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Guidelines for avoidance of getting involved in tax fraud schemes

It is always worth thoroughly examining the other party's background and the circumstances of the transaction prior to entering into a transaction in order to reduce business risk and tax risk. According to our historical practice and current court precedent, a taxable person that became aware of the actual circumstances (indicating tax fraud) involving a transaction but nevertheless participates in the transaction that may constitute committing tax fraud, may become subject to suspicion in the involvement of tax fraud. In order to avoid the foregoing, we have developed guidelines that are helpful in recognising potential fraud.

As the list of circumstances included in the guidelines are not exhaustive, following such guidelines will not necessarily result in a right to deduct input value-added tax and will not preclude amendments to tax accounting. It is important to also perform all due diligence duties applicable in business and to take into account other unusual circumstances. In addition, we advise you to rely on your own intuition and experience as an entrepreneur.  If any doubt persists, we advise you to refrain from such a transaction and consider seeking out a counterparty that is more trustworthy.

Examine thoroughly the other party's background and the circumstances of the transaction prior to entering into a transaction in order to reduce business risk and tax risk.

We recommend that you pose the following questions to yourself prior to entering into a transaction.

NB! Know your counterparty

  • What is the counterparty's history/background?
  • Is the counterparty capable of selling the goods and/or services offered?
  • Is the price of the transaction plausible?
  • Is the documentation related to the transaction drafted correctly?
  • Is the counterparty a taxable person for value-added tax or not?


Beginning from this year we are issuing special certificates for tax data to companies: tax information certificates whereby a company can give a survey on its economic activity to its counterparty. The data concerning the labour force, wages and salaries, supply and tax arrears of the company can be displayed in the certificate and sent directly through the e-Tax/e-Customs to its counterparty. By using the certificate for tax data, counterparties may enhance their trustworthiness and thus both parties will gain confidence that the tax matters of the counterparty are in order.

Circumstances that may deviate from your ordinary course of business and, if viewed on an aggregate basis, imply that tax fraud has been committed:

1. Information retrieved from public databases does not leave a trustworthy impression of the counterparty (including members of the management board)

Using various databases, including internet search engines, information is retrieved concerning the counterparty or their legal representatives that may raise questions of trust with regard to the counterparties and transaction. Such information may comprise subjects discussed in various articles or message boards, results from credit reporting registries, criminal records and adverse court decisions to the counterparty that have entered into force. It is definitely worth researching the background of a counterparty (including management board members) if it is a new counterparty and/or the transaction is of a large taxable value.

Among information retrieved, the circumstances that arise suspicion may include the existence of tax arrears, unfiled tax returns, the field of activity not matching the actual business activity, lack of an operational legal address, unsubmitted annual reports, frequent changes of members of management board/ shareholders, appointment of foreign citizens to the management board, lack of (functional) contact details and/or frequent changes, the email address and telephone number of the company do not belong to the local network operator.

The various public databases for researching a counterparty's background »

You can review court precedent here: judgement of Tallinn Circuit Court in the cases no 3-08-1021, p 16 and 3-06-1928, p 24

2. The other party to the transaction is left unidentified (failure to ask for the name, contact details, right of representation)

A reasonable business operator is expected to identify the representatives of the other party to the transaction (for instance by asking for an identification document, right of representation) and retain the contact details of the counterparty. By failing to identify the counterparty, a business operator assumes the risk that problems arise at a later date in submitting claims with regard to goods and/or services and it may be a challenge to subsequently prove the transaction.

3. There is no functional website on the internet describing the activities of the counterparty

Internet searches for the counterparty do not yield any other results except for registry entries. Even though a website is not mandatory, its existence demonstrates the counterparty's interest in advertising its activities and thereby finding potential customers. It would be wise to pay attention to the above especially in case of large volume transactions and first-time transactions.

4. The counterparty is unable to provide information on the services and/or goods they provide and are unfamiliar with the industry

Legal representatives of the counterparty are unfamiliar with the industry and the goods/services that they provide. In addition, they fail to adhere to requirements arising from laws applicable to the industry and other regulations (for example registrations, permits, applications, notices, licenses, certificates of special purpose goods, etc. that are required in the industry).
You can review court precedent here: judgement of the Supreme Court in the case no 3-3-1-49-13, p 17 and judgement of Tallinn Circuit Court in the case no 3-10-924, p 17

5. The company lacks the business premises necessary for selling the goods and/or services (for example a warehouse, shop, manufacturing building, salon, etc.)

