Where does the name VAT come from? It is the English abbreviation of “Value Added Tax”. In Polish literature and everyday language, it is also commonly referred to as tax on goods and services, and abbreviated to PTU.

Contrary to popular belief, a similar tax can be found not only in the European Community; it is quite common worldwide (for example, in Canada, Australia and New Zealand the tax is known as GST – Goods and Services Tax). The difference in the basic rates of the tax in individual countries is very large, and it is the basic rate that actually determines the tax importance in shaping the tax and price environment of the country.

VAT and tax authorities

VAT is the apple of the tax authorities' eye. It comes as no surprise since VAT and excise duty are the main sources of income for the state budget. In addition, VAT is extremely vulnerable to abuse (we will explain why in a little while). Hence, we are confronted with dozens of safeguarding and detailing provisions; therefore we have to deal with VAT refund and deduction problems. Finally, the special attention of tax officials inspecting the tax settlements, as well as special requirements for VAT-related documents, record-keeping obligations, etc.

Given all these factors, VAT seems a difficult tax to settle.

What is VAT really?

VAT is an indirect tax, added to the price by active VAT payers (i.e. such taxable persons that are obliged to increase the price of their goods and services by the tax) every time there is a supply of goods or services, except when the supply is tax-exempt or taxed at a preferential rate of 0%. However, each active taxable person making taxable sales has the right to deduct from the tax added to the price at the sales transaction (in settlements with tax offices and in the legal regulations referred to as the output tax) the tax that has been charged by other active VAT payer on supplies of goods and services needed to make taxable sales.

Example

Let us take a look at an entrepreneur that is an active VAT payer and is engaged in the business of selling industrial goods. Such types of sale are subject to VAT at the applicable tax rate (currently 23%).

It is clear that in order to sell a product, one must first purchase it.

While purchasing goods and services, VAT payers use the concepts of the net and gross price. The net price is VAT exclusive, whereas the gross price is the one with the tax. Because the tax is usually included in the price of purchased goods or services, entrepreneurs will be able to deduct the tax at a later stage of the cycle. Therefore, they pay attention mainly to the net price. That is what differentiates them from ordinary consumers, who will not be able to deduct the VAT paid in the price, and who thus focus on the gross price.

So an entrepreneur buys commercial goods from a wholesaler. A total of 100,000 PLN net is spent on these goods. This means that they have to pay to the suppliers 123,000 PLN gross (100,000 PLN + 23% VAT).

They then sell the same goods to consumers or other entrepreneurs, but this time the price is 140,000 PLN net. This means that they have to increase the price by 23% VAT (23% on 140,000 PLN, i.e. 32,200 PLN).

If entrepreneurs could not deduct the VAT that has been charged at previous stages in the cycle, than the entrepreneur from the example would have to pay to the state budget the full amount of VAT that they have collected from purchasers of their goods (that's right! – while collecting the price for the goods, any entrepreneur that is an active VAT payer becomes essentially a tax collector – which implies, of course, certain duties and responsibilities).

Fortunately, things are different here because the tax is collected on the added value. In our example, this added value is 40,000 PLN (goods are purchased for 100,000 PLN and sold for 140,000 PLN).

Let us see how the system works in its simplest form.

Upon the purchase of goods, the entrepreneur pays 23,000 PLN VAT (this amount has been added to the net price of the goods purchased). Upon the sales, they collect from customers as much as 32,200 PLN VAT.

Since the input tax (i.e. 23,000 PLN) can be deducted from the output tax (32,200 PLN), the entrepreneur will have to pay 9200 PLN tax (i.e. the difference between the output and input tax: 32,200 PLN – 23,000 PLN).

Please note: This amount is nothing but 23% on 40,000 PLN, i.e. the amount which constitutes the added value of the goods concerned. And hence the name: the value added tax.

At this point, it would be good to reflect on one issue: who actually pays the tax?

Although it is true that the entrepreneur from the example acts as the tax collector (receives the tax from the customer) and the tax payer – as they pay the tax in the amount due to a tax office, in fact the tax is paid by the consumer.

Of course the above example discusses a perfect, model situation. In the economic reality, taxable persons are unfortunately faced with limitations in deducting the input VAT on purchases, the necessity to limit the amounts deducted (on various grounds), or with the inability to recover the input VAT for a long time, etc.

