A Penalty That Violates the Principle of Proportionality: TEAC Case

TEAC ruling on the penalty under Article 171(One)(4) of the VAT Act

1. Facts and procedural background

• Proceedings and procedural history:
  The case began with an appeal lodged on 30 August 2022 against a decision of the Madrid Regional Economic-Administrative Tribunal (TEAR), dated 27 July 2022. The TEAR had dismissed an administrative economic claim arising from a VAT penalty procedure for the 2018 tax year.

• Inspection proceedings:
  In May 2019, the Tax Inspection began verification and investigation proceedings focused on a VAT refund claim for the fourth quarter of 2018. In the course of those proceedings, a settlement record was signed on 23 January 2020. It established that a property development company had acquired a property by exercising a purchase option.
  The transaction was subject to the reverse-charge mechanism under Article 84(One)(2)(e) of Law 37/1992, and the deed recorded a waiver of the VAT exemption. However, in its VAT return for the first quarter of 2018, the company failed to report the amounts it was required to declare as the recipient of the transaction.

• Assessment and penalty proceedings:
  The Inspection amended the VAT return, adding a taxable amount of €12,500,000 and VAT of €2,625,000. This resulted in a negative refund adjustment of €277,823.38 and late-payment interest. A penalty procedure was also opened and concluded on 27 February 2020. The company was charged with the offence under Article 170(2)(4) of the VAT Act for the omission in the first quarter of 2018. The penalty was set at 10% of the omitted VAT under Article 171(1)(4).

• Appeals filed:
  The company challenged both the penalty and the decisions dismissing its objections at successive stages: reconsideration, a claim before the TEAR and, finally, an appeal before the Central Economic-Administrative Tribunal (TEAC). It argued that the omission resulted from an accounting error, that there was no fraudulent intent and, above all, that the penalty was disproportionate.

2. Legal grounds and arguments

• Jurisdiction and applicable rules:
  The tribunal asserted jurisdiction under the General Tax Law (LGT) and its implementing regulations (RGRVA). It examined both the tax assessment and the penalty proceedings, focusing on the application of VAT rules.

• Nature of the offence and penalty:
  The alleged offence was the failure to report, in the VAT return for the first quarter of 2018, the VAT due under the reverse-charge mechanism.
  Under Article 171(1)(4) of the VAT Act, the penalty is 10% of the amount not reported. The tribunal noted, however, that the taxpayer met the conditions for deducting the VAT and the return was corrected through a settlement record. As a result, the penalty base was virtually fictitious and there was effectively no actual loss to the public purse.

• Proportionality and European case law:
  The ruling relies in particular on recent Supreme Court case law (judgment of 25 July 2023) and Court of Justice of the European Union decisions in Farkas and Grupa Warzywna.
  The tribunal reasoned that a penalty calculated as a fixed percentage, without allowing consideration of the absence of financial loss or fraudulent intent, breaches the principle of proportionality under EU law and the Charter of Fundamental Rights.
  It also compared the VAT penalty with Article 198 of the LGT, which provides minimum penalties for formal breaches involving other taxes. That comparison highlighted the excessive nature of the VAT penalty in relation to the actual seriousness of the conduct.

• Intent and error:
  The omission was attributed to an error in the accounting software, rather than an intention to conceal the transaction. This supported the argument that the penalty should be reduced or set aside because no actual loss to tax revenue had occurred.

3. Tribunal’s conclusion and decision on the appeal

The tribunal concluded that:

• Breach of the principle of proportionality:
  A penalty of 10% of a merely notional amount, where no financial loss occurred and there was no deliberate conduct, was disproportionate.
  Because the taxpayer’s position was corrected by the settlement record, which confirmed that the VAT deduction requirements were met, the penalty went beyond what was necessary to ensure proper tax collection and was imposed despite the absence of fraud.

• Penalty annulled:
  Consistent with recent Supreme Court and Court of Justice of the EU decisions, the tribunal upheld the appeal and annulled the penalty.

4. Final assessment

The article presents the decision as a careful reconciliation of the wording of the law with the principles of EU law, particularly proportionality. It highlights several points:

• Consistency with recent case law:
  The ruling follows decisions criticising rigid fixed penalties and calling for them to reflect the actual harm caused. The 25 July 2023 judgment illustrates a shift in tax-penalty case law toward avoiding excessive sanctions for purely formal conduct.

• Technical error and absence of intent:
  The finding that the omission resulted from an accounting error rather than fraudulent intent was central to assessing proportionality. It shows why penalty systems should distinguish material errors from fraud.

• Implications for tax administration:
  The decision invites reconsideration of VAT penalties where there is no financial loss and the return is corrected promptly. The administration should ensure that penalties deter non-compliance without becoming excessive.

TEAC’s stated criterion

In accordance with the Supreme Court judgments of 25 July 2023 (appeal no. 5234/2021) and 26 July 2023 (appeal no. 8620/2021), the penalty under Article 171(One)(4) of the VAT Act breaches the EU principle of proportionality. It imposes a fixed penalty of 10% of the VAT not reported without allowing the penalty to be adjusted where there is no financial loss to the public purse, and the omission is unrelated to tax fraud.