Guilt and intent as conditions for tax liability from January 2021

It’s a well-known fact that not paying taxes carries a penalty of 25% of the total amount owed. Tax authorities usually don’t care why a company failed to pay its taxes. Yet a taxpayer can have many reasons for failing to pay: malfunctions in the tax administration system, accountants’ errors, negligence when choosing a counterparty or deliberate “tax optimization” strategies that the company failed to conceal.

Starting January 01, 2021, approaches to establishing tax non-payment liability and the size of the penalty have changed. Let’s analyze what has changed and whether business will benefit.

The concept of guilt for non-payment of taxes

It’s logical to assume that absence of guilt should save taxpayers from penalties for tax offenses. This conclusion appeared until recently in case law, which tax authorities often disregard when drawing up inspection reports.

Starting January 1, 2021, the Tax Code stipulates that a person may be held financially liable for committing a tax offense only if their guilt can be shown.

“Guilt” here refers to a person’s failure to take sufficient measures to comply with the rules and standards while they were able to take such measures.

It’s interesting that it falls to the tax authority to prove that the measures taken by a taxpayer were not sufficient. In other words, a company is considered to have taken sufficient measures by default. To claim otherwise, the tax authority must prove that a taxpayer acted (a) unreasonably, (b) in bad faith and (c) without due care.

Anyone who has faced tax disputes related to “unreal” business transactions knows that the terms “bona fide taxpayer” and due care of a taxpayer are not new.

The Supreme Court has repeatedly emphasized that taxpayers must show reasonable care since they bear the consequences of choosing a bad faith counterparty. It means that taxpayers need to prepare the evidentiary basis to prove that they took due care when choosing the counterparty.

In other words, these terms are inherently interconnected: a bona fide taxpayer is a person who always shows due care when doing business and choosing their counterparties.

We recommend that companies prepare the evidentiary basis on their own, instead of leaving it to the tax authority to decide whether they complied with the “due care” concept.

The following may testify to due care:

• conducting an established internal counterparty selection procedure such as a tender;
• reviewing the counterparty’s permits and documents to prove that they have the labor, financial resources and experience to carry out the activity, prior to entering into an agreement;
• analyzing information about the counterparty obtained from public sources and state registers;
• setting mandatory warranties for the counterparty in the agreement.

Now that the guilt concept has been introduced into tax legislation, taxpayers who want to minimize liability risks must keep evidence of their due care for at least three years after working with a counterparty.

Is establishing a person’s guilt by regulatory authorities a prerequisite for bringing them to financial liability?

A tax authority will not have to prove guilt every time it wants to establish financial liability. Guilt is a prerequisite only in cases of intentional tax offenses, including:

• intentional acts revealed by a tax authority’s inspection;
• intentional violation of deadlines for paying the agreed amount of monetary obligation;
• a tax agent’s intentional failure to charge or pay taxes before or after the payment of income to a non-resident or another taxpayer.

Let us analyze when it is possible to conclude that an act is intentional and how a tax authority can prove it.

According to the Code, acts shall be deemed intentional if regulatory authorities can prove that a taxpayer falsely and deliberately created conditions, which cannot have any purposes other than failure to comply or improper compliance with the requirements set by tax legislation.

In other words, the tax authority must prove that a taxpayer’s intention was to obtain tax benefits.

The intent concept is not yet common in tax disputes. At the same time, the Supreme Court has already argued that: “if a taxpayer fails to establish whether a counterparty’s representative has the power to enter into an agreement when conducting a business transaction and executing primary documents, such conduct may show intent to groundlessly obtain tax benefits and may entail the risk of adverse consequences for such a taxpayer”.

Therefore, a taxpayers’ failure to comply with the due care principle will not only prove their guilt, but also may show intent in their actions.

The presence of intent affects the size of the penalty following a tax inspection.

Unless the tax authority proves a taxpayer’s guilt, the penalty will be smaller than before, only 10% of the determined tax obligation. However, an intentional offense will carry the prior penalty of 25% of the determined tax obligation.

Conclusion

The introduction of the terms “guilt”; and “intent” into tax legislation is a positive change aimed at protecting taxpayers’ interests. At the same time, these changes will lead to new case law, proving or refuting them in different categories of tax disputes.

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