But in essence it is the consumer who pays VAT to the state budget (with the consumer understood as the person who buys goods for consumption, i.e. for purposes unrelated to business activities).

Remember!

Your supplier is also an active VAT payer, and so they will perform a parallel tax calculation on their amount of added value. In this way, every participant in the trading chain adds the tax to the selling price and – while calculating the tax to be paid to a tax office – subtracts the tax that they themselves had to pay as part of the price of goods (services) purchased.

If so easy, why so difficult?

The above example might suggest that there is nothing easier in the world than VAT and its application.

After all, the rules for its calculation are trivial. So what makes the application of VAT so cumbersome, burdened with many document-related obligations, and why, in real life, will every taxable person sooner or later be faced with some VAT problems?

Things could be so simple. It would be enough to introduce one tax rate on all goods and services, without exemptions, exclusions, reliefs, exceptions or exempt entities. This, however, is impossible, from both social and economic reasons. We are also bound by the provisions of international law. In fact, Polish VAT regulations simply implement EU laws (although Poland still has some problems with VAT-related harmonisation). It all makes things more complicated.

The existing exemptions and differences in tax rates, as well as numerous limitations associated with tax deductions, and the need to settle transactions between entities that are located in different countries, mean the simple rules from the above-described example very rarely met in real life.

I would like to present here another example that shows how things can get complicated in a relatively simple situation.

This time our entrepreneur is a manufacturer of medical equipment, with individual items taxable at different rates. Depending on their intended use, individual components may be taxed at 0%, 8% or 23% (unfortunately, when the legislator decides to introduce reduced rates, the situation became complicated because there should always be someone who has to pay the basic rate, and care should be taken that that someone does not benefit from the reduced rate; besides, there are many other things to look after that we will discuss in a little while).

In order to be able to manufacture, an entrepreneur buys all kinds of materials, auxiliary materials, machinery, services, etc. Let us assume, for simplicity reasons, that while buying all the above items, they pay to the suppliers the net price plus 23% VAT.

So three situations may occur now (this is only an example; in real life, combined scenarios will also apply).

I. An entrepreneur buys goods and services for 100,000 PLN net, paying 23,000 PLN (23%) VAT at the purchase. This amount may be deducted from the output tax (in each scenario). They produce equipment and sell it for 140,000 PLN net, with the tax rate of 0%.

II. As above, but they sell the equipment for 140,000 PLN net, with the tax rate of 8%.

III. As above, but they sell the equipment for 140,000 PLN net, with the tax rate of 23%.

In the first scenario, the output tax is 0% on 140,000 PLN, i.e. 0 PLN. In the second scenario, the output tax is 8% on 140,000 PLN, i.e. 11,200 PLN. And in the third scenario, the output tax is 23% on 140,000 PLN, i.e. 32,200 PLN.

In each scenario, the entrepreneur has the right to reduce the output tax with the input tax paid at purchase, i.e. 23,000 PLN. And here starts the problem.

Let us analyse individual scenarios:

In examples I and II, the manufacturer is entitled to receive the tax REFUND from the tax office, but in scenario III, they have to pay the tax. You are not surprised then, that it is only natural that manufacturers often want to sell at the rate of 0% and get the refund from the tax office?

You are probably not.

But you should not be surprised either that tax authorities do everything in their power to ensure that the rate is applied solely and exclusively to the extent for which it is intended. And because we cannot have a tax official in every company, we have to deal with a multitude of regulations, records, returns, and – unfortunately – audits.

It would be much easier if sales of medical equipment in the example were taxed at a single rate only. But then social (and political) goals would not be pursued and achieved, and taxes are also, unfortunately, part of social policy.

Abuses

In the above example, we have dealt with an entrepreneur that is able to obtain an obvious tax benefit by applying different tax interpretations. If they do it in line with the applicable legal regulations, it is rational, honest and permitted conduct. However, the VAT application mechanism is such that it makes the tax very sensitive to fraud: one can create an artificial situation where the input tax is higher than the output tax, so the tax office will be required to refund the difference. Unfortunately, this is a common practice when groups of businesses are established whose sole purpose is VAT fraud.

Let us have a look at the following example:

Company A (a fake enterprise registered only for fraud purposes) sells goods at the rate of 23% to Company B (another fake enterprise). Such sales are usually fictitious, but a method that fraudsters also employ is the massive inflation of the price (transactions between companies do occur, but their value is disproportionately high in relation to the actual market value).