If a counterparty offers a large quantity of goods/services that require a specific business premises and employees to sell (for example a warehouse, shop, manufacturing building, salon, etc.), it may be a factor that arouses suspicion if the counterparty's sole business premises is a mailbox, apartment or another company's legal address. A factor that arouses suspicion is also entry into agreements and/or demonstration/handover of goods outside of the company's business premises (for example petrol stations, car parks, vacant land).
You can review court precedent here: judgement of Tartu Circuit Court in the case no 3-08-855, pp 9 and 10

6. The quantity of goods offered is so large that it is not plausible given the company's size and level of experience

If a counterparty offers a large quantity of goods or a large volume/industry-specific service, circumstances that may arouse suspicion with regard to the execution of the transaction and/or the existence of the goods/services include the absence of necessary skills, experience, knowledge and resources on the part of the service provider.

7. The price of goods and/or services offered is unexpectedly high/low

It is important to pay attention to the price of the goods and/or services offered: if it is substantially lower or higher than the market price and the price difference cannot be explained by logical business reasons, a risk may arise that tax fraud has been committed somewhere in the supply chain.
You can review court precedent here: judgement of the Supreme Court in the case no 3-3-1-67-08, p 14

8. The counterparty dictates to whom and at what price the goods and/or services should be resold
 
9. The counterparty does not have a valid value-added tax identification number

If a vendor does not have a valid value-added tax identification number, they are not entitled to add value-added tax to an invoice and the buyer is not entitled to deduct input value-added tax. We would like to point out that an invoice alone is not sufficient as a document to prove the transaction and a basis for deducting input value-added tax. Instead, the actual economic substance of the transaction will prevail.

10. Transaction-related documentation is incomplete or non-existent

Contracts are not concluded in case of first-time and/or large-volume/high-price transactions or they are broadly worded. Also, other potential documents proving the existence of the transaction are not drafted (documents of delivery and acceptance of goods/services, transport documents, product certificates, terms and conditions of delivery and warranty, price quotations and other documents common in the particular industry).

While the drafting of all of the aforementioned documents is not obligatory, failure to draft or retain such documents could result in a risk that in case of a subsequent potential dispute the parties are unable to prove the circumstances surrounding the transactions. Therefore, it makes sense to accumulate and retain evidence on transactions that arouse reasonable suspicion or have large taxable value.

You can review court precedent here: judgement of Tallinn Circuit Court in the case no 3-09-2473, p 9

11. Accompanying documents for goods are incorrectly completed

In case of transactions, the correct completion of accompanying documents is one important method for the identification of goods and potential lodging of claims with regard to the quality of goods. For example, correctly entered dates, locations of origin and destination, vehicle numbers, details of the consignor, consignee and transporter and the description of goods on bills of lading and delivery notes, CMRs, product certificates and invoices. In addition, we would like to point out that the retention of transport documents is important for proving import, export and transport within the European Union.

12. Documents have been drafted with a broadly defined wording of goods and/or services (for example only "construction services", "business consulting", "materials", etc.)

If documents (invoices, forms, contracts, etc.) define the goods and/or services broadly (for example only "construction services", "business consulting", "materials", etc.), the transactions that have been documented in such a manner may become subject to the risk that the actual nature of the services and/or goods, volume and price cannot be determined at a later date.

You can review court precedent here: judgement of the Supreme Court in the cases no 3-3-1-57-13 and 3-3-1-76-14

13. Financing of the transaction is unusual

If a transaction is financed with a loan where the lender's background is unreliable and the terms of the loan are unusual (non-existent interest rates, lack of collateral, excessive loan maturity dates), this may give rise to doubt as to the actual granting/receipt of the loan. There may also be a risk that you have become involved in a tax fraud scheme.

You can review court precedent here: judgement of Tartu Circuit Court in the case no 3-11-1176, p 9

14. The payment terms of goods and/or services purchased are unusual (e.g. requesting large amounts of prepayments; making of payments to persons not involved in the transaction)

It is important to be very careful with situations where a counterparty requests the payment of a large amount in exchange for goods and/or services in cash and/or making of a (pre)payment/bank transfer to persons not involved in the transaction. If you accept such payment terms, it may later be difficult to prove that you have paid for the transaction.

You can review court precedent here: judgement of the Supreme Court in the case no 3-3-1-67-08, p 14


If any single factor from the list outlined above is true in your case, this will not automatically constitute an allegation of involvement in business fraud or tax fraud. If you have any doubts about a counterparty on the basis of the factors provided above, we recommend that you make additional inquiries to research the credibility of the counterparty and/or relevant transaction (see also "Public databases for conducting background research on counterparties").

 

17.04.2017