1. Introduction to the subject
2. Main principles for certification of transactions
2.1 Conditions for deduction of input value added tax on the taxable supply
2.2 Requirement for documentation of transactions pursuant to law
2.3 Documenting transactions as accurately as possible
2.4 Exercising due diligence
2.4.1 The required duty of care in business
2.4.2 The normal duty of care in business
2.5 Performing the obligation to co-operate
3. Income tax on payments not related to business
The Estonian Tax and Customs Board (hereinafter also ‘tax authority’) brings forth the main principles in the guidance material that will assist purchasers of goods or services to certify the occurrence of purchase and sale transactions. If a purchaser of goods/services follows the guidance, he or she will minimize the risk to the involvement of a tax authority and the creation of tax liability.
The certification of occurrence of transactions by a purchaser is important both for the certification of the right of deduction of input value added tax and possible avoidance of income tax liability.
In a situation where the person cannot certify sufficiently the occurrence of a transaction to the tax authority, the tax liability of the purchaser on the transaction for 12,000 euros, (the value of goods/services is 10,000 euros + value added tax 2,000 euros), shall be 5,000 euros (value added tax of 2,000 euros which is not deductible as input value added tax + 3000 (12,000 × 20 ÷ 80) euros, of income tax on payment not related to business).
A person may deduct only the value added tax paid in Estonia as the input value added tax
2.1.1 Pursuant to the Value-Added Tax Act (hereinafter the ‘VAT Act’), on the supply created in Estonia and subject to taxation the following conditions must be met for deduction of input value added tax (subsections 29 (1) and 31 (1) of the VAT Act). All legislative texts are accessible at the address https://www.riigiteataja.ee/.
- This must concern the costs incurred for the taxable supply or sales of the purchaser who is a person liable to value added tax registered in Estonia. The content of sales is the transfer of goods or provision of services, or the business activities. Thus, a person registered in Estonia as a person liable to value added tax must acquire goods/services for the purpose of using these for the transfer of goods or provision of services as a result of his/her business.
- Another person from whom goods or services are purchased must also be registered in Estonia as a person liable to value added tax. Thus, prior to conducting a transaction, the purchaser has to check the existence of the seller in the national VAT register. The information about the registration of the seller in the VAT register can be found at the address https://maasikas.emta.ee/saqu/public/kmkrnr.
- The invoices issued must meet the requirements listed in section 37 of the VAT Act. The invoice is necessary for the identification of a purchaser and checking the fact of transfer of goods or services and the circumstances relating thereto where necessary (see also point 2.2).
- Goods or services have been obtained from the person indicated on the invoice. In the case where it becomes clear that the seller indicated on the invoice has not been the actual seller of goods, the purchaser has no right to deduct input value added tax in general. In the described situation, input value added tax may be deducted only in the case where the purchaser acted in good faith and with due diligence to a required extent (see also point 2.4).
2.1.2 The import VAT paid to the customs and the VAT calculated in the case of the reverse charge may be deducted as input VAT as well. The import VAT paid to the customs may be deducted according to the conditions stated in section 31 of the VAT Act, whereas a customs declaration instead of the invoice certifies the right for deduction. In the case of the reverse charge (subsections 3 (4 to 6) of the VAT Act), goods/services are purchased at net price and the whole calculation is made in the VAT return (a purchaser declares the VAT liability and the deduction of the same amount). No invoice is required in the case of reverse charge, whereas the purchaser calculates the VAT himself/herself.
In general, the tax authority proceeds from the tax calculation submitted by the taxable person when conducting an inspection procedure and he/she expects the accuracy of the information submitted. Thus, the first base for certifying transactions is the documentation drawn up correctly.
An accounting source document is a certificate confirming the occurrence of a business transaction (subsection 7 (1) of the Accounting Act). One transaction may be certified and often it is certified by several documents indicated in the legislation and generally to be made up in everyday practice instead of a single accounting source document (for example, a contract of purchase and sale, a document concerning consignment of goods, an invoice, a payment order, a statement of account). The basic certification, but often not the only one, in VAT accounting is the invoice complying with the requirements provided in section 37 of the VAT Act.