Company B sells goods abroad (again fictitiously, to another bogus entity – Company C), applying the VAT rate of 0%. Since the sale is taxed at 0%, Company B is entitled to reduce the tax with the amount of VAT that is shown on the invoice received from Company A. Therefore, we have the input tax, but no output tax (0%).

So Company B applies to a tax office for a refund, and once it receives one, it vanishes into thin air.

Company A disappears as well without paying the output tax shown on the invoice.

Of course, Company C is equally difficult to track down.

Obviously, this example includes simplifications. There are numerous safeguards provided for in the legal regulations against such fraud (extending the refund period to allow the conduct of audit proceedings, a requirement to possess evidence of exports and supply, etc.). But if the system is so complicated, it is equally hard to tighten it up. If tax officials come across a gang of well-organised and determined fraudsters, fraud will happen.

The problem is that the tax authorities tend to generalize, and often treat honest taxable persons as cheaters. What is even worse, the legislator follows the same path by introducing new safeguards, reservations, and powers of auditing bodies to the existing regulations, thereby effectively complicating the already confusing system of VAT collection and calculation.

Definitions to remember

- output tax – tax that you add to the net price of goods or services that you sell;
- input tax – tax that your supplier adds to the net price;
- tax to pay – positive difference between the output and input tax;
- tax for refund – negative difference between the output and input tax.

International nature of VAT

As a Member State of the European Union, Poland is obliged to apply the EU regulations on VAT. This is because the tax is subject to the EU harmonisation: all states involved in trade are obliged to apply the same rules for calculations, refunds, limitations in deduction, rates, etc. This does not mean that the rates and rules are identical everywhere – harmonisation only applies to general issues.

A typical example of a general rule that is valid in the Union is that an active VAT payer is entitled to deduct the tax paid in connection with the purchase of goods and services related to taxable sales. This general principle has actually led the Polish state to several spectacular failures in the European Court of Justice. This is because the Polish legislator is often inclined to restrict the availability of tax refunds and deductions. Here the EU legislation is of help for taxable persons.

The essential EU act that Polish VAT payers should read is Council Directive 2006/112/EC. As with any directive, here we also deal with numerous implementing acts, which provide a detailed guidance for its application.

The national act that regulates VAT issues is the Act on Tax on Goods and Services dated 11 March 2004. Based on the powers delegated by the Act, the Minister of Finance (sometimes in consultation with another minister) issues a number of regulations that lay out the detailed conditions for the application of the Act.

VAT payers

The fact that a company or a person is a VAT payer does not automatically mean that they will add the tax to goods or services sold, or benefit from the deduction of the input tax related to purchases. This is because numerous exemptions, exceptions and exclusions apply to tax on goods and services.

In our discussion, we will focus on taxable persons that are engaged in business and business-like activities. We should remember, however, that in some unique situations, an individual who does not pursue a business activity may become a VAT payer as well. Individuals can be VAT payers, even if they are unaware of the fact, also in a situation where their activities will make them subject to the same treatment as is applied to persons engaged in a business activity.

It is the Act that determines whether we are VAT payers or not. The Act says that taxable persons under VAT include legal persons, non-corporate bodies and individuals that pursue an independent business activity, whatever the purpose or result of such activity.

And in the Act business activities are quite broadly defined. Hence, they include:
all activities of producers, traders or service providers, including entities extracting natural resources, and farmers, as well as persons in liberal professions, even if a single activity has been performed but in circumstances indicating an intention that it will be repeated.

A business activity also includes activities involving the use of goods or intangible assets on a continuous basis for commercial purposes.

This definition was changed on 1 April 2013. Since then, a business activity should be understood as all activities of producers, traders or service providers, including entities extracting natural resources, and farmers, as well as persons in liberal professions. A business activity includes in particular activities involving the use of goods or intangible assets on a continuous basis for commercial purposes.

Typical VAT payers include, for example, corporations and partnerships covered by the provisions of commercial and civil law, cooperatives and self-employed individuals, as well as persons who do not pursue a registered business activity but who are involved in repeated sales transactions of land or premises, or earning revenue from rent.

