Tax credit and VAT recovery are traditionally amongst the most complicated and controversial issues relating to Ukrainian businesses, both in terms of law and practice. The involvement and abuse of administrative resources are rather common in this sector. At the same time, a reliable and smooth procedure of applying for VAT credit is an essential component of operations for companies whose ordinary business operations are subject to VAT. The Ukrainian legislation7 defines tax credit as the amount by which the taxpayer is entitled to decrease its tax liability for the reporting period. At the same time, under the general rule, the taxpayer becomes eligible for a tax credit if it meets all the requirements stipulated in the Law in this regard; for example, purchases goods and services for their subsequent use in its business operations, makes settlements and fills in a tax invoice supporting the fact of purchase of merchandise.

In this respect it should be pointed out that in some cases the Ukrainian tax authorities believe it is illegal for a company to apply for a tax credit where its supplier, from whom goods and services were acquired, effectively failed to transfer the amount of VAT charged by the supplier to the state budget. At the same time, the higher judicial authorities of Ukraine supported the taxpayers regarding this matter. In particular, this position was set forth in a ruling by the Higher Administrative Court of Ukraine dated April 4, 2006. With respect to this case, the courts found out that the amount of the company's tax credit had been supported by the tax invoice issued by the VAT taxpayer; the cost of the merchandise purchased had been deducted; and the amount of VAT was effectively paid by the plaintiff (as a part of the price of the merchandise purchased).

The "VAT Law" (the version effective as at the date when the company classified its VAT amount as a tax credit) stipulates two cases when the amount of VAT paid shall not be included in the tax credit of the reporting period:

• if the cost of goods purchased is not deducted;
• if VAT expenses are not supported by tax invoices.

However, the court found out that the tax invoice was prepared in accordance with the requirements of Ukrainian legislation. By the time the tax invoice was issued, the company's Contractor had been duly registered with the state tax authorities as a VAT taxpayer. Thus, the courts had correctly concluded that the amount of the company's tax credit had been calculated on the basis of the prepared tax invoice received from the registered VAT taxpayer, and that the cost of the merchandise purchased at a price inclusive of VAT, had been legally deducted.

The key point in the position of the Higher Administrative Court of Ukraine is that it did not take into consideration the statement of the tax authorities that the company failed to prove the fact that it had paid VAT to the state budget.

In accordance with the provisions of Article 67 of the Constitution of Ukraine, each person is responsible for the payment of taxes and duties according to the procedure and in the amounts prescribed by the Law. The legal order in Ukraine is based on the principles according to which no one shall be forced to do anything that is not envisaged in the legislation (part 1 of Article 19 of the Ukrainian Constitution).

The effective Ukrainian legislation, particularly, the "VAT Law", does not stipulate that the purchaser is obliged to pay VAT to the budget, when such tax was not paid by the seller. Under the provisions of the "VAT Law", the amount of value added tax included in the price of merchandise represents a tax liability for a seller of merchandise and it is the seller of the merchandise who is responsible for the payment of this tax to the budget. In the case in question, such responsibility had been effectively imposed by the tax authorities on the purchaser, which contradicts the requirements of the effective legislation.

Thus, the Higher Administrative Court of Ukraine has set an important precedent, according to which it is illegal for the tax authorities not to acknowledge the taxpayer's right to receive a tax credit only on the grounds that VAT paid by this taxpayer for merchandise purchased was not effectively transferred to the state budget by its supplier.