Supply means the transfer of goods and provision of services in the course of business activities (clause 4 (1) 1) of the VAT Act). The time of supply or the time of receipt of services is deemed to be the date on which the goods are dispatched to the purchaser, or the services are provided or the payment is effected for these (clauses 11 (1) 1) and 2) of the VAT Act). The transfer of goods to be identified by the specific, essential characteristics or the provision of services are kept in view in these provisions.
Thus, an invoice confirming the occurrence of an economic transaction is important because the actual economic content must be established according to this, or the transfer of goods to be identified or the provision of services. In a situation where the invoice is insufficient and therefore the actual economic content of a transaction cannot be established, it is reasonable to take a position that the taxable person has not received the goods/services.
At the same time, mistakes pertaining to the form of the invoice (for example, spelling mistakes), that will not prevent from checking the seller’s person and the content of the transaction, are not essential from the point of view of taxation.
On the ground that in tax proceedings the principle of economic interpretation applies, according to which a tax authority proceeds from the actual content of transactions and not from the form thereof, when imposing taxes on transactions, the tax authority may, in exceptional cases, have a suspicion about the conclusion of actual transactions also in the existence of the formally correct documents required by law (e.g. an invoice). In order to avoid the suspicion described, it is important to follow the principles stated below (points 2.3, 2.4 and 2.5).
A taxable person shall keep records of facts relevant for taxation purposes, preserve and provide evidence about such facts, if necessary (subsection 56 (2) of the Taxation Act).
The documentation of a concluded transaction as accurately as possible is important and this applies as well, if the supplementary documentation of a transaction is not obligatory, resulting from the legislation (the documents compiled as required by the Accounting Act, for example, an invoice). Otherwise, a taxable person shall take a risk that he/she cannot certify the conclusion of a transaction to a tax authority.
The existence of goods/services and the occurrence of a transaction between the parties indicated on the invoice shall confirm besides the accounting source documents in addition also correct stock records, consignment notes of goods, instruments of delivery and receipts, records, contracts and evidence about the communication between the purchaser and the seller (for example, e-mail correspondence).
The Chamber agrees that as the documentation is not obligatory, resulting from the legislation, we cannot require compiling any specific document besides source documents under the Accounting Act from a taxable person. We should still admit that in the case of failing the documentation of providing services, the taxable person undertakes a risk that he/she shall be further not able to certify the receipt of services if justified doubts arise. (Judgment of the Supreme Court No. 3-3-1-57-13, p 16)
The purpose of obtaining goods or services must be obvious or the purpose or use must be controllable. For example, to collect and preserve evidence about the purpose of usual office supplies in reasonable quantities and their use would be superfluous because the purpose and use for business activities is obvious. However, to collect and preserve evidence about the details of transactions casting unusual, reasonable suspicion thereon or with a great tax value for an undertaking shall be an obligation to a taxpayer for ensuring the verifiability. (Judgment of the Supreme Court No. 3-3-1-43-09, p 14)
The tax authority explained above (see item 2.1.1 4)) that if in the course of inspection it would appear that the seller indicated on the invoice had not been the actual seller, the purchaser would not have the right to deduct input value added tax. At the same time, if the purchaser can certify to the tax authority that he/she acted in good faith and with the due diligence when concluding the transaction, the tax authority shall not restrict the purchaser’s right to deduct the input value added tax.
The tax authority deems the good faith here to be the fact that the purchaser did not know that the seller indicated on the invoice was not the actual seller. If the purchaser knows that the person indicated on the invoice is not the actual seller, then the purchaser has intentionally reflected a transaction on the invoice, which shall not meet the requirements of the deduction of input value added tax.
The tax authority deems the exercise of due diligence for the purchaser to be provisions and operational rules characteristic of just this sphere of activity where the purchaser is operating and that can be written down in the legislation as well. Meeting the diligence requirements, the purchaser shall, in general, come to know, if the seller indicated on the invoice is not the actual seller or the seller indicated on the invoice is not registered in Estonia as a person liable to value added tax. Thus, the purpose for exercising the due diligence is to be sure that the seller indicated on the invoice is the actual seller, because the precondition for the deduction of input value added tax is that there is a transaction between two persons liable to value added tax. The person failing to exercise the due diligence shall undertake a risk that he/she may not succeed later in certifying the occurrence of the transaction in the case of a well-founded suspicion.