However, certain categories of activities are excluded from the statutory definition of a business activity. And so, the following are not considered to be independent business activities:

1) those activities the revenue from which is listed in Article 12 para. 1-6 of the Personal Income Tax Act – i.e. the activities performed as part of the service relationship, employment relationship, cooperative employment relationship and putting-out system;
2) those activities the revenue from which is listed in Article 13 item 2-9 of the Personal Income Tax Act, if due to performance of such activities, the persons concerned become connected with an entity commissioning the activities by a legal relationship which governs the conditions of performance, remuneration, and a liability of the commissioning entity towards third parties.

To express this rather complicated provision in simpler terms: if the results of a person's gainful activity constitute the responsibility of an employing entity (hirer, principal), then the activity is not a business activity.

Here is an example:

An artist hires himself to perform a cabaret show. An organizer sells tickets; however, the artist cannot appear on stage for some reason. In this situation, it is the organiser that returns the ticket money and pays for the reserved venue. The organiser carries out such activities as part of their business.

We can also imagine a situation where an artist organises their performance on their own: they rent a venue, make promotional arrangements, hire a person to sells tickets, etc. Now, if the performance is cancelled, it is the artist who bears the financial consequences. If the said artist is repeatedly engaged in such activities, it will be considered that they pursue a business activity, even if it has not been registered.

So there is nothing left for us but to list the above-mentioned revenue that is specified in the Personal Income Tax Act in Article 13 item 2-9. So, the relevant revenue includes:

Article 13
(…)
2) revenue from contractual professional services: artistic, literary, scientific, coaching, educational and journalistic, including from participation in competitions in the field of science, culture and art, and journalism, as well as revenue from sports, sports scholarships awarded on the basis of separate regulations, and revenue of umpires/judges/referees related to sports competitions;
3) revenue of the clergy, other than that earned under a contract of employment;
4) revenue of Polish arbitrators participating in arbitration proceedings with foreign partners;
5) revenue earned by persons performing activities related to social or civic duties, regardless of how they are appointed, including compensation for loss of earnings, with the exception of revenue referred to in item 7;
6) revenue of persons to whom a state or local government authority or administrative authority commissioned, pursuant to relevant regulations, certain specific activities, especially revenue of experts in court, investigation and administrative proceedings, and payers, subject to Article 14 para. 2, item 10, and collectors of public debt, as well as revenue from participation in committees established by a state or local government authority or administrative authority, with the exception of revenue referred to in item 9;
7) revenue earned by persons, regardless of how they are appointed, sitting on management boards, supervisory boards, committees or other decision-making bodies of legal persons;
8) revenue relative to performance of services under a contract of mandate or a specific-task contract, derived exclusively from:

a) a self-employed individual, a legal person and its organisational unit, and a non-corporate body;
b) an owner (holder) of the real property in which premises are rented out, or a manager or administrator acting on behalf of such owner (holder) – if a taxable person renders such services exclusively for the purposes related to that real property

- with the exception of revenue earned under contracts concluded as part of the taxable person's non-agricultural business activities, and revenue referred to in item 9;

9) revenue earned under enterprise management contracts, management contracts or contracts of a similar nature, including revenue from these types of contracts concluded as part of a taxable person's non-agricultural business activities – with the exception of revenue referred to in item 7.

Doubts

In practice, interpretation of the provisions related to the scope of activities that are not an independent business activity has proved problematic. Let us have a look at two typical cases in which taxable persons were in doubt whether they were VAT payers or not:

A. A VAT payer carries out a business activity and at the same time earns revenue under specific-task contracts (contracts of mandate) whose subject matter goes beyond the scope of their business activities.

This is a situation dealt with in the above-cited Article 13 item 8 of the Act. If a contract provides that it is a principal that is fully liable towards third parties for the consequences of any irregularities in the execution of the contract, then there is no reason to treat such activities as performed by a VAT taxpayer. A typical example will be the situation where a taxable person runs a shop but also renders commissioned services (such as painting, translations/interpreting, artistic performances at parties, etc.).

B. A VAT payer carries out a business activity and at the same time earns revenue under specific-task contracts whose subject matter falls within the scope of their business activities.

The provision of Article 13 item 8 that we have just referred to excludes revenue earned under contracts concluded as part of a person's business activity any revenue related to the provision of services under a specific-task contract or a contract of mandate. Therefore, in this case, revenue from specific-task contracts will be subject to VAT.

