How to conduct due diligence on suppliers to prevent the tax authority from denying your VAT deduction

What the Supreme Administrative Court decided in August 2026 and why it also concerns VAT

In its judgment of August 20, 2026, Case No. 22 Afs 37/2026 (judgment on the SAC search engine), the Supreme Administrative Court dismissed a cassation complaint of a company whose expenses for services and goods from six declared suppliers were not recognized by the tax authorities. This concerned corporate income tax for 2018 and expenses under Section 24(1) of the Income Taxes Act under Czech legislation.

The court focused mainly on procedural objections and the burden of proof. Under the Czech Tax Code, the taxpayer must prove all facts they are required to state in their tax return; for income tax, this means proving not only the formal existence of accounting documents, but also the alignment of the actual state with the formal state (Section 92(3) of the Tax Code). If doubts arise regarding the execution of the supply, the company must substantiate the correctness of its assertion with further evidence.

For VAT, the judgment is significant because the court recalls earlier case law, according to which the entitlement to a tax deduction is not based on a formal document, but on the existence of a taxable supply. A company claiming a deduction must therefore be able to prove that it actually received the supply. Under Czech legislation, the VAT Act stipulates that a payer is entitled to a deduction for a received taxable supply used for economic activity and must possess a tax document (Sections 72 and 73 of the VAT Act).

The distinction is important. This specific judgment addresses income tax, so it cannot be claimed that the court decided on a VAT deduction in it. However, the underlying principle is the same for both taxes: a document is a starting point, not proof, and doubts are resolved by evidence of the actual supplier and the actual supply.

At the same time, the court showed how it assesses a defense based on trust. Good faith that the persons acting on behalf of the suppliers are authorized to do so does not, in itself, replace proof of the actual course of the alleged business transactions. A company will therefore not succeed by claiming it had no reason to suspect the supplier. It must have evidence showing who provided the supply, regardless of what it knew about the supplier.

What the tax authority examines and where companies most frequently fail

In the described case, the tax administrator had doubts about the credibility of the documents due to a number of circumstances: the suppliers were unreachable, had no employees or assets, the invoicing contained discrepancies, payments were made in cash, and the persons acting on behalf of the suppliers could not be identified. Individually, none of these may be decisive, but combined they create a picture that the company must refute.

Crucially, the persons registered as managing directors of the suppliers denied any knowledge of the company, the issuance of the documents, or the authenticity of the signatures. This cast doubt on the very documents the company used to support its claim. The court stated that the tax administrator did not require the company to prove the fulfillment of the suppliers' tax obligations or their internal affairs, but only to credibly substantiate its own claim regarding who provided the supply and to whom it was paid.

Companies often defend themselves by claiming they cannot be held responsible for the supplier and have no obligation to audit their accounting. The court did not accept this defense in this case. It distinguishes between what lies outside the customer's sphere of influence—i.e., the supplier's internal affairs—and what falls within it, namely proof of who they actually dealt with, what they received from them, and how they paid.

A similar pattern is seen in practice by any company working with many smaller suppliers. An order arrives by email from an unknown person, an invoice from a company registered at a virtual office address, and the payment goes to an unverified account. Under normal circumstances, nothing happens, but during an audit, it turns out that the company knows almost nothing about its supplier.

A cash payment is a particularly sensitive element. It does not in itself constitute a breach of the law, but it deprives the company of the easiest proof of where the money actually went. A bank transfer to the supplier's account leaves a trail that can be presented to the tax administrator, whereas cash is proven only by cash receipts and testimonies. A company paying in cash must document other elements of the transaction all the more carefully.

How to verify a supplier before the first order

The law itself defines the circumstances under which it is assumed that the customer knew, or should and could have known, about unpaid tax. This includes, for example, a supplier published as an unreliable taxpayer, a price without economic justification that is clearly deviant from the usual market price, payment to an account other than the supplier's published account, or a cash payment exceeding the legal limit (Section 109 of the VAT Act).

These circumstances also serve as a useful checklist. Before the first order, it is wise to verify whether the supplier is listed as an unreliable taxpayer, whether the bank account stated on the invoice is published by the tax administrator, whether the price corresponds to the market, and whether the payment will be made in cash. These checks take minutes and leave proof that the company acted with due diligence.

The second layer is verifying the identity of the supplier. This includes a commercial register extract showing who acts on behalf of the company, its registered office and business premises, whether it has employees or assets corresponding to the scope of the supply, and whether communication is actually possible. A supplier who does not answer the phone and whose registered office is a mere mailbox is a red flag that the company should note.

The third layer is recording the result. Verification that was never documented is difficult to prove during an audit. A brief record in the supplier's file is sufficient: when and by whom the verification was carried out, what was verified, and with what result. The record should be updated during larger orders or when the supplier's bank account or managing director changes.

What to keep during cooperation to prove the actual supply

Verification before ordering is not enough, as the tax authority will ask even years later who actually delivered what. In a related judgment on a VAT audit of advertising services, the court pointed out that where cooperation lacks a solid structure, it is necessary to choose a method of documentation that makes it possible to prove what was delivered and to what extent. According to the court, the impossibility of proof is to the detriment of the party claiming the deduction (Case No. 10 Afs 204/2025, judgment on the SAC search engine).

The recommended evidence file contains several basic elements. This includes a contract or order with a precise definition of the subject matter and scope, handover protocols, communication specifying the supply, photo documentation or work outputs, the names of specific persons who provided the supply, and proof of payment to the supplier's account. The court explicitly mentioned minutes of business meetings and consistent logging of services provided as solutions.

