Ban on Recurring Tax Audits: How to Understand

Instead of Introduction

Major restrictions on the conduct of recurring unscheduled tax audits have been adopted in the framework of the so-called tax reform 2015.

The restrictions have been in force from 1 January 2015. They relate to both on-site and off-site unscheduled tax audits.

Brief History

It was not a rare occasion in my practice in the past that the tax authorities carried out an unscheduled tax audit in respect of the issues that had already been covered by a foregoing scheduled audit (a recurring audit). For instance, subject matter of such recurring tax audits was often the taxpayer’s dealings with a particular counterparty or particular counterparties.

Was the conduct of the above recurring tax audits lawful? It seems that rather yes, than not. Formerly, neither the Tax Code of Ukraine, nor any other piece of the legislation contained any restrictions on the conduct of recurring tax audits. The tax authorities appointed recurring audits on general terms and with having no regard to whether taxable periods subject to such recurring audits had already been checked within the scope of previous tax audits.

Of course, there are also those who would deny the lawfulness of recurring tax audits in the past. To bolster their point of view, they may make reference to para 4 of the "legendary" Presidential Decree "On Some Measures on Deregulation of Entrepreneurial Activities" (dated 23 July 1998 No 817/98) and para 78.1.12 of the Tax Code of Ukraine.

However, for the sake of fairness, it pays to say that the aforesaid provisions of the Tax Code of Ukraine and the Decree govern only a very specific and quite limited in number type of recurring tax audits. They have exclusively to do with recurring audits conducted by the tax authorities of a higher level with a view to check the accuracy of the findings made by the tax authorities of a lower level. In order for such recurring audits to be appointed, either an internal investigation or criminal proceedings against the employees of the tax authorities conducting the preceding tax audit is required. The provisions in question do not regulate a procedure for the appointment of "classical" recurring tax audits, i.e. tax audits performed by the same tax authorities that have already conducted the preceding tax audit.

After the reform

Since 1 January 2015 the situation has changed radically. The Tax Code of Ukraine was amended to provide expressly for a ban on some unscheduled tax audits of a recurring nature.

The ban is couched in terms of the grounds for unscheduled tax audits enumerated by Art. 78 of the Tax Code of Ukraine. The ban covers not all unscheduled tax audits, but only those of them that are appointed on the following grounds:

- The failure on the part of a taxpayer to furnish within 10 business days explanations or documentary evidence at the written request of the tax authorities sent in connection with the establishment of facts indicating either the violation of tax laws by the taxpayer or the unreliability of the data contained in his tax returns (paras 78.1 .1., 78.1.4 of the Tax Code of Ukraine);

- Filing a VAT return involving amounts of VAT refund/surplus of input VAT over output VAT in excess of UAH 100 thousand (para 78.1.8. of the Tax Code of Ukraine);

- the decision of a court / prosecutor’s office/ detective on the appointment of a tax audit in accordance with criminal procedural law (para 78.1.11. of the Tax Code of Ukraine).

Of particular importance is the definition “recurring tax audit”. In fact, there is no such term as "recurring tax audit” in the language of the Tax Code of Ukraine. The Tax Code of Ukraine operates a slightly different notion: "...  it is prohibited to carry out unscheduled tax audits… if the subject matter of such audits has already been caught during preceding tax audits of the concerned taxpayer”.

In many cases, it is rather difficult to determine whether the subject matter of a new tax audit has been already caught by preceding tax audits.

Let us consider the most typical situation for the sake of illustration. Suppose your company whose taxable periods from 1 January 2013 to 1 April 2014 have been already audited in the scope of a scheduled tax audit faces the appointment of a new tax audit. This time an unscheduled tax audit ought to be carried out. The new tax audit will explore the tax treatment of transactions between the company and its counterparty, X, LLC, conducted in March through August 2013. Has the tax treatment of such transactions with X, LLC been already covered by the preceding scheduled tax audit, given that the report of this scheduled tax audit has no mention of the counterparty at hand?

In this situation the taxpayer can naturally argue that given the comprehensive nature of the scheduled tax audit, it has covered the transactions conducted with X, LLC. The fact that X, LLC is not directly mentioned in the report of the scheduled tax audit is immaterial. Accordingly, there are no grounds for conducting the new tax audit in respect of dealings with X, LLC.

