Tax Evasion: Its Majesty Intention

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One of the key issues surrounding the qualification of tax crimes is an issue of intention. Intention (mens rea) is the attribute of tax evasion (s. 212 of the Criminal Code of Ukraine). If the tax has not been paid without the intention to do so, there is no criminal liability under s.212 of the Tax Code of Ukraine. However, given the existing practice the person who has failed to pay tax unintentionally (for instance, due to the poor knowledge of tax laws or their incorrect application) may incur criminal responsibility under s. 367 of the Tax Code of Ukraine (neglect of official duty).

There naturally arises a question as to how to determine that an intention aimed at tax evasion is in place? Undoubtedly, the main guidance here is para 3 of the Resolution of the Plenum of the Supreme Court of Ukraine dated 8 October 2004 No  15 "On Some Issues of Application of Tax Evasion Legislation" (hereinafter - "Resolution No 15"). This paragraph comprises  the non-exhaustive list of circumstances that may indicate the intention aimed at tax evasion, including:

• the absence of tax accounting records or keeping them at variance with the established procedure;

• distortions in accounting or reporting records;

• failure to register cash received for services rendered;

• maintaining dual (official and unofficial) accounting;

• the use of bank accounts not disclosed to the tax authorities;

• overstated cost of sales.

This very list is cited at almost all conferences, seminars and similar events dedicated to

tax evasion matters.

Unfortunately, the aforesaid circumstances are not formulated clearly enough to be safe in saying that there has been/has not been the intention aimed at tax evasion in a particular situation. I decided to try to go beyond the list and look at "live" criminal cases from the Unified State Register of Judgments.

Some examples from this register are outlined below.

No	Case	Court	Circumstances indicating the intention directed at tax evasion
1	In re Vinspetsodyag, 2010, http://reyestr.court.gov.ua/Review/7889655	Zamostyanskiy District Court of Vinnytsia	To substantiate the intention aimed at tax evasion, the court, namely, referred to the following circumstances from the Resolution No 15: (i) the keeping of tax accounting record in defiance of the established procedure; (ii) distortions in accounting and reporting records. In the court’s opinion, the tax accounting violations were evidenced by the declaration of deductable expenses/input VAT deduction related to the transactions with fictitious companies. The distortions in the accounting/reporting documentation, according to the court, were confirmed by the expert report pursuant to which the accounting was conducted improperly (confusions in line numbers and irregularities in the cash book).
2	In re Oris, 2009 , http://reyestr.court.gov.ua/Review/7499249	Chornuhynskiy District Court of  Poltava Region	The director’s failure to file annual corporate income tax return as well as three monthly VAT returns was regarded as an indicative of an intention leveled at tax evasion.
3	In re one private entreproneur, 2011, http://reyestr.court.gov.ua/Review/15414299	Andrushivskiy District Court of Zhytomyr Region	The private entrepreneur exceeded the revenue threshold allowed for the simplified system of taxation and failed to shift to the general system of taxation.

As you can see, even the rather modest sampling features how inventive courts and prosecuting authorities can be while deciding on the presence of the intention aimed at tax evasion.

Criminal Liability for Declared but Non-Discharged Tax

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In practice, there is a question whether the criminal charges can be brought against a company’s officers who have declared tax but have failed to remit it to the budget within the prescribed term.

It appears that the Unified State Register of Court Decisions (an “inexhaustible source of knowledge” to a certain extent) is able to provide an answer even to this question.

Let me look at two analogous cases from the register. These are In re Mirgorod Kombinat Khliboproductiv № 1 (http://reyestr.court.gov.ua/Review/20486739) and In re Tsukrovyi Zavod Maharynetskyi (http://reyestr.court.gov.ua/Review/9105838). The cases were resolved in 2011 by the general courts of first instance.

In the given cases directors were convicted because of the failure to discharge the declared tax liabilities on personal income tax and unified social contribution (pension contribution) in the presence of the financial ability to do so. 

The conduct of the Director of Mirgorod Kombinat Khliboproductiv was classified as neglect of official duty (s. 367 of the Criminal Code of Ukraine), while the conduct of the director of Tsukrovyi Zavod Maharynetskyi was classified as tax evasion/unified social contribution evasion (sections 212 and 212-1 of the Criminal Code of Ukraine).

Can this approach be extended to other taxes and contributions? For example, may the director who has declared corporate income tax due but has not paid it in time be exposed to criminal conviction?

It seems that the answer is rather ‘yes’ than ‘no’. Even though there is no priority for paying corporate income tax liabilities over any other liabilities at law, the prosecuting authorities can identify a crime in the conduct of the director remitting an amount “X” available at the company’s account not to the state budget, but to the supplier providing raw materials needed for the continuation of the company’s business.

In the above cases, the judges did not apparently burden themselves with considering the matter of priority/non-priority of certain payments. If they had opined that the criminal responsibility for the declared but not paid tax is only possible insofar as the legislation lays down the priority of the payment of such tax to the budget over making other payments, the directors of these companies would have been convicted only for the failure to remit unified social contribution (pension contribution), and would not have been convicted for the failure to discharge personal income tax.

Currently, the law sets forth the priority of discharging unified social contribution (pension contribution)*, but does not provide such a priority for personal income tax.

* - para 12 of s. 9 of the Law of Ukraine "On the Collection and Accounting of Unified State Social Contribution" and para 12 of s. 20 of the Law of Ukraine "On Compulsory State Pension Insurance".