The due diligence is divided into the required duty of care in business and the normal duty of care in business.
The required duty of care in business is the due diligence arising from law and from requirements in company internal procedure rules.
As to the requirements of law, the tax authority means both taxation laws (for example, the VAT Act) and specific acts governing operation in a certain sphere (for example, the Building Code, the Forest Act, the Waste Act, etc.). All taxable persons must keep themselves informed about the requirements of law and the implementation thereof is expected from everyone operating in the corresponding sector.
In accordance with the Building Code, it is obligatory to keep the journal of building operations (clause 15 (3) 2)). The list of data that must be reflected in the journal of building operations are stated in § 7 of the Minister of Economic Affairs and Infrastructure Regulation No. 115 of 12 September 2015 "Requirements for Documentation of Building Work, Preservation and Handing Over Building Documents, and Requirements for Maintenance Instructions, its Preservation and Presentation" established on the basis of subsection 15 (5) of the Building Code. Based on the journal of building operations compiled as required, it is possible to establish works done at the site on the dates shown on the invoice, the persons performing these works, and other circumstances characterizing the activities and their performance afterwards as well.
The obligation of the acquirer of timber or the cutting right results from the Forest Act, to verify whether the possession of the timber or the existence of the cutting right belonging to the transferor is legal or not (§§ 37 and 38). If the taxable person fails to complete this obligation, there may arise certification problems whether the taxable person himself/herself has acquired the timber or the cutting right lawfully. The obligation to verify the lawfulness of a seller’s possession means primarily the fact that the acquirer of the timber is obliged to require the documents from the seller certifying the lawfulness of the seller’s possession and not to accept obviously inadequate or repugnant documents that do not certify the lawfulness of the possession. If the purchaser does not require the presentation of documents or accepts thereof insufficiently completed or takes no notice of the obvious discrepancies in the documents provided, then he/she has not shown sufficient diligence and must be content with the fact that he/she has no right to deduct the input value added tax on the transaction, although the transaction has actually been conducted and the goods were formally acquired from another person liable to value added tax for the taxable supply. (Judgment of the Tallinn Circuit Court No. 3-08-1021, p 22)
According to the Money Laundering and Terrorist Financing Prevention Act, special due diligence measures (§§ 12 to 22) are applied to the economic or professional activities of several people (the list of obligated persons is provided in § 3). For example, in economic or professional activities an obligated person has to pay special attention to the activities of a person participating in a transaction or professional operation or of a person using a professional service or of a customer and to circumstances that refer to money laundering or terrorist financing or the connection of which with money laundering or terrorist financing is probable, including to complex, high-value and unusual transactions which do not have any reasonable economic purpose (subsection 12 (1)).
The normal duty of care in business is the diligence normally applied by the person himself/herself or in similar transactions by companies operating in the same sphere.
Upon concluding a transaction, from the aspect of diligence it is elementary to check the background of a transaction partner in the public databases: the commercial register (https://ariregister.rik.ee/), searching of persons who owe tax arrears (https://maasikas.emta.ee/saqu/public/taxdebt), register of economic activities (https://mtr.mkm.ee/), etc.
The normal duty of care in the building sector is primarily related to the ascertainment of the other party and storage of the relevant data. The Tallinn Circuit Court has found, for example, that a sensible main contractor shall determine the representatives of subcontractors and store their contact details keeping in mind a possible need for submitting complaints afterwards concerning defects revealed (Judgment of the Tallinn Circuit Court No. 3-06-1928).
The situation, where a reasonably behaving purchaser must have been realised that the seller was not the actual seller but despite that he/she did not do anything to identify the said person, shall be deemed to be a violation of the normal duty of care. In a situation, for example, where the purchaser shall disregard the obvious contradictions in the documents submitted (the data on the seller in the documents shall not coincide with the ones in the commercial register) and when checking these contradictions it would have appeared that the seller indicated on the invoice is not the actual seller, then the purchaser has not shown adequate duty of care.