In contrast, the tax authorities may claim that the scheduled tax audit cannot be regarded as covering the issues of dealings with X, LLC. To support this point, the tax authorities may refer to the absence of the analysis of the relations with X, LLC in the wording of the report of the scheduled tax audit.

Owing to the ambiguity of the changes made to the Tax Code of Ukraine, each of the parties to the above hypothecated dispute is right to a certain extent. The issue is highly controversial. It can be easily assumed that this issue will “come to surface” again and again in series of "court battles” between taxpayers and the tax authorities.

There has been already first court jurisprudence on this subject matter.

For example, in the case initiated by "Techno-Bud Service", LLC against an order on the appointment of an unscheduled tax audit the Chernivtsi Circuit Administrative Court took the side of the taxpayer. The court found that the dealings with a number of the counterparties specified in the order on the appointment of the new tax audit have been already covered by the preceding scheduled tax audit. That is why, in the judgement of the court, there had been no grounds for the tax authorities to appoint the new tax audit.

Working for the future

The tax authorities not worse than taxpayers understand the ambiguity of the changes brought to the Tax Code of Ukraine regarding the prohibition on recurring tax audits.

They are taking proactive measures to minimize the risk of a successful appeal against the orders on the appointment of recurring tax audits.

The vivid evidence of such an approach of the tax authorities is the letter of the State Fiscal Service of Ukraine (SFSU) dated 28 January 2015 No 2463/7/ 99-99-22-02-04-17. In this letter the SFSU, “in order to prevent the contraction of the performance of further [recurring] unscheduled tax audits", urges the local tax authorities to clearly define in documents related to the appointment and conduct of tax audits the scope of issues amounting to the subject matter of such tax audits.

In place of conclusion

It is beyond any doubt that a ban on recurring tax audits makes up a very important change designed to ease the administrative burden placed on taxpayers by the tax authorities. However, as it often happens, the very progressive change somewhat “suffers" from the lack of clarity in the legal wording. It is hoped that court jurisprudence will do what is called “to dot the i's and cross the t's” in this area.

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Protecting trade secrets during tax audits

Recently, the tax authorities have been paying more and more attention to auditing contractors of taxpayers (with a view to identify null transactions or other facts required to challenge the taxpayers’ right to input VAT or deductible expenses). If your enterprise makes money in that it buys goods and resells them at a higher price to other business entities, the conduction of such audits could be devastating for your business.

There are some situations in practice where such audits can result in the disclosure of the information on the suppliers of the taxpayer and the prices at which it buys goods from them to the customers (buyers) of the taxpayer. On the receipt of this information, it no longer makes sense for the customers (buyers) of the taxpayer to deal with the taxpayer and they may begin to purchase goods directly from the suppliers of the taxpayer. As a result, the taxpayer’s revenues can sharply decrease. In particular, this situation may occur when the tax authorities carry out a documentary audit of a customer (buyer) of the taxpayer and reflect in the audit report the movement of goods from the suppliers of the taxpayer to this customer (buyer).

To avoid a similar situation, it seems reasonable to take advantage of the legislation protecting trade secrets from disclosure by the tax authorities. The Tax Code unambiguously stipulates the right of a taxpayer for nondisclosure of trade secrets by the state controlling bodies (p17.1.3).

The following actions may be suggested to protect the interests of the taxpayer:

- Setting out in the internal documents of the taxpayer the list of information constituting trade secrets as well as the mechanism covering the protection of such information - the right of a taxpayer to trade secrets does not occur by itself and requires that certain  formalities are complied;

- A written notice to the tax authorities that the information on the suppliers of the taxpayer and the prices of goods at which they are sold to the taxpayer makes up the trade secrets of the taxpayer (with confirming internal  documents enclosed);

- Compliance during the documentary on-site tax audits with the requirement of the Tax Code to hand over documents containing trade secrets (such as contracts with the suppliers) to the tax authorities based on an acceptance certificate only (p 85.3); the acceptance certificate must clearly indicate that these documents contain the trade secrets of the taxpayer;

-  A written warning to the tax authorities that in the case of the disclosure of the trade secrets, including information on the suppliers of the taxpayers and the prices at which the goods are purchased from them, the taxpayer will have to (a) appeal to the prosecution office to hold the tax officials concerned criminally liable for breaching its trade secrets  (2) apply to the administrative court for the recovery of damages caused by the disclosure of trade secrets committed by the tax authorities.