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.

Draft law No 9221 "On Humanization of Liability for Economic Offences"

On 6 October 2011, the Ukrainian Parliament approved in the first reading the draft law No 9221 "On Humanization of Liability for Economic Offences" (the Draft law No 9221). The draft law radically changes the approach to economic crimes, including those related to tax evasion.

The state decided to punish white-collar criminals by high fines rather than by imprisonment. Does it make sense to sent unconscientious entrepreneurs and managers to prisons and spend government funds on them, when they can be turned into the separate revenue of the state budget?

Tax evasion (s. 212 of the Criminal Code of Ukraine) and evasion of unified social contribution (s. 212 of the Criminal Code of Ukraine) will no more be punished by imprisonment irrespective of the amount of the evasion.

The amounts of the fines are rather big. For instance, a large-scale tax evasion incurs a fine ranging from UAH255 thousand to 425 thousand, and a large-scale evasion of unified social contribution incurs a fine ranging from UAH170 thousand to 425 thousand. Yet, this is not a ceiling. Pursuant to the draft law in any case the amount of the fine should not be less than the amount of the damage caused by the crime. Consequently, the maximum amount of the fine is not confined at all and may reach fantastic sums in large tax cases.

Failure to discharge the fine within the prescribed time frame entitles the court to convert it into a prison sentence. The calculation formula is quite simple: one day of imprisonment is equal to eight non-taxable incomes (UAH17x8=UAH136). In the light of this, the conclusion about the cost of one day in prison can be easily made.

Fortunately, the draft law sets the maximum possible term of imprisonment in the application of such a "conversion", which is  12 years. Therefore, the prison sentences of several human lives length will be avoided (they may have been possible in several million hryvna cases if such a restriction had not been in place).

Another important feature of the draft law is that it limits the power of the law enforcement agencies to apprehend and arrest persons suspected or accused of tax evasion (evasion of unified social contribution). The law enforcement agencies will not be eligible to apprehend or arrest such persons, unless they fail to pay the bail or fulfill the obligations imposed on them in connection with the application of other preventive measures. These obligations may include: the timely appearance before an investigator or court, the ban to contact certain persons or visit certain places, the withdrawal of "foreign" passport by an investigator, etc.

It appears that the adoption of this bill will significantly improve the fate of taxpayers accused of tax evasion, and, conversely, will complicate the life of law enforcement agencies. The latter will be notably limited in the application of an apprehension and arrest as the most effective methods to influence "indocile" businessmen.

However, everything is not as good as it seems at first glance. In fact, the reform is half-done. Unfortunately, it did not touch upon such crimes as "forgery in office" (Article 366 of the Criminal Code of Ukraine) and "neglect of official duty" (Article 367 of the Criminal Code of Ukraine). A forgery in office and neglect of official duty leading to serious adverse consequences (UAH117,625 as at the date of the publication) regardless of whether these crimes are committed by an official of the private or public sectors carry a penalty of imprisonment for a term of one to five years.

The jeopardy for taxpayers is as follows.

Criminal proceedings under s. 366 of the Criminal Code of Ukraine ("Forgery in Office") are being instituted almost in all cases of the institution of the criminal proceedings for tax evasion. While producing a tax return, an accountant included false information in it, for example, understated taxable income (VAT output) or overstated deductable expenses (VAT input). This is well enough to accuse the accountant of forgery in office.

As for neglect of official duty (s. 367 of the Criminal Code of Ukraine), in practice this section is often employed to qualify the actions of persons who have not paid taxes to the budget without the intent to do so (by virtue of ignorance of the relevant tax laws or their improper application, etc.).

Hence, in reality things are not so bad for "fighters" against tax evasion. To command the full arsenal including the possibility to apprehend and arrest "indocile" businessmen, it is enough to initiate the criminal proceedings not only for tax evasion, but also for forgery in office, or instead of the institution of the criminal proceedings for tax evasion to institute criminal proceedings for neglect of official duty. This seems easy. Is not it?

This situation arose due to the fact that during the adoption of the so-called anti-corruption set of laws in April of this year (2011) introducing the division of criminal offences in office into those committed by officials of the private and public sectors, the legislature did not pay proper attention to forgery in office and neglect of official duty.

At that time, the Criminal Code of Ukraine was supplemented by the provisions laying down the responsibility for abuse of power and excess of authority committed by the officials of the private sector (ss. 364-1 and 365-1, respectively), but was not supplemented by the provisions establishing the criminal responsibility for forgery in office and neglect of official duty committed by this category of the officials.

Thus, there appears to be the paradoxical situation where the criminal responsibility for abuse of power and abuse of authority committed by the officials of the private sector is governed by the special provisions of the Criminal Code of Ukraine stipulating less severe penalties than those for the officials of the public sector, but when it comes to forgery in office and neglect of official duty the officials of the private sector are treated in the same way as the officials of the public sector.

Under these conditions, it seems expedient to ask the Parliament:

(1) to supplement the Criminal Code of Ukraine by the provisions that would set forth the criminal responsibility for neglect of official duty and forgery in office by the officials of the private sector;

(2) to extend the new fines regime provided by the Draft law No 9221 to neglect of official duty and forgery in office committed by the  officials of the private sector.

If these amendments are made, taxpayers will be put in much better position to resist the "ghost" of criminal responsibility for tax evasion.