A taxable person is required to notify a tax authority of all facts known to him/her which may be relevant for taxation purposes. A taxable person shall keep records of facts relevant for taxation purposes, provide explanations, submit returns and other evidence, and preserve such returns and evidence for the term prescribed by law. A taxable person shall not prevent a tax authority from performing procedural acts. (§ 56 of the Taxation Act)
If a taxable person violates the obligation to co-operate (for example, the person does not submit the desired information to a tax authority and hinders thereby the conduction of checks), then the burden of proof of the tax authority shall decrease and, on contestation of a notice of assessment, the burden of proof of the taxable person shall increase.
In Estonia income tax shall be charged on expenses or payments not related to business. The notion used in the Income Tax Act ‘expenses or payments not related to business’ shall be interpreted, applying the definition, according to which expenses are related to business if they have been incurred for the purposes of deriving income from taxable business or are necessary or appropriate for maintaining or developing such business and the relationship of the expenses with business is clearly justified (§§ 51 and 52 and subsection 32 (2) of the Income Tax Act).
Due to the fact that payments of value added tax and income tax are principally effected on different bases and in different ways, then it is possible that economic transactions occurred in business shall be treated differently in accounting of value added tax for taxation purposes and in accounting of income tax for taxation purposes. The abovementioned means that it is important whether it is possible to ascertain the occurrence of the economic transaction indicated in the document. t is essential as well, that expenses should be made for the purpose of purchaser’s business.
3.1 Income taxes are imposed on payments in a situation where the taxable person has made payments concerning which the taxpayer does not have a source document in compliance with the requirements prescribed in the legislation regulating accounting (clause 51 (2) 3) of the Income Tax Act). One transaction may be certified and often it is certified by several documents instead of a single source document (for example, a contract of purchase and sale, a document concerning consignment of goods, an invoice, a payment order, a statement of account). Thus, if the taxpayer does not have a source document meeting the requirements which would certify the payment for services/goods, as a result of which the occurrence of the economic transaction is not adequately identifiable, then the payments shall be charged irrespective of the fact whether services are necessary for business or not.
In the estimation of the Chamber the invoice submitted does not meet the requirements for a source document whereas the data about the economic content of the transaction are lacking on the invoice (subsection 7 (1), clauses 7 (2) 2) and 3) of the Accounting Act). In the description of the invoice there is indicated indeed that payments for advertising and marketing services shall be effected in accordance with the agreement but no corresponding written agreement has been concluded, as it has become evident in the judicial proceedings. Whereas there is a reference to the agreement on the invoice, the economic content of the transaction is not identifiable due to the lack of the agreement. Resulting from point 10 of this judgment, the invoice shall be deemed to be a source document not meeting the requirements due to the lack of the economic content of the transaction, and in accordance with clause 51 (2) 3) of the Income Tax Act, income tax on payments based on such invoice shall be paid. (Judgment of the Supreme Court No. 3-3-1-46-11, p 15)
3.2 Payments for services or goods, that have not been made for the purpose of profit of a legal person or that are not necessary or appropriate for maintaining or developing business or the relationship of services/goods with business is not clearly justified, shall be charged with income tax (clauses 51 (2) 4) and 52 (2) 1) of the Income Tax Act). Thus, payments shall be charged with income tax if the payment and the occurrence of the transaction, which was the basis of it, are certified, but the relationship of the transaction with business is not certified.
An invoice alone recorded in accounting and payment of sums of money and declaration on the basis of this do not certify the actual provision of services or transfer of goods or acquisition thereof, if there are no matters of fact to prove the occurrence of the business transactions or the fact that the counterparty of the transaction is actually the person indicated on the invoice.
Thus, in order to prevent problems of justification in the course of a fiscal control, a taxable person must verify upon performing a purchase and sale transaction that the seller of goods/services is actually the person indicated on the invoice. If the law outside law of taxation imposes additional obligations to the contracting party for effecting sales or the obligation for the purchaser to check the identity of the seller’s representative, then you shall have to meet these requirements.
If the occurrence of economic transactions in the way indicated on the expense receipt cannot be confirmed and the payment made cannot be related to particular goods/services reliably or if the services/goods have not acquired to be used for business purposes, then the transactions shall be charged with income tax as well, in addition to value added tax.