Initiating Criminal Proceedings and Pending Tax Assessments

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In practice, there is a position that the criminal proceedings on tax evasion cannot be instituted until the underlying tax assessment becomes due (effective). The proponents of this position refer to para 56.22 of the Tax Code of Ukraine (before the enactment of the Tax Code of Ukraine, to para 5.2.6. of the Law of Ukraine "On the Procedure for Discharging Tax Liabilities to Budgets and State Special Purpose Funds"). According to these points of law in case of an appeal is filed against a tax assessment the tax evasion charges cannot be rested on such a tax assessments until the end of the appeal procedure, i.e. until the tax assessment becomes due (effective).

In my opinion, the position is more than questionable, especially given that:

1. Pursuant to the novelty incorporated into the Tax Code of Ukraine (para 58.4) a criminal investigation should precede the issuance of a tax assessment, and not vice versa;

2. The prohibition established by the specified legal provisions applies to tax evasion charges, not to the institution of a criminal case;

3. The above rules clearly prescribe that this prohibition does not extend to the cases where the tax evasion charges are not only bolstered by a tax assessment, but also by other evidence collected in accordance with criminal procedure law.

The court practice on the issue raised is not consistent. In most cases, the courts dealing with the complaints against the initiation of the criminal cases do not adhere to this position. They observe that the above prohibition covers tax evasion charges, rather than the institution of criminal cases. The decision of the Highest Specialized Court of Ukraine on Civil and Criminal Trials of 7 February 2012 in re Striy Plant Metalist, JSC* seems to be a classic example of such practice.

Nonetheless, some judges turn out to be the "apologists" of the given position, especially if at the time of the consideration of the complaint against the institution of criminal proceedings an administrative court has already canceled the relevant tax assessment. An example here is the decision of the Highest Specialized Court of Ukraine on Civil and Criminal Trials of 28 April 2011 in re Blits-Trade, Private Enterprise**.

*- http://reyestr.court.gov.ua/Review/21840417

**- http://reyestr.court.gov.ua/Review/15724973

Pseudonullity from Height of Eagle's Flight

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Several years have already passed by since the tax authorities embarked on their raid against null transactions or, to be more precise, against the transactions that, in their understanding, which is very difficult to share are null.

Usually, the "battlefield" is as follows. The tax authorities manage to find among the suppliers of a taxpayer some problem, in their view, entities (not available at their registration office, under liquidation, registered in the name of false persons, with no fixed assets, with the small number of employees, etc.). It is concluded that the execution of the supply contracts with such problem contractors has been leveled at attaining unlawful tax benefits (artificial input VAT deduction or expenses). The relevant agreements are rendered null. The tax authorities believe that these agreements violate public order as those directed at the misappropriation of the public property (tax revenues). As a consequence, the taxpayer loses the right to input VAT deduction and/ or expenses.

Typically, these battles find their final resolution in the administrative courts. If the taxpayer can vindicate the real (true) nature of the business transactions and his unawareness of the violations made by the suppliers, it is in principle a good chance for him to come out of the "battle" as a winner. More detailed information on the practice of resolving such disputes can be found in my posts of 15 March 2012, 9 September 2011 and 6 April 2011.

Nevertheless, sometimes there occur unfortunate exceptions when combating "pseudonullity” goes beyond the administrative proceedings by putting the taxpayer under the extremely heavy "tracks of the criminal proceedings tank."

It so happened to the unlucky directors of “VLATA Ltd”, LLC and "Vizavi ", LLC who were convicted in 2010 of para 2 of s. 367 of the Criminal Code of Ukraine (neglect of official duty) for declaring the input VAT deduction based on the  transactions with the problem (in opinion of the tax authorities) contractors. The guilty verdicts were delivered by Justice Anatoliy Orel (Ukrainian “orel” means “eagle” in English) of the Slavutych Court of Kyiv Region.* The verdicts were affirmed in 2011 by the Appellate Court of Kyiv Region. **

Failing to ascertain that there were any dummy (not linked with the real movement of goods and services) transactions involving "VLATA Ltd", LLC and "Vizavi", LLC, the court justified the charges in neglect of official duty  in a manner like this:

...the defendant had not inquired into the real existence of the suppliers, had not personally met their directors, had not checked the lawfulness of the origin of the goods supplied, had not verified the trustworthiness of the contracts and primary accounting documents, VAT invoices included, had not visited for this purpose the offices of the suppliers, had not determined the real identities of the contracting representatives of the suppliers, while he had been able to do so taking account of the information, experience, organizational and technical capacities available to him; instead, he had unreasonably limited his enquiry only to the verification of the suppliers’ VAT registration...

