Tax Payer’s Compliance with the Risk Criteria

Until 2019, the State Tax Service of Ukraine (hereinafter referred to as the “STS of Ukraine”), when awarding the tax payer the status of compliance with the Risk Criteria (hereinafter also referred to as the “Criteria”), had been guided by the Letter of the State Fiscal Service of Ukraine dated November 05, 2018 No. w/n, which approved recommendations to tax authorities for granting a risk status to a tax payer.

On February 01, 2020, the Resolution of the Cabinet of Ministers of Ukraine No. 1165 of November 12, 2019 “On Approval of Procedures for the Registration of a Tax Invoice/Calculation of Adjustments in the Unified Register of Tax Invoices” entered into force, by Appendix 1 of which a value-added tax payer’s risk criteria were adopted (hereinafter also referred to as the “Resolution No. 1165”). This document eliminated the recommendatory nature of the application of the Criteria and approved a separate procedure for an administrative appeal against decisions of regulatory bodies on assigning the risk status. This did not entail a simplification of the procedure for challenging the decisions of a supervisory body on the compliance of a tax payer with the Risk Criteria. On the contrary, the Resolution No. 1165 fully and completely cancels the informational nature of the Decision on Assigning the Risk Status to a Tax Payer and provides supervisory bodies with the authority to apply “sanctions” to a tax payer in the form of blocking tax invoices/calculations of adjustments (hereinafter referred to as the “TIs/CAs”), conducting a documentary unscheduled audit, which has led to changes in judicial practice. This issue calls for more detailed consideration, as a rather long period has passed since the date of entry into force of the innovations, and we observe good results in clients’ cases.

Grounds for Assigning the Risk Status to a Tax Payer and Consequences for Economic Activity

The updated Risk Criteria of a value-added tax payer (hereinafter referred to as “VAT”) provide for the following grounds:

A tax payer is registered on the basis of invalid/forged documents; registered with the subsequent transfer into the possession/management of non-existent, deceased, missing persons; had no intention/authority to conduct financial and economic activities according to the information of supervisory bodies.

A tax payer was registered and carried out financial and economic activities without the knowledge and consent of their founders and appointed managers in accordance with the information provided by them.

A tax payer does not have open accounts with banking institutions, except for accounts with the Treasury.

A tax payer has not submitted to the supervisory body tax reporting on VAT for the last two reporting (tax) periods, contrary to the norms of the Tax Code of Ukraine.

An income tax payer did not provide financial statements for the last reporting period, contrary to the norms of the Tax Code of Ukraine.

A supervisory body has tax information that indicates the risk of carrying out an economic transaction specified in TIs/CAs.

Thus, a supervisory body, based on the data and/or reporting provided/not provided by a tax payer, has the right to make the Decision on Assigning the Risk Status. At the same time, in the event that a tax payer contests the Decision on Assigning the Risk Status, a supervisory body tends to continue referring to the informational nature of the Decision made. However, in actual practice, such a Decision inflicts serious damage on the tax payer in terms to the implementation of economic activities in the future in connection with the consolidation of special rules applied by the supervisory body due to the presence of the risk status (the above-mentioned “sanctions” in the form of blocking TIs/CAs, conducting a documentary unscheduled audit, etc.).

On a practical level, one of the most common Risk Criteria used by supervisory bodies is Clause 8, which states that “the supervisory body has tax information that has become known in the course of its activities during the execution of tasks and functions assigned to the regulatory bodies, which determines the riskiness of the implementation of the economic transaction specified in the TI/CA”.

The designated criterion implies an undefined reason and is almost never in practice represented by documentary evidence provided by the supervisory body in the process of appealing the Decision.

Along with that, there is a common case of absence of specific reasons indicated of the supervisory body in the Decision when assigning the risk status to a tax payer, namely: non-submission of accounting, errors in its preparation, lack of properly executed documentation with a counterparty, or the discrepancy between the data held by a supervisory body and one declared by a tax payer.

Thus, a supervisory body may be guided by information that may not even directly relate to the economic activities of a tax payer and/or may not serve as sufficient evidence when making decisions on assigning the risk status.

