Fictitious Invoicing and Abusive Exercise of Rights

In economic life, situations increasingly arise where an apparently routine tax audit escalates into suspicion of budgetary fraud, triggering criminal proceedings. Often, it is sufficient for the National Tax and Customs Administration (NTCA) to obtain information during a compliance review that lays the groundwork for a subsequent criminal case, without notifying the targeted individuals of the suspicion. The classic procedure is also common: a comprehensive tax audit uncovers evidence leading to proceedings against “unknown perpetrators,” which later target specific individuals or companies.

This article aims to provide a comprehensive overview of the jurisprudence established by the Kúria—particularly regarding fictitious invoicing and abusive exercise of rights—addressing how courts evaluate the legitimacy of exercising the right to tax deduction and where the line is drawn between civil law disputes and criminal liability. Additionally, it highlights how a professional law firm, such as Molnár & Márk, can assist clients during tax audits and related legal disputes.

Fictitious Invoicing – Definition and Consequences

Judicial practice categorizes cases of fictitious invoicing into several factual groups. The 5/2016 (IX.26.) KMK Opinion identifies three typical scenarios frequently encountered by tax authorities:

• The Economic Event in the Invoice Did Not Occur
  In this case, there is no genuine sale of goods or provision of services behind the invoice; it is issued solely “on paper” in a fraudulent or abusive manner to enable VAT deduction. The subjective awareness of the invoice issuer and recipient typically aligns: both are participants in the fraud.

  “The parties named in the invoice are aware of the absence of the economic event, and their subjective awareness encompasses its fictitious nature.” (5/2016 KMK Opinion)

• The Sale of Goods or Provision of Services Occurred, but Not by the Invoice Issuer
  Here, the company seeks to deduct VAT related to a real economic event, but the invoice issuer is not the actual supplier. The invoice recipient often claims to have been misled, believing in good faith that the issuer was the seller or service provider. The tax authority focuses on examining the recipient’s awareness, proving that they knew or should have known that the underlying economic event involved a different party than the one named on the invoice.

• The Parties Named in the Invoice Performed the Transaction, but Fraudulent Conduct Exists
  In this scenario, the formal conditions—performance and the identity of the invoice issuer—are met, but either the issuer or another participant in the supply chain commits tax fraud (e.g., concealing tax obligations, maintaining false records, etc.). The key question is whether the invoice recipient knew or should have known they were part of a tax evasion scheme.

Invoice Cancellation in Cases of Fictitious Transactions

Under earlier—often contested—judicial practice, if an invoice was proven to relate to a non-existent transaction, cancellation was frequently rejected on the grounds that a fictitious invoice cannot produce legal effects. However, the Kúria ruled in a specific case that if the conditions under Section 55(2) of the VAT Act are met and the invoice correction complies with legal requirements, cancellation cannot be denied solely because the invoice was issued in the context of a fictitious transaction.
According to the decision:

“…if the conditions regulated in Section 55(2) of the VAT Act are fulfilled, a duly executed invoice correction is lawful and cannot be denied on the grounds that the invoice was issued in the context of a fictitious transaction, as the law contains no such restriction.”

Nevertheless, invoice cancellation must reflect a genuine legal transaction: the parties must indicate the prior error or deception, or the authorities may presume the correction is merely intended to conceal the abuse.

Abusive Exercise of Rights – Case Law and Regulation

The concept of abusive exercise of rights in tax proceedings primarily relates to Section 2(1) of the Tax Administration Act (Art.) and EU legal principles (Halifax Doctrine). The Kúria, for instance, in Decision No. Kfv.I.35.028/2018/7, thoroughly analyzed when an economic event qualifies as “abusive” or “contrary to purpose”:

“Section 2(1) of the Art. generally defines abusive exercise of rights but does not provide a precise delineation of what conduct constitutes it or under what circumstances it can be established, leaving it to the legal practitioner to determine based on an evaluation of the relevant facts of the specific case.”

The Court of Justice of the European Union established the three-step test in the Halifax Case (C-255/02), which Hungarian authorities and courts have adopted. Abusive exercise of rights occurs when:

• The formal conditions of national or EU tax law are met, but the transaction lacks a genuine economic purpose (economic substance).
• The primary aim of the transactions is to secure a significant tax advantage (e.g., non-payment of VAT while deducting it, fictitious cost accounting, etc.).
• The obtained tax advantage conflicts with the objectives of the VAT system or national regulations (i.e., it circumvents or undermines the essence of the legal provisions).

If any of these conditions is absent, abusive practice or exercise of rights cannot be established. In practice, authorities typically examine whether the business bore real economic risk, achieved genuine profit, and to what extent the transaction served solely to reduce tax liability.

What Constitutes a Tax Advantage?

In the same decision, the Kúria explained that a tax advantage typically arises when one party—e.g., the invoice recipient—deducts or reclaims VAT while the issuer or an earlier participant fails to remit it to the state treasury. This asymmetry causes budgetary loss, which may justify findings of budgetary fraud or abusive exercise of rights.

Right to Tax Deduction – Judicial Practice and Conditions

The right to tax deduction is a cornerstone of the modern VAT system, allowing businesses to deduct input VAT paid on purchases if invoiced by a taxable person and tied to a genuine economic event. However, this right applies only if the taxpayer does not knowingly participate in tax evasion and the actual performance is verifiable.

Judicial practice assesses this in two main areas:

• Occurrence of the Economic Event: Whether a purchase of goods or provision of services actually took place, and whether the product was integrated into the business’s activities.
• Awareness of the Invoice Issuer and Recipient: The extent to which they were aware that other suppliers or subcontractors might be behind the invoices, or that the actual performer concealed tax payments.

