanism, as these are one who are in all likelihood liable to be covered under IBC proceedings at a later date.

GST design needs constant improvement from ease and compliance point of view both and hence such 'split payment' mechanism as introduced by Poland requires a closer look.

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[Note: These views are strictly personal]