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How to verify a contractor to avoid being involved in a tax fraud (part 2)

Przemysław POWIERZA
Tax Partner at RSM Poland

In the latest post on the blog, we discussed some of the factors the National Revenue Administration officials will be guided by in evaluating due diligence compliance by a taxpayer at the onset of the taxpayer’s cooperation with a contractor. Today we will continue on this topic, hence we are going to take a closer look at the remaining assumptions.

Starting cooperation with a contractor – transaction criteria cont

Concluding a transaction in circumstances described below may be found suspicious by the tax authorities and result not only in a refused right to VAT deduction, but also in the payment of someone else’s tax. Therefore, in order to avoid being involved in a tax fraud, already when verifying the contractor we need to check out if the conditions of the transaction we are about to conclude coincide with those described in the Methodology.

The purchase of goods at a price considerably different from the market price – without economic substantiation

According to NRA, the low price of goods offered by a contractor should prompt us to keep higher standards of contractor verification. In such a case, seeing whether the price reduction can be reasonably substantiated (primarily in economic terms) should be investigated. The crucial criteria here include the nature of the industry, stage of turnover (wholesale, large wholesale, etc.) and its volume. What should be understood by a ‘reasonable economic substantiation? The Ministry of Finance gives situations in which the price offered by the contractor is very different from the market price due to a promotional campaign or a loyalty program as an example of circumstances demonstrating ‘economic substantiation. In this case, we do not have to fear any negative consequences. So when should we be particularly cautious?

Firstly, in a situation in which a newly established entity offers us a price that is ‘attractive’ as compared to the prices of the competition that has been present on a given market for many years (e.g. if a large distributor of given goods cannot offer a price that would be comparable with the one suggested by the contractor).

Secondly, in a situation in which a very attractive price is offered by a contractor who is a relatively small entrepreneur on a given market (this does not apply to manufacturers of given goods) and therefore, due to its turnover level, should not for example customarily receive such a big discount from the producer/distributor of given goods that could justify such a low price. What is striking in the examples provided by the MF is a very narrow perspective. We shall note here that a lower price can result from the very fact that a small entity is simply trying to win the market.

Paradoxically, large entities, which could afford discounts for regular customers, just because of the level of turnover itself, act rationally from the perspective of fundamental principles of economics, i.e. they drain the market to obtain a maximum possible price. In some industries, small entities find it hard to compete only with product quality, and they must encourage customers to cooperate with them using something that is most appealing, i.e. a lower price. T

his holds true among others for the fuel market, which has for a long time now been under scrutiny of the tax office anyway. The same problem can be observed on the market of small, yet expensive electronics. The simple principle “I do not buy it if it is too cheap” may give us peace of mind when it comes to VAT, but what good comes out of it, if the spectre of bankruptcy looms large? This is a yet another case in which there is no one-size-fits-all solution.

It is often the case that, when being tempted by a ‘good deal’, we do not pay attention to the reasons behind such an attractive price, and we should be doing it, and doing it carefully, if we do not want to be targeted by the tax authorities.

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The purchase of goods that belong to a different industry than the one in which the contractor operates and that had not been purchased by the taxpayer from this contractor before – without economic substantiation

This assumption pertains to a situation in which we entered into business transactions with a given contractor in the past, but the new transaction covers goods either from other industries or typical for a different business profile, and we have not purchased such goods before. This does not always mean that we should abandon such a transaction right away due to concerns that it may be a part of a tax fraud scheme. The circumstances in which it is economically substantiated for the contractor to offer goods from an industry different from the one in which they have operated so far are as follows:

  • change of the business profile of the contractor;
  • extension of the contractor’s business by a new scope of goods, confirmed, e.g. in a public tender, references from the producer/supplier, information on the entity’s website or a relevant entry in the Polish Classification of Activities;
  • our request (as the purchaser of goods) for a comprehensive delivery (delivery of goods consistent with the contractor’s business profile together with goods that do not match this profile);
  • the fact that the supplier had such goods on offer, but we were not offered them before or we were not interested in purchasing them;
  • the fact that the new goods on offer were subject to licensed trading, and the entity has obtained relevant licenses or permits.