The primary consequence for a VAT payer who meets at least one Risk Criterion will be the blocking of TIs/CAs drawn up by this tax payer, which is directly referred to in Clause 6 of the Procedure for Stopping Registration of TIs/CAs in the Unified Register of Tax Invoices (hereinafter referred to as the “URTI”), approved by the Resolution No. 1165. The consequences of application of this rule in relation to a tax payer also affect their counterparties.

An indirect consequence of the adoption of the Decision on Assigning the Risk Status to a Tax Payer may also be the implementation of a documentary unscheduled tax audit on the basis of Clause 78.1.9 of Article 78 of the Tax Code of Ukraine (submission of a complaint about the violation by a seller/buyer of the deadline for registration of TIs/CAs in the URTI by a counterparty; or in case a tax payer does not provide a response to the request of a supervisory body), which, accordingly, may entail the imposition of additional penalties on a tax payer.

An equally important consequence of the assignment of the risk status is damage to the business reputation of a tax payer, since the above consequences entail problems in maintaining the level of economic activity and, subsequently, lead to the refusal of counterparties to cooperate.

As such, although the Resolution No. 1165 regulates the procedure and grounds for making a Decision on the Compliance of a Tax Payer with the Risk Criteria, in practice, representatives of a supervisory body do not bother themselves with choosing and confirming such grounds, having sufficiently broad powers to impede economic activities of a tax payer.

Procedure for Appealing

To challenge any decisions of a supervisory body, Article 56 of the Tax Code of Ukraine provides for a general procedure for administrative and judicial appeal. The Resolution No. 1165 introduces a special procedure.

First of all, the issue of excluding a tax payer from the list of payers that meet the Risk Criteria shall be considered by a regional commission within 7 days from the day following the date of receipt of information from a tax payer. The application is carried out by submitting information and copies of documents through the tax payer’s Electronic Cabinet, which “indicate that the tax payer does not meet the Risk Criteria”. The deadline for appealing the Decision on Assigning the Risk Status, in contrast to the general procedure for appealing the decisions of the supervisory body, has not been set.

At the same time, the above Procedure establishes a list of documents that the tax payer may submit for consideration, namely:

agreements, including foreign economic contracts, with annexes thereto;

contracts, powers of attorney; primary documents for the supply/purchase of goods/services, storage and transportation, loading/unloading of products, warehouse documents, invoices, acts of acceptance and transfer of goods (works, services), taking into account standard forms and industry specifics, waybills; documents confirming the conformity of products (declarations of conformity, quality passports, certificates of conformity), the presence of which is stipulated by the agreement and/or legislation;

settlement documents, bank statements from personal accounts;

other documents confirming non-compliance with the risk criteria of the tax payer.

Most often, the commission of a supervisory body does not find sufficient evidence in favor of the tax payer to cancel the risk status, and the documents provided by a tax payer are actually not taken into account. In addition, the commission does not provide additional explanations of the circumstances and grounds for adopting the Decision bearing a negative nature for a tax payer.

An administrative appeal of the decision of the Regional Commission by the Central Commission is not provided for by the Procedure No. 1165.

Thus, the process for an administrative appeal of the Decision on Assigning the Risk Status to a Tax Payer is completed under a special procedure.

It is also necessary to take into account Subparagraph 14 of Clause 6 of the Procedure for Stopping Registration of TIs/CAs in the Unified Register of Tax Invoices, which provides for the exclusion of a tax payer from the list of those corresponding to the Risk Criteria in the absence of a decision by the commission based on the results of consideration of the information submitted by a tax payer with documents confirming non-compliance with the risk status.

The judicial procedure for appealing the above Decision of a supervisory body shall take place in accordance with the procedure set forth in Article 56 of the Tax Code of Ukraine.

In case of a judicial appeal, the following terms for filing a statement of claim should be taken into account:

if the Commission of a supervising body submits a decision based on the results of consideration of information and copies of the a tax payer’s documents within the time period established by the Procedure (or with its omission), Paragraph 1 of Clause 4 of Article 122 of the Code of Administrative Procedure of Ukraine sets the deadline for judicial appeal at 3 months from the date of receipt by a tax payer of such a decision;

in the absence of (failure to provide) decisions based on the results of consideration of information and copies of documents of a tax payer by the commission of a supervisory body within the time period stipulated by the Procedure, Paragraph 2 of Clause 4 of Article 122 of the Code of Administrative Procedure of Ukraine sets the deadline for appeal at 6 months from the date of submission of information and copies of documents by a tax payer to appeal the decision of a supervisory body.

