This seems logical to treat the doctrine of business purpose and the doctrine of due care and caution as two
of the most important anti-avoidance tools in Ukraine developed by the court
practice in recent years.
This article will talk about the
doctrine of due care and caution. Unlike the doctrine of business purpose, this
doctrine has not become part of the Tax Code of Ukraine yet. Nevertheless, this
fact does not significantly diminish its high importance for tax litigation.
The
Essence of the Doctrine
The doctrine applies to cases
related to the recognition of VAT input/deductible expenses by a taxpayer who
purchases goods (services) from problem (in terms of taxation) suppliers,
including their counterparties in the chain of supply.
The doctrine provides the answer to
the question whether such a taxpayer-purchaser should be held liable by depriving
of his VAT input and deductible expenses in connection with the tax abuses
committed by his suppliers or their counterparties.
The answer is as follows: the
taxpayer-purchaser should not be held liable only if he showed due care and caution
and he was not aware of the abuses of his counterparties.
To prove the familiarity of the
taxpayer-purchaser with the abuses of his suppliers the reference can be made,
for instance, to the following circumstances:
- the orientation of the taxpayer-buyer
or his affiliates to the transactions predominantly involving counterparties breaching
their tax liabilities, particularly in the case the transactions are entered
into through intermediaries in the presence of direct contacts with
manufacturers;
- the dealing of the
taxpayer-purchaser with the supplier in one market segment where there are the
stable relationships and all the participants are aware of the nature and the
real intentions of each other in carrying out business transactions.
Starting
Point
The first widely known mention of
the doctrine of due care and caution occurred on 12 February 2008. This was the
date of the resolution of the Administrative Chamber of the Supreme Court of
Ukraine in case No 08/28brought by
"Metpromservis", LLC against the State Tax Inspection in
Shevchenkivskiy District of the city of Zaporizhia.
In this case the Supreme Court of
Ukraine found for the local State Tax Inspection, cancelled the ruling of the
Highest Administrative Court of Ukraine
(issued in favor of the taxpayer) and
remand the case to the court of first instance for new consideration.
Overriding the ruling of the Highest
Administrative Court of Ukraine, the Supreme Court of Ukraine made the
following interesting conclusions:
-
"... the violation of the tax liabilities by the suppliers of a purchaser
may constitute the grounds for denying such a purchaser’s entitlement to tax
benefit - VAT refund from the state budget if the tax authorities establish
that the taxpayer (purchaser) acted without due care and caution and he had to
be aware of the breaches committed by his suppliers ... ";
-
"Satisfying the claim the courts only referred to the availability of the
VAT invoices issued by the suppliers. They did not take into account the fact
that the claimant had been acquiring raw materials, particularly scrap metal,
for a long time from intermediaries who regularly did not pay taxes, whose
activities were of fake nature, who did not reside at their registered offices,
did not file tax returns or filed “zero” ones, whose registered owners (shareholders) and
officers did not acknowledge their
involvement in their activities, and that the claimant, his suppliers and contractors
had been trading in the same market segment in which there was the stable
relationships and all the participants were knowledgeable about each
other".
Borrowing
from Northern Neighbor
The doctrine of due care and caution
exists in the Russian
Federation as well. One would like to
believe that the Russians have borrowed it from us, but, unfortunately, things
are quite the contrary.
In Russia,
this doctrine has been actively used since October 2006 (the Resolution of the
Supreme Arbitration Court of the Russian Federation dated 12
October 2006 No 53). In Ukraine
the doctrine has found its operation only since February 2008 (the above-cited
decision of the Supreme Court of Ukraine of 12 February 2008).
Doctrine
and Practice of the European Court of Human Rights
It is worth noting that the issue of
the liability of the taxpayer-purchaser for the tax abuses of his suppliers also
finds its solution in the practice of the European Court of Human Rights, which
is mandatory for the use in Ukraine.
In the case of "Bulves" AD
v Bulgaria (para 71 of the judgment
dated 22 January 2009) the European Court of Human Rights took view that does
not fall foul of the doctrine of due care and caution: the VAT payer should not
be held liable for the abuses committed by his suppliers, if he does not have
knowledge of those abuses or the means to obtain such knowledge.
What
should taxpayers do?
In view of the operation of the
doctrine, it is advisable for good faith taxpayers to create evidence
confirming the expression of due care and caution when choosing the suppliers.
The smallest, but very necessary and
important thing that every taxpayer should do before entering into any supply
contract is to check his suppliers with regard to their tax “integrity” through
the electronic databases available on the official website of the State Tax Service of Ukraine. Those databases encompass: the Database of VAT Payers, the
Database of Cancelled VAT Payers Certificates, the Database of “ Non Bona Fide”
VAT Payers, and the Database of the Places of Mass Registration of Taxpayers.
Everything else depends on the
resources and imagination of the taxpayer. One can, for example, ask the
certified copies of the supplier’s registration documents, the copy of the
passport of the signatory of the supply contract, the letter specifying the
number of the supplier’s personnel, the availability of the fixed assets, the
size of his warehouse and office space, his actual location, etc. In other
words, the idea is to gather as much as possible information attesting real,
not fake nature of the supplier’s business.
The documents collected in the
course of the inquiry, including the screenshots made while running
the suppliers through the State Tax Service of Ukraine’s electronic databases
should be kept in electronic and /or hard form taking account that a dispute
with the tax authorities may arise.
The ideal decision seems to be the
adoption of internal regulation (policy) governing the examination of the
suppliers with reference to their tax “reliability” embracing the list of
responsible employees, examination procedures, documents storage procedures and
so on.
In
Lieu of Conclusion
Apparently, the implementation of
the doctrine of due care and caution has loaded taxpayers at least those of
them concerned with minimizing their tax risks with a great deal of new work
related to the need to check the tax "integrity" of the suppliers.
However, it is difficult to view this doctrine as something out of the
ordinary. The doctrine appears to be in
line with the practice of the European Court of Human Rights and offers
more or less a fair balance between public and private interests in the fight
against tax evasion.
The main problem today is the vague criteria of due
care and caution resulting in the
material risks for taxpayers. Hopefully,
this gap will be filled in the future by the clarification of the Highest
Administrative Court of Ukraine.