On a good note, the conviction of the directors of the taxpayers who has had the business relations with problem contractors is not a systematic phenomenon nowadays. However, it is better to be prepared for the worst. FOREWARNED IS FOREARMED.

*- http://reyestr.court.gov.ua/Review/13269815 and  http://reyestr.court.gov.ua/Review/12158044

**- http://reyestr.court.gov.ua/Review/17131346 and http://reyestr.court.gov.ua/Review/14961212.

Long-Term Contracts Taxation

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Project finance entails a number of issues requiring a response from a tax lawyer. This article deals with long-term contracts taxation.

Project finance always involves construction. Even if in the focus is not a new transnational gas pipeline or a power plant of unprecedented scale, but a modest 10,000 square meters  shopping centre in one of the regional (oblast)  centres of Ukraine, no one can dispense with the knowledge of long-term contracts taxation.

It should be borne in mind that the law provides a special taxation regime for long-term contracts (concluded for a term exceeding one year).  The special regime relates to both "heavyweights" of the Ukrainian taxation system – corporate income tax and VAT.

The special regime for the taxation of long-term contracts had also existed before the Tax Code of Ukraine came in force.  However, the present regime appears to be quite different from the previous one. In addition to technical distinctions relevant to the calculation of taxes, it should be noted that the special regime for the taxation of long-term contracts became obligatory. It is no more at the discretion of taxpayers to use it or to refrain from its use. 

First of all, it will be expedient to outline the coverage of the special taxation regime. The special regime extends to cases where the relevant contract (i) provides for producing goods, performing works or rending services within a long-term (more than one year) technological cycle and (ii) does not provide for their interim (stage by stage) acceptance by the customer (paras 137.3 and 187.9 of the Tax Code of Ukraine).

In the "realm" of corporate income tax, the special regime affects a taxpayer-contractor (as regards project finance – the contractor being in charge of the construction project) only. The transactions on the part of the customer (real estate developer) are taxable under general rules.

The special taxation regime seems to be nothing, but the government’s care about its tax revenues during the discharge of long-term contracts. Had not this special procedure subsisted, the accrual method would have been applied and the income corporate tax would not have fallen due until the handling over of the result of the works to the customer. Just this very event triggers the recognition of income by the taxpayer-contractor (para 137.1 of the Tax Code of Ukraine).

The special taxation regime is an exception from the accrual method. The taxpayer being the contractor under a long-term contract must show income in each tax period (quarter) notwithstanding that the results of the works are not yet passed to the customer (developer). The income is to be computed according to the degree of the completion of the works, which is determined (i) by the ratio of the expenses incurred in the tax period to the total expected amount of such expenses and/or (ii) by the ratio of the services rendered in the tax period to the total expected volume of such services. Since the latter mechanism of calculating income is regarded with service provision contracts, it is unlikely to be extended to construction works. 

As for the expenses, the taxpayer-contractor is allowed to deduct expenses associated with the performance of the works under the long-term contract concurrently with the recognition of the above income.

Upon the results of the works are transferred to the customer, the contractor makes adjustments to his income. If the actually received income exceeds the amount of the income accrued in each preceding tax period concerned, the surplus is attributable to the income of the ongoing tax period. If, on the contrary, the actually received income is less than the amount of the previously accrued income, the deficiency reduces the income of the current tax period.

The "realm" of VAT also faces an exception. The special taxation regime for long-term contracts lays such contracts outside the well-known rule of "first event". Input VAT/output VAT arises at the date of transferring the results of the works under a long-term contract. This special regime seems to be favourable for the contractor, as it allows him to adjourn the recognition of the output VAT to the final stage of the performance of the contracts. However, when it comes to the customer (developer), things turn out to be the opposite. The customer appears to be placed in an extremely disadvantageous position. Despite the advance payments made by the customer in favour of the contractor, the former is not able to qualify for the input VAT deduction for a long period of time.

It is difficult to figure out what purpose the government pursued while putting long-terms contracts beyond the operation of the “first event” rule. Perhaps, by doing so it intended to protect the state budget from VAT refund claims of the customers (real estate developers). Had the "first event" rule been in effect, such customers would have been able to claim VAT refund out of the input VAT accumulated in the course of the construction (the advances paid to the contractor under long-term contracts). Albeit our system of the VAT administration diminishes the chances of getting the VAT refund in this situation almost up to the minimum, the government decided to save itself once again.

Apparently, the special taxation regime for long-term contracts is not the thing that taxpayers can undoubtedly benefit from. Sometimes it makes sense to frame a contract to the effect that it will not be treated as long-term one for tax purposes (say, to incorporate the interim (stage by stage) acceptance of the works into the contract).