The concepts of “classification”, “conflict in the application of tax provisions” and “simulation” are not interchangeable
Supreme Court concludes that all these concepts must be used for their intended purposes when they were created, observing the procedures specifically defined for each.
Article 13 of the General Taxation Law or LGT (“classification”) states that tax obligations must be sought by reference to the legal nature of the facts, actions or transactions that have taken place, regardless of the form or name that taxpayers have given to them and without regard to any defects affecting their validity. Article 15 and article 16 of the same law define the specific concepts of “conflict in the application of tax provisions” and “simulation”, respectively. The procedures for finding the existence of conflict and simulation also show significant differences.
In a judgment delivered on July 2, 2020 (appeal 1429/2018), the Supreme Court ruled on the concepts defined in those articles and concluded that they are not interchangeable.
In the case at the heart of the judgment, the auditors had concluded, under the rules on classification (article 13), that the activities carried out by a company and by three individuals (who had been registered under the same caption for the tax on economic activities as the company, billed the company, and used the objective assessment method on their personal income returns) qualified as a single activity that was really only carried out by the company. At that company, according to the auditors, the individuals’ activities were simply those of employees, even though they acted under the appearance of being self-employed. The adjustment made to the company's corporate income tax and VAT involved attributing to the company all the revenues of the individuals and all the VAT incurred on activities; and treating the sums received by the individuals as income from personal work for these purposes. A penalty was also imposed on the company.
The judgment is interesting because it contains a very detailed analysis of the three concepts and their scope of application. It notably makes the following affirmations:
a) Classification is aimed at determining the legal nature of the taxable event that actually took place, regardless of the form given to it by the parties. Conflict in the application of tax provisions requires an instance of avoiding the occurrence of a taxable event including through artificial transactions, wherever the legal or economic results (other than the amount of tax saved) are not significant. And, lastly, in simulation, the taxable event on which tax is charged must be that actually carried out by the parties. The tax authorities must state the existence of such simulation in the assessment decision, and may impose penalties.
b) Case law makes a distinction between simulation and conflict in the application of tax provisions: in conflict in the application of tax provisions (as opposed to simulation), a real transaction is performed; it is not a case of concealing one type of action behind the appearance of another, but instead of finding protection for an action in a provision that is not rightly the one that should be applied.
c) To apply these concepts it first needs to be determined whether it is required to correct the classification given by the taxpayers to the actions or transactions that have taken place. Only if transaction's name reflects its legal nature can it be analyzed whether there is simulation (article 16); and the anti-avoidance catch-all clause (article 15 LGT - conflict in the application of tax provisions -) applies only in relation to correctly classified actions or transactions that are not considered to be simulated.
d) Therefore, it cannot be sought to obtain in relation to classification alone the consequences associated with conflict in the application of provisions or simulation. On this subject, the judgment states that “the concepts were not created by the lawmakers on a whim and (…) have not been made available to public servants to be used freely or at their discretion (…). They are not, in other words, interchangeable”.
The court concluded from those arguments that it is not possible, on the basis of article 13 LGT (classification), for the auditors to ignore the activities reported by individuals, attribute their income and input VAT to a company that carried out the same activity; or reclassify the sums received by the individuals as income from personal work. As a result, it rendered void the assessments and the imposed penalties.