If the invoice recipient actively contributed to a fraudulent scheme, the tax authority’s denial of the deduction right is undisputed. The same applies to passive conduct if circumstances clearly indicate the taxpayer knew or should have known of the fraud.

Standardized Elements for Denying the Right to Tax Deduction

Tax authority decisions often cite the presence of “standardized circumstances” in large numbers, including:

• Lack of economic rationality (e.g., the service is unrealistically expensive or cheap compared to market prices).
• Absence of real risk (the invoice recipient bore no risk, and the process was uncontrollable).
• Low profit margins or indicators of tax minimization.
• Reverse payment flows (cash movements, with sums potentially returning to the buyer).
• Personal interconnections (relationships such as relatives, business partners, or “frontmen” among transaction parties).
• Lack of personnel or material conditions for performance.
• Disappearing or “unverifiable” companies in the chain (e.g., using registered office providers or unknown representatives).
• Missing or questionable documentation.
• Transactions between non-independent parties (entities within the same interest group invoicing each other).

According to the tax authority, a single circumstance may not suffice to deny the deduction right, but a combination of many supports such a decision. This practice was shaped by earlier Kúria rulings, though we note that recent jurisprudence, influenced by CJEU decisions, has superseded it. The tax authority can no longer deny the invoice recipient’s deduction right based solely on this practice.

KMK Opinion – Legal Foundations of Fictitious Invoicing

The 5/2016 (IX.26.) KMK Opinion is a key professional guideline, developed by the Kúria to standardize judicial practice on fictitious invoicing. The opinion:

• Clarifies the various types of fictitious invoices.
• Emphasizes the significance of the invoice recipient’s awareness (knew or should have known).
• Summarizes the conditions for the right to tax deduction (actual occurrence of the economic event and identity of the invoice issuer).
• Addresses the interplay between unauthorized VAT deduction and abusive exercise of rights.

The KMK Opinion also confirms that CJEU decisions (e.g., Mahagében, Dávid, Halifax) remain authoritative in assessing restrictions on tax deductions. If the recipient acted in good faith and the performance occurred, VAT deduction cannot be denied on purely formal grounds.

Carousel Fraud – Chain Transactions and Legal Consequences

Carousel fraud is a specialized, multi-party form of fictitious invoicing. It involves a product (or service) passing through multiple companies—often across borders—in a short time, with VAT payment omitted at some point in the chain while other participants claim tax benefits or deductions. The resulting “tax shortfall” is often borne by a good-faith business unaware of the fraud or by the state budget.

In such transactions or chains (carousel schemes), at least one active tax evader is typically involved, unless the scheme was orchestrated by a background actor who did not appear as a contracting party.

Carousel fraud not only justifies denying the right to tax deduction but may also entail criminal consequences, particularly if investigations establish intentional participation in tax evasion. Comprehensive tax audits and related investigations often jointly uncover the true ownership structures and financial flows of companies in the chain.

How Can the Molnár & Márk Law Association Assist?

Expert support is critical in ntcaigating tax structures and investigations conducted by the NTCA. The Molnár & Márk Law Association offers assistance in the following areas, among others:

Tax Law Advice

• Assisting businesses in properly exercising their right to tax deduction.
• Ntcaigating strictly regulated VAT obligations.
• Identifying risks of fictitious invoicing and developing preventive measures.

Legal Representation in Tax Audits

• Preparing for tax authority audits and organizing documentation.
• Advocating for clients’ interests during proceedings, including maximizing remedies (comments, appeals, judicial review).

Representation in Litigious and Non-Litigious Proceedings

• Providing expert defense in judicial proceedings, with particular attention to abusive exercise of rights and domestic judicial practice based on the KMK Opinion.
• Participating in civil litigation, such as when fictitious invoicing arises in contractual disputes.

Criminal Law Defense

• Offering comprehensive criminal defense if a tax audit escalates into a criminal case (e.g., suspicion of budgetary fraud).
• Providing expert legal advice on liability issues in carousel fraud or other chain transactions.

Review of Contractual Structures

• Conducting thorough audits to ensure contractual arrangements comply with applicable laws.
• Minimizing risks, including in international transactions.

Additional Services of Molnár & Márk Include:

• Tax and Financial Law: Assistance in complying with tax rules and interpreting legal obligations correctly.
• Corporate Law: Handling company law matters, amendments, restructurings, and drafting agreements.
• Labor Law: Comprehensive advice on employment contracts and internal regulations.
• Debt Management: Conducting litigious and non-litigious proceedings, enforcements, and settlement negotiations.

These areas often involve tax-related issues, underscoring the need for comprehensive, practical legal support in complex tax matters that may carry criminal risks.

Conclusion

Domestic and EU legal practice rigorously address fictitious invoicing, abusive exercise of rights, and carousel fraud. The right to tax deduction is assured only if the economic event’s substance complies with regulations and the invoice recipient neither knew nor should have known of tax fraud or abuse in the supply chain. The KMK Opinion and Kúria jurisprudence establish numerous criteria to assist tax authorities, courts, and businesses in managing disputes effectively.

The Molnár & Márk Law Association leverages its extensive experience and deep legal expertise to support clients in prevention, preparation for tax audits, and representation in tax authority or judicial proceedings. Expert assistance can reduce or eliminate significant financial burdens and the risk of severe criminal consequences.

If you have any questions regarding the above topics, please feel free to contact the Molnár & Márk Law Association with confidence.