Turnover for VAT registration purposes – spinning “non VAT companies”

I found the company Reconstruction of flats s.r.o. in the commercial register . The company is a VAT payer and carries out construction work. At first glance, therefore, nothing unusual. Until I found its sister companies there:

• Reconstruction 1 Ltd;
• Reconstruction 2 Ltd;
• Reconstruction 3 Ltd;
• …
• Reconstruction 20 s.r.o.

All these sister companies are not subject to VAT. It is true that the Commercial Code does not prohibit such conduct. However, doing business through a company established in a tax haven is not prohibited either, but it can still be a criminal offence. And similarly in this case.

VAT registration

A taxable person becomes a VAT payer in Slovakia only after exceeding a turnover of EUR 49 790 and registering for VAT. This approach is thus different from the approaches we know from some other EU countries. There, you become a VAT payer as soon as you exceed the relevant turnover. This is similar to the situation in Slovakia when you sell a property. If a Slovak taxable person (i.e. normally a natural or legal person) sells a property for more than EUR 49 790, he/she becomes liable for VAT upon the supply or receipt of the payment itself (and not after VAT registration).

Turnover for VAT registration purposes

This turnover does not include certain supplies of goods and services that are exempt from VAT. For example, while the proceeds from the supply of health care services, educational services or the operation of lotteries are not included in turnover, the proceeds from the sale of an older property that is exempt from VAT are already included in turnover. So even if the taxable person carries out only activities that are exempt from VAT (for example: selling old real estate or providing financial services), once the turnover is exceeded, he has to register for VAT. However, as a VAT payer, he does not subsequently charge VAT on his supplies.

Is it worth being a VAT payer?

Not every taxable person wants to be a VAT payer. The standard reason is that such a taxable person has to increase his prices. Let us illustrate this with a simple example:

• Person X is a shareholder and managing director of company X;
• Company X is in the business of providing construction services (for example, building kitchens);
• The clients of Company X are mainly natural persons – non-businessmen in Slovakia;
• Company X has the following costs:

• “VAT costs” €1,000 + €200 VAT (e.g. purchase of a tool case);
• “non-DSH costs” €2,000 (occasional services from a self-employed person);

• Company X has deliveries totalling EUR 50 000 as output;

If company X is not subject to VAT, its profit before tax is equal to the difference between €50,000 and the sum of €1,200 (i.e. ‘VAT costs’) and €2,000 (i.e. ‘non-VAT costs’). The profit is thus EUR 46 800.

However, if company X becomes subject to VAT, it has in principle three options:

1. They load their prices with a 20% surcharge (i.e. VAT);
2. The prices will remain, but the EUR 50 000 will be considered to be the price including VAT and the revenue of company X will thus be about 20 % lower;
3. Combinations 1. and 2. options

If Company X chooses Option 2, it will have the following economic impacts:

• He will be able to claim a VAT deduction (i.e. EUR 200) on the “VAT costs”;
• The amount of EUR 50 000 including VAT will consist of a tax base of EUR 41 667 and EUR 8 333 VAT to be paid to the State.

The profit before tax of company X will thus be equal to the difference between €41 667 and the sum of €1 000 (i.e. ‘VAT costs’) and €2 000 (i.e. ‘non-VAT costs’). The profit is thus EUR 38 667.

So the difference in profit is really dramatic. And that is why some entrepreneurs try to avoid paying VAT.

When is it still worthwhile to be VAT exempt?

Business practice also brings other cases when it is worthwhile for an entrepreneur not to be a VAT payer. These are for example the following situations:

Self-employed person – VAT payer

For example, if a self-employed person (including sole traders) becomes a VAT payer, he will not be able to apply the so-called. This helps the entrepreneur to dramatically reduce their income tax liability. In terms of tax-efficiency, the key intervention is for the self-employed who do not show large real costs with their business. By default, this includes, for example, solicitors, accountants or other advisers.

Thus, if a self-employed person becomes a VAT payer, he/she will be able to deduct VAT on input supplies, but will not be able to use the flat-rate expenses (i.e. currently 60% of income, but up to a maximum of EUR 20,000/ EUR 40,000 per year).

One company is a VAT payer and the other company is a non-VAT payer

An even more common standard in current business realities is a simple structure where the entrepreneur uses one paying and one non-paying company for business purposes. Through that paying company, he makes all purchases with VAT so that he can claim the full VAT deduction. And through the non-VAT payer he sells goods/services to non-taxable persons without VAT.

But when is it worth being a VAT payer?

If the taxable person’s clients are VAT payers, they are not charged VAT by default. Being a VAT payer is thus neutral for such a business. However, if this entrepreneur has suppliers who invoice him with VAT, being a VAT payer with a possible VAT deduction is undoubtedly economically advantageous for this taxable person.

For smaller companies, the need to register for VAT is often driven by the entrepreneur’s need to buy, for example, a car or more expensive hardware. For such purchases, he can deduct input VAT up to 100%.

Is spinning by “non-DPH” companies legal? Can it also be criminal?

Yes and no. This issue, as well as the above-mentioned case with the sister companies within the “Reconstruction” group, may, in certain circumstances, fulfil not only the elements of abuse of law, but also of one of the fraudulent tax offences. On the other hand, if such a structure is built on legitimate grounds (i.e., justifiable on non-tax grounds), the defensibility is certainly higher.

However, each such situation needs to be viewed very individually. The case law seems to suggest that it could take a more aggressive approach to the subject and apply a more expansive interpretation, at least in terms of the interpretation of abuse of rights. This does not preclude it from considering the case in question to be a fraudulent act and from referring it to the law enforcement authorities.

This would mean that the tax authorities should look at the above-mentioned case of the sister companies at least through the lens of abuse of law and require the entrepreneur (and it is not clear from which entity in particular) to repay the VAT in the full amount starting from 31. day after the day on which any of the companies (while it is not clear which entity this would apply to) the tax administrator should at the very least demand reimbursement of VAT on all supplies.

As the above example also shows, the tax administrator is in practice entrusted with a very significant discretionary power in decision-making. This creates legal uncertainty. Thus, the entrepreneur may not be able to anticipate the behaviour of the tax administration and possibly the law enforcement authorities. In one Czech case with a similar factual situation to the case of the ‘Reconstruction’ group, the tax authorities imposed an obligation to pay VAT on the shareholder, an individual of the companies in question. In professional legal parlance, such an aggressive approach is called “piercing the corporate veil“.