Informal relationship

The analysis of business transactions, in which the counterparty is defined as risky one, shall be made by the fiscal authorities not formally, but transactions of the kind shall be assessed individually.

Freedom of entrepreneurial business is declared and guaranteed in Ukraine.  This freedom includes both the right of a citizen to engage in any unprohibited types of economic activity, and the right to choose at ones discretion the form of implementation of this activity, as well as trading partners.

Everything is admirably clear as regards the first two paragraphs of this definition. As one of the judges of the Supreme Court of Ukraine once said: “There exist no forbidden types of economic activities, whereas there are permitted activities. Certain actions can only be prohibited – the types of any activities that have the characteristics of business”. With regard to forms of economic activity implementing, all seems so easy – they are clearly regulated by law.

Prudence is required

As regards the third point – the choice of trading partners, everything here is much more complicated than it seems at first glance.

To a certain extent, the tax authorities, having secured the backing of the judicial system, establish prudential requirements when choosing counterparties, that is to say, trading partners.

If during the risk assessment, the automated tax service control systems determine your trading partner as a risky one, no matter how much do you refer to the principle of tax payer’s individual responsibility, the service will draw conclusions that will be profitable only for itself, and this will almost always result for you in additional liabilities.

In my viewpoint, the arguments of the tax authorities remain particularly remarkable, namely if the officers of any of your trading partners are involved in a sentence of a criminal case, according to which these persons are found guilty of committing a crime under article 205 of the Criminal code (CC) of Ukraine (fictitious entrepreneurship), this fact gives reason to automatically recognize all your transactions, which were conducted with this trading partner, as “unreal”, that is to say, those that were performed exclusively on paper, without actual movement of goods or services.

This conclusion in its turn allows the tax authorities to credit additionally monetary liabilities under the profit tax of the enterprises, manifesting unfounded adjustment of the financial result subject to taxation on the amount of such “unreal” transactions, and credit additionally value added tax, if transactions were subject to VAT and amounts of these transactions participated in the generating of tax credit on VAT.

That fact sounds interesting – seeing that EGRR often arrives at a verdict against the officials of the contractor of the entity being audited, the tax inspector doesn’t even check actual movement of goods and funds on the above-said transactions, and just makes the extract from this sentence in the tax audit report and conclusion – all economic transactions with the same trading partner sound fictitious.

Judicial practice

Having received such a tax audit act, and later a tax notice-decision for a significant amount, sometimes also with penalties, a prudent businessman seeks protection in the law court, since an administrative appeal of such decisions almost never ends effectively.

However, filing a lawsuit with the court, even if all the necessary primary documentation, detailed explanations and a description of the movement of goods, services and cash charts are provided, does not always lead to the entrepreneur receiving a positive court decision.

The point being, as always, in judicial practice, which is currently being shaped by the Supreme Court, and is active, and nearly always can be said, used by the courts of the first and appeal instances as a justification for a certain viewpoint, sometimes not always objective one.

At the moment there are completely opposite viewpoints of Supreme Court judges regarding the necessity of a full and comprehensive investigation of proofs of the implementation to a business transaction with the counterparty to be real, in respect of officers who are involved in a sentence in a criminal case under article 205 of the criminal code of Ukraine.

The first viewpoint is that the fact of a verdict existing in criminal proceedings against officials of a counterparty enterprise is not an automatic basis for considering all transactions conducted with such a counterparty to be “unrealistic”, that is to say, fictitious one.   The judges talk about the need to check all the components of a business transaction in this case, and check each installed tax violation and the impact of this violation on the consequences of specific business transactions. In this case, evidence obtained within the scope of criminal proceedings, shall be taken into account by the administrative courts, but only in conjunction with other evidence collected with regard for the case, and shall not be regarded as prevalent force for the court.

Another viewpoint, that some judges of the Supreme Court adhere to, is that in case there exists a verdict that  establishes – a person has been found guilty of an offense under Article 205 of the Criminal Code of Ukraine, namely – creation or acquisition of an enterprise with a view to conceal illegal activities, all transactions  conducted with this enterprise sound “unrealistic” and all the primary documentation signed by persons, in respect of which there exists a court verdict, also sounds not a proper confirmation of the existence of a business transaction.

It turns out that the success of the claim in cases of the kind often depends on the above-said viewpoints closer to the judge hearing your case.

Lawyers of the tax service will always refer only to the judicial practice of the “second viewpoint”.  And it doesn’t matter whether in such a sentence the investigation of business transactions with your company or your client’s company was made, what exactly is the qualification of a criminal offense under article 205 of the Criminal Code of Ukraine, the viewpoint on the unreality of business transactions is unchanged. It’ll be unchanged even if other transactions, for example, the ones involving transportation of goods that your company “allegedly did not purchase from a fictitious trading partner”, will be recognized by the same inspectors as real.

A formal approach

It shall also be borne in mind, that the crime provided by part 1 of article 205 of the Criminal Code of Ukraine, sounds a crime with a formal composition. It is completed from the moment of creation or acquisition of an economic entity subject to the existence of a specific intent. For sentencing by this competency it is enough to prove the existence of intent at the time of creation/acquisition of an enterprise.     And when you consider that most of verdicts of guilty under article 205 of the Criminal Code are based on confessions of guilt, and punishment is just fine for a small amount, there exist risks of imposition of sentence without a full investigation of specified unlawful activity, and sometimes no investigation is made at all. The question arises, what the facts and established circumstances, then, will the tax authorities refer to during inspections, using similar sentences.

However, practice suggests that the persons against whom sentences are imposed under article 205 of the  Criminal Code of Ukraine, can enter into legitimate transactions with enterprises of the real sector of the economy and lead a completely legal activity in parallel with carrying out illegal activities, with the aim of putting legitimate activities into semblance.

In this case, the formal approach of the tax service and the judicial system to the analysis of such business transactions deprives prudent tax payers of all civil remedies, it remains only to constantly monitor the status of their counterparties and demand more and more proof of their good faith.  As practice shows, although, these means do not give absolute guarantees.

In its turn, such an approach sounds a violation of the principles of legal certainty and good governance, which was repeatedly mentioned in the decisions of the European court of human rights. After all, state agencies are charged with the obligation of establishing the proper legal procedures by which taxpayers will be able not only to foresee the negative consequences before taking certain actions in the sphere of economic activities, but they are not required to bear an excessive tax burden due to improper establishing such legal procedures by the state.

Oleg ZHERYOBKIN – the lawyer of Dynasty Law Firm

Publications 22 August, 2019

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