VAT, tax audit, litigation

VAT Deduction Right: requirements, challenges, defence

The right to deduct VAT rests on two series of requirements: substantive conditions (the expenditure must be allocated to transactions qualifying for deduction under CGI Article 271 - Code General des Impots, the French General Tax Code) and formal conditions (possession of a proper invoice containing the particulars required by CGI Annex II Article 242 nonies A). In an audit, the tax authorities challenge VAT deductions covering entire accounting periods: invoices deemed incomplete, expenditure treated as foreign to the business, deduction coefficients disputed, or alleged involvement in fraud schemes. Reassessments commonly reach several hundred thousand euros, including penalties. However, CJEU case law, notably Senatex of 15 September 2016 (Case C-518/14), establishes the primacy of substance over form: an irregular invoice may be rectified retrospectively provided the reality of the transaction can be verified. The firm defends companies and their managers at every stage, from audit through to the Council of State (Conseil d'État).

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Principle
VAT burdening expenditure is deductible if the expenditure is used for transactions qualifying for deduction (CGI art. 271)
Form
Possession of a proper invoice containing the particulars required by CGI Annex II Article 242 nonies A
Measurement
Deductible VAT = VAT invoiced x deduction coefficient (taxable status x taxation x admission, CGI Annex II art. 205 and 206)
Substance over form
An incomplete invoice may be rectified with retroactive effect if the transaction is verifiable (CJEU Senatex, Case C-518/14)
Stakes
Reassessments over three years, penalties of 40% or 80%, possible joint liability in fraud schemes
01

VAT deduction is a major reassessment ground in tax audits

VAT deducted is, alongside VAT collected, a line systematically examined in tax audits. The reason is straightforward: challenging a deduction does not require proving concealed income; the authority needs only establish that a substantive or formal requirement is absent. Incomplete invoice, expenditure treated as foreign to business purposes, disputed deduction coefficient: each issue yields a mechanical reassessment, accompanied by late-payment interest and, often, a 40% penalty for deliberate non-compliance.

The financial stakes are structural. VAT is reassessed across the entire audited period, in practice three years, and applies to gross flows: for a group deducting several million euros in VAT annually, even partial disallowance of deductions quickly amounts to several hundred thousand euros, or even several million euros. By way of illustration, the firm secured abandonment of the vast majority of a reassessment exceeding one million euros based on allegedly irregular supplier invoices, by producing rectified invoices and material evidence establishing the reality of the services.

This dispute is nonetheless one where the defence has particularly solid foundations. The right to deduct is a fundamental principle of the common VAT system, and the CJEU consistently holds that VAT neutrality requires that deduction be granted once substantive conditions are satisfied, even if certain formal requirements have been omitted. The Senatex judgment (CJEU, 15 September 2016, Case C-518/14) admits rectification of an invoice with retroactive effect, which eliminates late-payment interest for the intervening period.

The firm limits the number of engagements to ensure direct involvement of partners on each file, and systematically assesses the relevance of an engagement before any commitment.

02

VAT deduction right point by point

01

Substantive requirements: allocation of expenditure

VAT burdening expenditure is deductible only if the expenditure is used for transactions qualifying for deduction.

  • Principle of CGI Article 271: VAT burdening elements of the price of a taxable transaction is deductible from the tax applicable to that transaction
  • Requirement of direct and immediate connection with taxed transactions, or allocation to overheads of an activity qualifying for deduction
  • Birth of the right to deduct when the tax becomes due at the supplier
  • Common reassessment ground: expenditure treated as incurred in the interest of third parties (manager, shareholder, related company) or foreign to business purposes
02

Formal requirements: the invoice and its particulars

Exercise of the right to deduct assumes possession of an invoice issued in accordance with CGI Article 289.

  • Deductible tax is that shown on invoices issued in accordance with CGI Article 289 (CGI art. 271, II)
  • Mandatory particulars set by CGI Annex II Article 242 nonies A: identification of the parties, VAT numbers, date, quantity and precise description of goods or services, price excluding tax, tax rate and amount
  • Imprecise description of services ("fees", "service provision") is a very common audit ground
  • The invoice must emanate from the actual supplier: compliant or fictitious invoices exclude any deduction
03

The deduction coefficient and exclusions

Deductible VAT is measured by a coefficient specific to each good or service.

  • Deduction coefficient = taxable status coefficient x taxation coefficient x admission coefficient (CGI Annex II art. 205 and 206)
  • Nil admission coefficient, notably, for vehicles designed for passenger transport or dual-purpose vehicles immobilised (CGI Annex II art. 206, IV-2-6°), save exceptions (traders, lessors, driving schools, public passenger transport)
  • Exclusions also covering free housing provided to managers and staff, assets disposed without consideration, and assets used more than 90% for purposes foreign to the business (CGI Annex II art. 206, IV-2)
  • Expenditure of a luxury character (holiday homes, hunting, fishing, pleasure vessels) is in practice excluded from deduction, owing to absence of business allocation; substantial stakes for partly-taxed businesses, holdings and separate sectors of activity
04

Primacy of substance over form: the CJEU's contribution

A formal irregularity alone is not sufficient to forfeit the right to deduct.