A practical example: for the supply of construction work, keeping the invoice and contract is not enough. It is wise to also keep the construction log, handover protocols of individual parts, progress photos, a list of workers on site, and proof of payment. For the supply of advisory services, it is worth keeping outputs, minutes of meetings, and communication showing who prepared what and when.

Special attention should be paid to individuals. In case of doubts, the tax authority will interview the supplier's managing directors and witnesses, and the company must be able to identify the persons who dealt with it. In judgment 22 Afs 37/2026, the court emphasized that anyone proposing a witness interview must identify them with sufficient certainty so that they are identifiable and the interview is feasible, as it is not the tax administrator's job to track down vaguely identified witnesses on their own.

Therefore, it is useful to maintain a list of contact names for each major supplier and a brief record of who from the company dealt with whom. Such a list takes just a few minutes of work and, during an audit, can determine whether the company can propose concrete evidence or is left with a general assertion.

What to do when a challenge from the tax administrator arrives

The first reaction must be specificity. In its judgment, the court repeatedly stressed that the taxpayer must specify evidentiary proposals already during the tax proceedings, i.e., state what they are intended to prove and how they relate to the decisive facts. Arguments added by the company only in the cassation complaint may not be considered by the court at all.

The second rule is to exercise the right to inspect the file in a timely manner. The court confirmed that the right to inspect the file must not be merely formal, but it cannot be inferred that the tax administrator is obliged to postpone issuing a decision until the participant exercises it. A company that proposed inspection dates weeks in advance, even though the end of the tax assessment period was approaching, failed to exercise its right, and the court found no unlawful denial of rights in the tax authorities' procedure.

The third rule is not to appeal to justice in general terms. If a company claims it was denied the right to a fair trial, it must describe what specific document it wanted to verify, what evidentiary proposals it wanted to submit, and how the decision would have changed if the alleged defect had not occurred. The court does not consider a mere claim of a procedural defect with no impact on the outcome to be sufficient.

The fourth rule is to prepare for challenges before they arrive. A company that maintains an evidence file for major suppliers can respond within days in cooperation with an advisor. A company that is only just compiling documents loses time and often credibility, as retroactively created documents carry less weight than those created during the cooperation.

How to address verification in the contract with the supplier

The contract can transfer part of the risk to the supplier and improve the customer's evidentiary position. It is wise to agree on the supplier's obligation to cooperate during a tax audit—i.e., to hand over documents, confirm the identity of persons, and enable verification of the supply. Furthermore, the obligation to notify changes in bank accounts, registered offices, or managing directors, and the customer's right to withhold payment if the supplier becomes an unreliable taxpayer.

It is also good to remember that you cannot demand from a supplier what is not in the contract. A company that wants to ensure the supplier cooperates during an audit must arrange this in advance, because once a dispute arises, there is no tool to compel the supplier to act if they do not wish to.

The contract should also specify the payment method. Payment only to the supplier's published account and a ban on cash payments exceeding the legal limit restrict the circumstances under which the law assumes knowledge of unpaid tax. Under Czech legislation, the customer also has the option to pay the tax for the supplier directly to their tax administrator using the statutory details; this is a special method of securing tax, which is suitable for high-risk transactions (Section 109a of the VAT Act).

Contractual arrangements do not replace proof of the actual supply, but they create a framework in which evidence is easier to gather. A company that drafts a contract for work or services with a view to a subsequent audit incurs higher initial costs but significantly lower risk during an audit. This is also related to how the burden of proof is generally distributed, which is discussed in our article on the burden of proof in a tax audit.

When preparing for a tax audit, it is also useful to know the general procedure described in our article on tax audits in 2026. A company that knows how an audit is conducted, the deadlines for responding, and its rights when inspecting the file can maintain its evidence file purposefully and will not lose time upon the first challenge.

As regards the boundary between the legitimate claim of a deduction and its questioning for abuse of rights, this is based on the case law described in our article on the SAC decision on the abuse of rights in VAT. This boundary is different from the question of proof of the actual supply, but both often meet during an audit.

A special situation is substantiating deductions for services that are difficult to describe, such as advertising and advisory services. There, companies often face the issue that the invoice does not state the scope of the supply, which is discussed in a separate article on substantiating VAT deductions for advertising and advisory services.

How exactly to set up supplier verification and the evidence file depends on how many suppliers the company has, the volume of payments, and how risky the sector is – which is why the Czech legal team at ARROWS law firm always assesses this based on the specific company, not using a universal template.

Risks of an unverified supplier

Final Summary

In August 2026, the Supreme Administrative Court confirmed that a formal document is not enough for a company and that, in case of doubt, it must prove who actually provided the supply and to whom it paid. The article showed that while the judgment concerns income tax, it is based on a principle also applicable to VAT deductions, that the law assumes knowledge of unpaid tax under certain circumstances, and that the evidence file maintained during the cooperation is decisive.

For company management, this implies a clear task: implement supplier verification before the first order and maintain an evidence file for every major supplier. Retroactively compiled documents carry less weight during an audit, and a company that knows nothing about its suppliers cannot claim to have acted with due diligence.

The Czech legal team at ARROWS law firm sets up supplier verifications, prepares evidence files, and represents companies during tax audits and appeal proceedings. Write to us at consultation@arws.cz or explore our tax advisory services.