BFH: Confiscated proceeds must no longer be subject to VAT

The case

A salaried engineer in charge of awarding construction contracts accepted bribes from the contractors. The tax office took the view that the bribes were remuneration for services provided by the engineer to the contractors and were subject to VAT. During the appeal, the engineer was sentenced to prison for commercial bribery and tax evasion. The court also ordered the confiscation of the bribes, which the engineer had paid into the court's coffers. He claimed that this had reduced the tax base of his services. The tax office and the tax court disagreed.

The ruling

The BFH first considered whether the bribes were subject to VAT at all. According to Section 41 of the General Fiscal Code (Abgabenordnung), it is irrelevant whether an activity violates a legal prohibition or offends common decency. The German legislator thus opted for value-neutral taxation. The European Court of Justice (ECJ), on the other hand, considers illegal transactions to be non-taxable under certain circumstances. However, this only applies to situations where the specific characteristics of the goods or services exclude any competition between a legal and an illegal economic sector, e.g. drug trafficking. The bribes in this case, however, concern an economic sector which is legal in itself; there is competition between the legal and illegal sectors when it comes to awarding contracts. The engineer had therefore provided a VAT-taxable service consisting of the provision of advantages in the procurement process.

As far as the taxable amount is concerned, the sums collected constitute “levies” within the meaning of Art. 78 of the VAT Directive and therefore form part of the tax base. However, the reduction of the tax base is required by EU and German constitutional law; the perpetrator must not be burdened twice, by both confiscation and taxation. This would also violate the neutrality of VAT. The Fiscal Court’s assumption – that the reduction of the tax base only applies if the recipient of the service has recovered his remuneration – is incorrect. This can already be deduced from sentence 3 of the German provision Section 17 UStG (VAT Act) (which explicitly takes into account the case where a third party is favoured by the change in the tax base – author’s note).

The wider legal context

Illegal transactions are of course not advisable per se. However, it is correct for the state not to tax fees that it has confiscated.