Active and exempt VAT payers

The mere fact that someone has become a VAT payer does not mean that they will be required to add VAT to the price of their goods or services. This is because of the fact that one may be either an active VAT payer (where the taxable person enjoys full rights and is subject to all obligations under VAT regulations) or a VAT-exempt entity.

A taxable person that is VAT-exempt is relieved from the obligations of an active VAT payer, but cannot enjoy the rights vested in the latter either (e.g. deduct the input tax relative to purchases).

Taxable persons exempt based on the sales revenue criterion

The most common type of VAT exemption for persons engaged in a business activity is related to the turnover. So VAT exemption will apply to taxable persons whose taxable sales in a tax year do not exceed the total of 150,000 PLN. While determining the limit, we exclude the tax amount from sales (understood as the tax that would apply if a seller was an active VAT payer).

The limit value is also exclusive of supplies of goods and the provision of services that are tax-exempt, as well as goods that a taxable person classifies, pursuant to the income tax regulations, under fixed and intangible assets that are subject to depreciation/amortisation.

This exemption also applies to persons that start a business in the middle of the year. Later we will discuss the conditions for the use of such exemptions.

Record-keeping obligation of VAT-exempt taxable persons

If a taxable person wants to benefit from the exemption concerning tax on goods and services, they are obliged to keep VAT records so that they can identify the moment when they exceed the amount of revenue and thus lose the right to VAT exemption.

These records should be completed daily (EOD) but not later than prior to any sale transaction on the following day. If an entrepreneur keeps the tax book of revenue and expenditure, they may – instead of keeping the VAT records – use their sales records, which are kept in accordance with the Regulation on Keeping the Tax Book of Revenue and Expenditure, and in separate column there (usually column 15) disclose revenue that is subject to VAT and the total amount of their daily sales as resulting from invoices. In this case too, the entries must not be made later than prior to the first sale transaction on the following day.

Failure to keep the records may cost a taxable person dearly, if disclosed by a tax audit. If it is determined that an entrepreneur does not keep these records, or the records prove unreliable, the head of a tax office or a tax inspection authority will determine the non-recorded sales by estimate and levy a tax at 23%, excluding the right to reduce the output tax with the input tax paid at the purchase of goods.

Determining the exemption limit for taxable persons starting their business mid-year

Entrepreneurs often make a mistake assuming that that the limit of sales is a fixed figure for a given year, regardless of when they start their business. Meanwhile, if an entrepreneur takes up business activities that are subject to VAT in the middle of a tax year, they will be exempt from VAT if their expected sales do not exceed the limit amount in proportion to the duration of the sales period.

Of course, the question arises of how to calculate the ratio.

The amount at which the right to exemption will be lost is calculated using the formula:

elA = bA * D / 365

where:

elA – the amount which, if exceeded, will result in the loss of exemption;
bA – the bound amount, fixed for a given year;
D – the number of days remaining until the end of the year.

Resignation from exemption

Although it is applied by default, the turnover-based exemption is not obligatory.

On the contrary, a taxable person may resign from the exemption, provided that they submit a written notice to this effect to the head of a tax office, prior to the start of the month in which the waiver is to become effective.

Entrepreneurs who want to resign from the turnover-based exemption right from the start of their business should submit a relevant notice to the head of the tax office prior to the day when they complete the first taxable transaction.

Moment of the tax-exemption loss

Any taxable person using the turnover-based exemption should remain vigilant because the exemption ceases to apply if the limit amount is exceeded – that is when the tax obligation arises. The tax applies to the entire surplus of sales over the limit amount.

There are no transition periods here (such as: 'the tax will apply from the beginning of the day following the day when the limit has been exceeded).

Basic rights and obligations of VAT payers

As usually happens with taxes, the obligations considerably outweigh the3 rights. The primary right vested in active VAT payers is the possibility to deduct the tax paid on purchases related to taxable sales (unfortunately, if the payer's sales activities are VAT-exempt, the input tax on purchases will not be deductible – with a few exceptions).

An active VAT payer has the right to issue VAT invoices (but this is obviously an obligation too).

A taxable person is also entitled to the refund of VAT that they have not deducted from the output tax.

And what are the basic obligations of an active VAT payer?

They must issue VAT invoices and keep the records of VAT sales and purchases that are necessary for the correct preparation of tax returns. A taxable person is also required to prepare and submit to the tax office regular VAT returns. Last but not least, they must pay the amount of VAT payable, on the dates specified in the regulations.