  • CJEU, 15 September 2016, Senatex (Case C-518/14): rectification of an invoice has retroactive effect, the right to deduct is exercised as of the period of the original invoice
  • CJEU, 15 September 2016, Barlis 06 (Case C-516/14): deduction cannot be refused solely on grounds of formally incomplete invoice where the authority has necessary information to verify substantive requirements
  • Practical consequence: production of rectified invoices and all material evidence (contracts, deliverables, correspondence, payments) establishing the reality of the transaction, including during audit
  • Limit: substance does not cover fictitious transactions or tax invoiced in error, which remains due by the issuer and is not deductible by the customer
05

Fraud, adjustments and burden of proof

Large-scale challenges mix fraud allegations, adjustments and penalties.

  • Refusal of deduction where the taxable person knew or could not ignore participation, through purchase, in VAT fraud (CGI art. 272, 3; CJEU, 6 July 2006, Kittel, Case C-439/04): the authority must establish these objective factors
  • Adjustments of initial deductions on fixed assets on change of allocation or disposal: period of 5 years for movable property, 20 years for immovable property (CGI Annex II art. 207)
  • Omitted deduction: recovery possible on returns filed until 31 December of the second year following that of omission (CGI Annex II art. 208)
  • Defence articulated on burden of proof, the economic reality of flows and proportionality of penalties, from administrative appeal to the Council of State
03

Our approach

The firm acts on VAT deduction right at all stages: preventive audit of flows and deduction coefficients, assistance during tax audit, response to notice of adjustment, administrative appeals and tribunal petitions, then proceedings before the administrative court, the administrative appeal court and the Council of State, and where appropriate, referral for a preliminary ruling before the CJEU. Defence systematically mobilises European case law on primacy of substance, material reconstruction of transactions and close scrutiny of penalties. Analysis is coordinated with VAT credit refund claims and group taxation.

  • Deductible VAT
  • CGI art. 271
  • Deduction coefficient
  • CJEU Senatex
  • Tax audit
FAQ

VAT deduction right: your questions

What are the requirements for deducting VAT on an expenditure?

Two series of requirements must be met. On substance, the expenditure must be used for the needs of transactions qualifying for deduction (CGI Article 271): taxed transactions or equivalent transactions, such as exports. On form, the taxable person must possess an invoice issued in accordance with CGI Article 289 and bearing the particulars of CGI Annex II Article 242 nonies A. The deductible amount is then measured by the deduction coefficient, the product of taxable status, taxation and admission coefficients. Absence of any one of these requirements exposes to reassessment across the entire non-barred period.

Can the authority refuse deduction for a merely incomplete invoice?

Not solely on grounds of formal irregularity, provided the reality of the transaction is verifiable. The CJEU holds that the principle of VAT neutrality requires that deduction be granted where substantive requirements are satisfied, even if certain formal requirements have been omitted. The Senatex judgment (15 September 2016, Case C-518/14) admits rectification of an invoice with retroactive effect, and the Barlis 06 judgment, delivered the same day, forbids refusal of deduction solely on grounds of a formally incomplete invoice where the authority possesses the necessary information. In practice, production of rectified invoices and material evidence from the file (contracts, deliverables, payments) frequently secures abandonment of reassessments of several hundred thousand euros.

Is VAT on passenger vehicles deductible?

In principle, no. The admission coefficient is nil for vehicles designed for passenger transport or dual-purpose vehicles constituting a fixed asset (CGI, Annex II, Article 206, IV-2-6°), as well as their component parts, spares and accessories. Exceptions exist, notably for vehicles intended for resale in new condition, let out as part of a leasing activity subject to VAT, allocated exclusively to driving instruction or public passenger transport. The classification of the vehicle and its allocation is a common reassessment ground, particularly for group fleets.

What is the risk for a company whose supplier is involved in VAT fraud?

Loss of the right to deduct, even though the company paid the tax. The right to deduct is refused where it is established that the acquirer knew or could not ignore that, through purchase, it participated in VAT fraud (CGI Article 272, 3, in line with CJEU Kittel case law). The burden of proof rests on the authority, which must establish objective factors: abnormal prices, atypical invoice circuits, supplier inability to perform. In carousel-type cases, reassessments commonly reach several million euros, accompanied by the 80% penalty and, where applicable, criminal prosecution. Defence consists in establishing the company's diligence and the economic reality of its supplies.

Can forgotten deductible VAT still be recovered?

Yes, within a limited period. Tax the deduction of which was omitted may be shown on returns filed until 31 December of the second year following that of omission (CGI, Annex II, Article 208). Beyond that, the right is in principle lost, save special circumstances, notably where exigibility or the invoice arose late. This hypothesis must be distinguished from adjustments of deductions made on fixed assets, which spread over five years for movable property and twenty years for immovable property (CGI, Annex II, Article 207) and may operate in favour or against the company. An audit of omitted deductions usefully accompanies any audit procedure.

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