Fictitious subcontracting arrangements: suppliers’ tax irregularities are insufficient to disallow cost deductions

Abstract

Tax irregularities attributable to a subcontractor are not, in themselves, sufficient to establish that the underlying transactions did not take place or to justify the disallowance of the related costs and the denial of VAT deduction. This was clarified by the Lombardy Tax Court of Appeal in judgment no. 895/2026, in which it dismissed the Italian Revenue Agency’s appeal against a decision annulling a tax assessment concerning corporate income tax (IRES), regional tax on productive activities (IRAP) and VAT for the 2017 tax year.

The burden of proving the non-existence of transactions rests with the tax Administration

The dispute concerned a company operating in the construction sector whose entitlement to deduct costs incurred in connection with a subcontractor, as well as the related input VAT, had been challenged by the Italian Revenue Agency on the grounds that the transactions were either non-existent or insufficiently documented.

Unlike the Court of first instance, which had upheld the taxpayer’s appeal on the basis that the statutory time limit for issuing the assessment had expired, the appellate Court applied the principle of ragione più liquida (the principle whereby a dispute may be resolved on the most readily determinable ground). It therefore examined the substantive merits of the tax claim directly and upheld the judgment under appeal, albeit on different grounds.

The Court reaffirmed that, where transactions are alleged to be non-existent, the initial burden rests with the Tax Administration to produce sufficient evidence establishing that they were either objectively non-existent or subjectively non-existent, in the sense that they were not carried out by the person identified in the relevant invoices. Only once that burden has been discharged does the burden of adducing evidence to the contrary shift to the taxpayer.

In the case at hand, the assessment was based primarily on the supplier’s tax irregularities and the alleged inadequacy of the supporting documentation. By contrast, the company had produced subcontracting agreements, invoices, evidence of traceable payments and technical documentation relating to the construction sites, including operational safety plans and records concerning the personnel employed.

Taken together, these documents satisfied the Court that the services had actually been performed and were connected with the company’s business activities, thereby undermining the evidential weight of the presumptions relied upon by the Tax Administration.

Why suppliers’ irregularities are insufficient to justify the disallowance of costs

The principal significance of the judgment lies in the distinction between tax irregularities attributable to the subcontractor and evidence that the invoiced transactions did not actually take place.

According to the Lombardy Tax Court of Appeal, failures to comply with tax filing obligations, irregularities in the supplier’s tax conduct and insufficiently detailed invoices may constitute indicia of irregularity. However, when considered in isolation, they are insufficient to establish that transactions were fictitious where their actual performance is supported by documentary evidence.

The assessment must therefore be based on a comprehensive evaluation of the available evidence, rather than allowing breaches attributable to one party to result automatically in adverse tax consequences for the contracting company.

This approach is particularly significant in the construction sector, where subcontracting is a standard means of organising business operations. In this context, construction-site documentation, traceable payments and evidence linking the services performed to specific projects are essential in establishing that the transactions actually took place.

A distinction must nevertheless be drawn between the actual performance of the services and whether those services were provided by the entity that issued the invoices.

Documentation establishing that the works were carried out is decisive where the Tax Administration alleges that the transactions were objectively non-existent. By contrast, where the allegation concerns transactions that were subjectively non-existent, evidence relating to the contracting company’s awareness of, and possible involvement in, the fraud also becomes relevant.

Similarly, proof that costs were actually incurred does not automatically establish their connection with the taxpayer’s business activities. The latter requirement must be demonstrated through a specific link between the expenditure and the business.

The judgment recognised that both requirements had been satisfied on the basis of the documentation produced, although it did not examine the different legal scenarios in detail.

The Court did not attribute conclusive evidential value to contracts, invoices or payment records. Rather, it criticised an assessment essentially based on indicia that were insufficient to outweigh the documentary evidence submitted by the taxpayer.

The principle emerging from the judgment is therefore not that properly documented costs are automatically deductible, but that any challenge to their deductibility must be supported by concrete and specific evidence consistent with the nature of the transactions concerned.

The revenue agency’s change of position and the importance of administrative consistency

Arguably, the most significant aspect of the judgment concerns the Tax Administration’s change of position regarding the deductibility of the same costs.

The Court attached decisive importance to the fact that the Revenue Agency had accepted the deductibility of costs relating to the same supplier for the 2016 tax year and had expressed a similar view during the exchanges with the taxpayer concerning the 2017 assessment.

The subsequent disallowance of those costs, in the absence of new evidence or adequate reasons for departing from its earlier position, was considered inconsistent with the principles of administrative consistency and good administration.

Although the Tax Administration is not legally bound by assessments or conclusions reached in relation to previous tax periods, a change of position unsupported by new evidence or adequate reasoning may undermine the logical coherence, adequacy of reasoning and evidential basis of the tax claim.

The judgment thus recognises administrative consistency not as an absolute restriction on the exercise of the power to assess and collect taxes, but as a relevant criterion for evaluating whether a tax assessment is adequately substantiated and reasoned.

From a practical perspective, this makes it particularly important for taxpayers to retain not only documentation relating to the performance of subcontracted works, but also records of previous tax audits and communications exchanged with the Tax Administration during the administrative proceedings.

Any favourable findings or assessments previously made by the Revenue Agency may be relevant to the overall evidential picture, even though they do not provide the taxpayer with an automatic guarantee against subsequent challenges.

The judgment therefore offers a broader interpretative insight extending beyond the circumstances of the individual case: the lawfulness of a tax assessment depends not merely on the existence of indications of irregularity, but also on the Tax Administration’s ability to establish a coherent evidential and reasoning process in support of its claim.

From this perspective, allegations that transactions are fictitious must be supported by evidence specifically relating to the taxpayer’s circumstances. Irregularities attributable to the supplier, or an insufficiently justified change in the Tax Administration’s position, cannot, in themselves, constitute an adequate basis for recovering additional tax.