These cases are particularly interesting, because the reasons we enter into transactions involving goods that are not typical for us often tend to pertain to business secret and different sensitive business matters. We can rest assured provided that we are very familiar with the business reasons behind the transaction (even if they are confidential). We should only be aware of the fact that we need to lay all the cards on the table for the NRA if they ask about such transactions. Evading the topic may be interpreted to work to your disadvantage and lead the officials to speculate on it, which will produce a wave of unnecessary procedural measures (attempts to gather evidence that the transaction is strange, artificial and economically unsubstantiated).

Contact with the contractor or their representative is unsuitable for the circumstances of a given transaction

In the era of modern communication technologies, there are many options of getting in touch with the contractor. Therefore, if this contact is hindered for some unexplained reasons, we should exercise extreme caution, according to the MF. So what should be understood by the term “unsuitable contact”? As stated in the guidelines of the MF, these are primarily situations where:

  • the contractor (their representative) does not have a permanent residence in Poland, and can be contacted only in a foreign language, through a foreign e-mail address, instant messenger or by phone;
  • the contractor does not live in Poland and has failed to provide any contact person in Poland;
  • the contractor does not have any office, agency, branch or a representative office in Poland, and had only a foreign address of the place of business;
  • the contractor (their representative) has failed to authenticate their identity in a way that would give the taxpayer the certainty about whom they were really contacting;
  • any personal meeting with the contractor or their representative was impossible;
  • the same person acted as a representative of different entities or as a person with whom you agreed the transaction details concerning different entities.

The above tips can obviously be helpful in many cases; however, it should be clearly stated that some of them in most cases should be considered absurd. Trade negotiations in a foreign language? Talking only over the phone or a messenger? Trading in Poland with someone from abroad? Please forgive my sarcasm, but it sounds a bit like we were creating a virtual world, in which in Poland you only speak Polish, you trade only in honey and pork, and a merchant at the market speaks with a familiar accent. Feels safer right away? Jokes aside, the thing is that NRA (and tax authorities from other countries of the world, as well) very often find it hard to handle the challenges of the global economy. In the area of VAT, this can be particularly painful, because the trade in goods and services has become much internationalised over the last decades. You have to expand your horizons, acquire expertise and learn foreign languages in order to keep up with the taxpayers.

However, let us not buy too recklessly and too much from someone who does not want to meet us, who is far from being professional and who cannot quite explain what he actually does in this particular business. Such contacts can truly have disastrous (tax) consequences.

The contractor’s registered office or the place of business is located at an address where there are no signs of any business activity

According to the MF, what should make us doubt the contractor’s credibility is a situation in which we can only find what is known as a virtual office, offering the service of providing its address for registration purposes, at the address of the contractor’s registered office or the place of business unless using a virtual office is adequate for the scale of the contractor’s business. the MF provided a situation in which the registered office or the place of business clearly contradicts with the scale or the type of contractor’s business as circumstances that may indicate a lack of due diligence. For example, the contractor offers the wholesale supply of fuel, while their registered office is located in a garage or some ruined buildings. I honestly must admit that I cannot quite understand the point of making a connection between the scale of the business (understood as turnover volume, as you can see) and the size of the company’s seat, office, warehouse or any other property. A massive part of business nowadays operates in virtual reality. Until recently, it was difficult to travel for business around Poland and check your e-mails at the same time; a large desktop computer would hardly fit on the driver’s lap or the passenger seat. Today, however, it’s all there in a smartphone. So what do we need the office for? A company must (officially) have its registered office somewhere… because it is required under commercial law.

The contractor does not have organisational and technical facilities corresponding to the type and scale of their business activity

Extreme caution should be exercised in the event when the contractor does not have relevant assets and organisational and technical facilities as well as appropriate human resources that permit running the business in the scale we are being offered. As an example, the MF has outlined a situation in which the contractor offers the supply of household appliances in large quantities and of considerable value, but does not have any access (e.g. as an owner, tenant, lessee, buyer of transport services, etc.) to suitable warehouses or means of transport.

Is this all we should do to avoid being involved in a tax fraud? Unfortunately not …

I am soon going to discuss the remaining assumptions behind observing due diligence at the onset of cooperation with a new contractor.

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