It should be borne in mind that, in accordance with Clause 6 of the Procedure for Stopping Registration of TIs/CAs in the Unified Register of Tax Invoices, from the moment the procedure for appealing against the Decision of the commission of a supervisory body in court begins, the procedure for an administrative appeal is not available.

Judicial Practice

The Decision of the Administrative Court of Cassation within the Supreme Court in case No. 340/474/20 dated December 16, 2020 indicates the following position regarding decisions taken by the supervisory body:

“The court of first instance, in order to clarify all the circumstances in the case, requested from the tax authority the minutes of the meeting of the commission, on the basis of which the appealed decision was made, but the defendant did not provide this document.

The court notes that the commission of the supervisory body, making a decision with reference to the fact that the VAT payer was registered (re-registered) on the basis of invalid (missing, lost) and forged documents, according to the information available to the supervisory bodies, is obliged to justify to the court on the basis of what information the commission has come to this conclusion and provide adequate and admissible evidence to support this information.

The court of first instance, satisfying the claims of the plaintiff, proceeded from the fact that, during the consideration of the case, the defendant did not provide any evidence that would be examined during the meeting of the commission and which served as the basis for making the appealed decision.

The court of first instance did not establish that the defendant had grounds for classifying the enterprise under Paragraph 1 of the Risk Criterion. The court of first instance also recognized that the decision of the commission did not contain motives and justifications for including the plaintiff into the list of payers that met the risk criteria. The court considers such a conclusion to be unfounded, given the form of the decision approved by the Order No. 1165, which does not provide for specifying the grounds if Paragraphs 1-7 of the Risk Criteria of the Tax Payer are met, and tax information in this case is not filled out. However, due to the defendant’s failure to fulfill the obligation of proving established by Part 2 of Article 77 of the Code of Administrative Procedure of Ukraine, namely, the defendant’s failure to prove to the court the legality of the decision (that it was made reasonably, in good faith, judiciously and taking into account the existence of the grounds specified in the Order No. 1165), the Court agrees with the court of first instance on recognition as unlawful and cancellation of the appealed decision”.

In this way, the Supreme Court notes the obligatory existence of specific grounds for the commission of the supervisory body to issue the Decision on Assigning the Risk Status to a Tax Payer, as well as the obligation of the supervisory body to provide the court with arguments that serve as the basis for the issuance of such a Decision during the judicial examination.

The judgment of the court:

In the judgment of the Second Administrative Court of Appeal dated August 06, 2020 in case No. 520/480/20, the court draws the following conclusions on the issue of canceling the risk status of a tax payer:

“Based on the given norms of the current legislation of Ukraine, it clearly and unambiguously follows that the adoption by the supervisory body of the decision on the compliance of the VAT payer with the risk criteria changes the legal regime for monitoring the registration of income tax in the URTI, which with absolute inevitability leads to the termination of the registration of any tax registration in the URTI , and, accordingly, the controversial decision of the Regional Commission may be appealed under an administrative or judicial procedure. (…) Considering the above, the defendant’s assertion to the contrary is unfounded and contradicts the requirements of the Order No. 1165.

(…) According to Clause 8 of the Risk Criteria of a Tax Payer, (…) the disputed decision only indicates that the enterprise and/or the counterparty is involved in risky transactions. (…) During the consideration of the case, the supervisory body did not provide any evidence of the plaintiff’s economic activity in the conditions and circumstances that have signs of non-compliance with the requirements of the current legislation of Ukraine, either to the court of first instance or to the court of appeal.

(…) Thus, the panel of judges (…) has come to the conclusion that, when making a decision, the court of first instance came to exhaustive legal conclusions on establishing the circumstances of the case and correctly applied the norms of substantive and procedural law to the disputed legal relations, and, therefore, there are no grounds for its cancellation.

The panel of judges considers that, without providing a decryption of tax information, without citing risky transactions and names of enterprises that were involved in such transactions, in the contested decision, as provided for in Clause 8 of the Order No. 1165, the defendant actually acted without following their own procedure, non-explicitly and in a way that excludes the possibility of minimizing the risk of error in a disputable relationship.”

