Tax investigations can make even a very cautious and meticulous financial director or chief accountant nervous. This is because the provisions of tax law are considered as one of the most common investment risks due to their inconsistency and ambiguity, especially in Central and Eastern Europe.
It is therefore very important to prepare properly for such an investigation, even if we believe our business is not exposed. Relatively large transactions or transactions of an international nature tend to attract the attention of the tax authorities. What can be done to ensure a good night’s sleep even when it’s certain that tomorrow the tax authorities will be knocking on the door?
Even such certainty unfortunately is not guaranteed. For example, in Poland some tax investigations may be conducted without notice. Customs and tax inspections (CTIs) are initiated only by the delivery of the authorization of such an inspection. Control activities may start immediately after delivery, which is often made in person by a tax inspector. This is because CTIs usually concentrate on tax and customs offenses, frauds in value-added tax (VAT), VAT carousels and organized tax and customs crime, where it is necessary to act quickly.
On the other hand, ordinary tax controls (OTCs), which focus on all tax aspects of doing business, are usually announced in advance. OTCs cannot start sooner than seven days and later than 30 days from the delivery of a notice of the intended inspection. If an inspection is not commenced within 30 days from the delivery of a notice, another notice must be delivered in order to commence the inspection.
In Germany a tax audit is announced in a formal letter informing the place of audit, taxes and the period which will be audited, as well as the date when the audit begins. This, however, does not mean that the short period between notifying of a tax audit and starting of audit activities would be sufficient to prepare for the inspection.
In both cases above, preparation must be long-term and include periodic analysis of certain areas of business activity. In particular, the following aspects should be considered.
Identify Risk Areas and Areas of Interest
It is important to identify the risk areas and areas of interest of the tax authorities. In 2018, many inspections in Poland were initiated by the tax authorities based on a “unified control file” (UCF), introduced into the Polish VAT system in 2016. A UCF is submitted by each VAT taxpayer after the tax settlement period, and includes basic transaction data which were subject to VAT in a given settlement period, such as the names of the seller and buyer, transaction amounts, VAT amounts, transaction dates, subject of the transaction, the tax rate, information on intra-Community deliveries and acquisitions, import, export or reverse charge transactions.
In addition, in 2018 the Polish tax authorities were interested in businesses which showed tax losses in recent years (especially in 2016, during which the total amount of tax losses was 55.4 billion Polish zloty ($14.3 billion), much higher than in 2015, when it was 40.8 billion zloty).
Taxes such as corporate income tax, VAT and excise duty were priorities in 2018, and at the same time the Polish tax authorities were keen to inspect medium and large businesses, but were more reluctant to inspect small and micro businesses. Transfer pricing, tax optimization structures, intra-Community transactions and the reverse charge mechanism were subject to careful investigations.
In the Czech Republic the main triggers for tax inspections are reducing taxes, issuing fictitious invoices and overvaluation of invoices. It is also common for taxpayers deliberately not to present foreign assets or income in their tax return. All these actions can result in the triggering of a tax inspection, especially after the introduction of a control report (the VAT ledger) in the Czech Republic in 2016, which all Czech VAT payers must file and where errors in data can be easily identified. In 2013, only 13% of tax inspections were in a digital form, and 22% of those resulted in an additional tax assessment. With the VAT ledger, this number will most probably increase. Because of that, some taxpayers may be audited without even knowing it.
Review Tax Settlements
It is wise to periodically review tax settlements and opt for extra tax analysis of unusual transactions as well as high-value transactions.
Even if a certain transaction is closed, it is advisable to review recent tax and court interpretations issued in similar cases. Unfortunately, in tax cases the interpretation line often varies or changes unexpectedly, even if the tax law remains unchanged. This may influence past settlements and provoke tax investigations.
Consider Securing Future Transactions
Also consider securing future transactions that are potentially a risk by filing for individual interpretations. If some planned transactions are considered risky with respect to tax consequences, and at the same time the interpretation of tax law raises doubts, it is a good idea to file for an individual tax interpretation.
In some jurisdictions such interpretation protects against additional tax liability or initiation of criminal fiscal proceedings: this is the case in Poland and Germany. individual tax interpretations are also available in Czech Republic. However, unlike in Poland, both in Czech Republic and Slovakia these interpretations are limited only to transfer pricing and are in fact an equivalent of binding price agreements which are present in the Polish and other legal systems.
Establish Formal Procedures
Whereas tax compliance procedures are quite common, it is still rare for companies to have procedures in place in the event of tax inspections. Establishing formal procedures will reduce stress connected with the tax inspection and will allow employees to act appropriately.
Such procedures should indicate the employees responsible for supervision and direct contact with the tax authorities as well as reporting rules. The procedure should also include the principles of providing documents and objects and making rooms available to tax inspectors, as well as the rules for preparing answers to the tax inspector’s queries. The procedure should be available to employees, who should be properly trained to apply it.
Tax Authority Effectiveness
Although in Poland the number of CTIs has fallen during recent years, the tax authorities are becoming more specialized and effective. In the first half of 2018, customs and tax authorities conducted 1,700 CTIs, setting tax liabilities in the amount of 6.4 billion Polish zloty. In the same period of 2017, 2,633 inspections were completed, with findings amounting to 7.44 billion zloty. As a result, the average amount of additional tax liabilities for one inspection amounted to 3.55 million zloty in 2018, and in the same period a year earlier, 2.82 million zloty.
The improvement in the tax authority’s effectiveness is also visible in their activities. In the first half of 2018, they carried out 10,361 OTCs. The amount of additional tax liabilities reached 3.88 billion Polish zloty. In the corresponding period of 2017, the authorities completed 13,854 inspections; the reported arrears amounted to 3.21 billion Polish zloty. The average amount of arrangements for one inspection in 2018 was 375,000 Polish zloty; in 2017, it was 232,000 zloty less.
In comparison, according to the most recent full report published by the Czech Ministry of Finance (Zpráva o činnosti Finanční správy ČR a Celní správy ČR za rok 2018) in 2018 there was a total of 11,715 tax audits, with 7,032 completed with an additional tax liability (60%). The total number of tax audits decreased by 16.1% in comparison to 2017. The financial administration focused on different areas, such as VAT deficiencies in case of fictitious services (agency employment, advertising services) or fictitious documents and transactions.
The Polish tax authorities have become much more knowledgeable and qualified in certain areas of taxation. Tax inspections are frequently preceded by in-depth analyses.
Meticulous preparation for such an inspection, which includes the implementation of all the above points may significantly reduce the risk of fiscal and criminal responsibility and may secure a good night’s sleep even if a tax inspector knocks on the door.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners
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Paulina Karpinska-Huzior is a Senior Associate and Andrzej Pośniak is Managing Partner and Head of Tax with CMS Poland.