Why are tax audits still the bogeyman of the honest businessman?

Tax audits are still a problem. Particularly in the case of businesses trading in goods, tax audits can even put a business out of business and plunge the director/owner into personal bankruptcy. What role do the courts play in this and what protection should there be? Peter Varga commented more extensively on this topic for Hospodárská noviny.

In the past, we have also seen tax audits that may have been intended to protect the interest of the taxpayer, rather than the State’s right to collect taxes fairly. Although it is possible to believe that this time is behind us, the aftertaste of tax audits in Slovakia still remains.

Arbitrariness of tax authorities

The service company supplied services to companies in the group. For this purpose, it used its own employees as well as business partners (i.e., self-employed persons and ‘one-person LLCs’). A tax audit was carried out at one of the companies to which the service company provided these services. The tax office found that the services in question were not supplied by the service company but directly by its business partners. The audited company was thus not entitled to deduct VAT on the entire amount invoiced by the service company, despite the fact that the services were also supplied internally by the service company’s employees.

Such decision-making by the tax administrator is difficult to justify and understand. The right to deduct VAT is a fundamental principle of the common VAT system. That principle can only be derogated from if there has been an abuse of the right or if there has been tax fraud. In the above case, there was no tax fraud (everyone paid the VAT) and there could be no abuse of the right. Indeed, there can only be an abuse of law if one of the parties involved has obtained a tax advantage. Therefore, in a chain where the business partners, as suppliers, invoiced the service company with VAT and the service company invoiced the audited company with VAT, no tax advantage could objectively have been obtained.

“It has not been proved that the goods have been delivered”

In the case of commodity trades, this arbitrariness is almost a structural problem. If the tax authority does not grant a VAT deduction, the amount of the VAT deduction is often higher than the taxable person’s margin. If the tax authority audits one type of supply chain over several tax periods (we have encountered as many as 13 or 36 tax audits in a row), this can be devastating for the audited entity. In practice, it is even common for the tax authority to disallow VAT deductions on the one hand, but on the other hand to require VAT to be paid on the same goods when they are sold to another member state. Many cases are justified by the tax authorities on the grounds of failure to prove that the goods were supplied by the person named on the invoice. However, such a doubt on the part of the tax authorities should not in itself be decisive. In some cases, the reversal of the burden of proof pushes the taxable person beyond the limits of what the taxable person is able to prove. Yet the burden of proof does not shift to the tax administrator.

Judges have no incentive to grant stays of execution to actions in tax cases because they then have to rule within 6 months

What do the courts say?

It is the courts that are supposed to protect the subjective rights of tax subjects against decisions of the financial administration. Unfortunately, in practice, this is often not the case. The length of the proceedings alone, although generally shorter compared to other court proceedings, is disproportionate given the invasive nature of the impact of the enforceable decisions of the tax administration.

Decisions of the Tax Directorate are final and enforceable, unless the court decides to postpone their enforceability. However, judges have no incentive to grant such suspensive effect to actions. This is because if a judge suspends the enforceability of a decision of the tax administrator, he is obliged to decide on the action within 6 months. And that is usually too short a time.

This anomaly of the otherwise recently adopted Administrative Procedure Code thus causes negative application problems. Tax entities, especially in the field of goods business, lose their business positions (e.g.: bank ranking, ranking for business partners, etc.) by the enforceability of the decision, in the better case, and in the worse case it liquidates tax entities and can lead their statutory officers to personal bankruptcy.

How to cope in these situations?

Prevention on multiple fronts. In addition to the basic prevention of meticulous archiving of documents on individual deliveries, there is also the prevention of legally secure structuring of the business.

Such structuring includes, in particular, the protection of assets and values that may be threatened by tax proceedings, as well as the protection of the owners of the companies themselves. However, caution must be exercised in such structuring. In situations where the tax administration is already circling over the tax entity, for example, the transfer of assets and business to another company needs to be dealt with not only through the lens of transfer pricing, but also through the lens of criminal law.

Clients need to be represented not only during tax audits and subsequent procedural phases, but also preventively. This mainly includes setting up the overall structure of their business and protecting their assets. As long as the decision-making practice in Slovakia remains unpredictable and the courts do not grant stays of execution to actions, there is probably no other option.