Thus, the conclusion of the court regarding the decision on the compliance/non-compliance of the tax payer with the Risk Criteria states the lack of information and groundlessness of the conclusions of the supervisory body on the compliance of the tax payer with such Criteria on the basis of economic transactions with the counterparty.

The judgment of the court:

The position of the Eighth Administrative Court of Appeal in the Decision of February 18, 2020 in case No. 380/5012/20 states the following:

“(…) Inclusion in the list of risky VAT payers entails legal consequences in the form of stopping registration of all TIs/CAs submitted by the payer, without exception. At the same time, such consequences are extremely negative for the plaintiff, due to the fact that the registration period for each TI is significantly increased, and the plaintiff is charged with an additional obligation to provide explanations and documents (…) the plaintiff’s counterparties are not able to form a tax credit for a TI, the registration of which has been suspended; in the future it bears the risks of termination of economic relations between the plaintiff and their counterparties (…) as a result of the decision (…) the plaintiff is in a state of legal uncertainty, since the supervisory body did not notify which documents shall be submitted to exclude the tax payer from the risk list.

(…) Therefore, from the evidence contained in the case file, it should be concluded that the inclusion in the list of risky VAT payers entails legal consequences in the form of stopping the registration of all TIs submitted by the payer, without exception, and the termination of such a decision will restore the right of the plaintiff to carry out full-fledged economic activities.”

As such, the judgment expresses the position on the negative consequences of the adoption by the supervisory body of the Decision on Assigning the Risk Status to a Tax Payer in the form of obstacles to their economic activities, which led to the impossibility for the tax payer to fulfil their obligations both to the supervisory body and counterparties in contractual relations.

The judgment of the court:

Additionally, by the Decision of the Kharkiv Regional Administrative Court dated June 09, 2020 No. 520/111/20 on the consequences of the adoption of the decision of the supervisory body on compliance with the Risk Criteria of the tax payer, the following is indicated:

“Regarding the referral of the defendant’s representative to the fact that the controversial decision on the determination of the plaintiff’s enterprise in accordance with Paragraph 8 of the Risk Criteria of the tax payer is not a decision that entails the occurrence of negative consequences for the enterprise, the court notes the following.

The general requirements for an act of individual action, as an act of law enforcement, are its validity and motivation, that is, instructions for the tax authority to provide specific grounds (factual and legal ones), as well as convincing and understandable reasons for its adoption. In addition, the acts approving the Risk Criteria of transactions are aimed at establishing the rules of law that affect the rights, freedoms and legitimate interests of citizens and other persons, and, subsequently, shall be subject to mandatory registration (…).

Taking into account that the provisions of the Order No. 1165 stipulate for the suspension of registration of TIs/CAs in case of referring a tax payer to at least one Risk Criterion, the court concludes that referring a tax payer to at least one Risk Criterion of a Tax Payer creates obstacles for the tax payer to carry out their economic activities.”

Thus, the court focuses on the fact that, when making the Decision on the compliance of the tax payer with the Risk Criteria as an act of the supervisory body, the rights, freedoms and legitimate interests of the tax payer were violated.

Decision of the Court

Based on the current judicial practice, it can be concluded that the legislation has been transformed in favor of a tax payer, since the decision of a supervisory body on granting a VAT payer the risk status has lost its informational character due to the entry into force of the Resolution No. 1165, as well as in connection with the normative consolidation of negative consequences in the form of obstacles for economic activities of an enterprise. It is of importance that courts refer to the fact that a supervisory body is obliged to indicate specific grounds for assigning a risk status to a tax payer during the court proceedings due to the vague wording of the Risk Criteria for a VAT payer. Therefore, we recommend that tax payers, in respect of whom a supervisory authority has adopted the Decision on Compliance with the Risk Criteria, use their rights to appeal against such a Decision, both in administrative and judicial procedures, as soon as possible. We recommend that you seek professional legal assistance for the effective implementation of defense strategies and the preparation of a complete set of documents to be submitted to a supervisory authority or the court.

Kateryna Malamaniuk, Lawyer