What is due diligence in commercial transactions and how does the Polish tax office interpret it?

What is due diligence in the selection of a tax contractor? Entrepreneurs operating in Poland may have the impression that there is something elusive about this concept, which makes it resemble the legendary yeti. It's something that a lot of people have heard about, and that a lucky few may have seen... but has anyone had the opportunity to have a first-degree experience of meeting and meeting the due diligence requirements and guidelines set forth by the tax office to prevent VAT fraud? Katarzyna STYPA-SADOWSKA, Senior Tax Supervisor at RSM Poland, explains this in an interview for "Dziennik Gazeta Prawna".

In what situation can an official come to an entrepreneur and say that the company did not exercise due diligence in the selection of a tax contractor?

"Failure to exercise due diligence in the selection of a tax contractor" is, unfortunately, an accusation that an entrepreneur can usually hear when it is too late to correct the error. Why?

Let's start with the absolute basics: what role does due diligence play in business activities, why do we, as taxpayers, have to exercise due diligence and what are the penalties for negligence in this respect?

We can talk about due diligence for VAT purposes when the taxpayer verifies the contractor before concluding a transaction with them.

If - even without realizing it when establishing business relations - we come across a dishonest contractor, the Polish tax office can easily detect irregularities and conclude that fraud occurred at some stage of the transaction or state that the invoice does not document actual economic events. The tax office may then decide, for example, that the taxpayer had no right to deduct input tax.

And this is where the problem arises, because - when there is an accusation of failure to exercise due diligence in the selection of a tax contractor - there is also an economic risk, which, of course, always involves money and problems. Unfortunately, we usually find out that the contractor was dishonest and committed VAT fraud after the fact, sometimes even several years later. Which means that the problems caused by the concept of due diligence can affect anyone - even an entrepreneur who thinks that because he is honest, pays taxes, has a good accountant and is in order, this topic does not concern him.

Let's use an example: let's say that the taxpayer, during an inspection, presents to officials all the documents he is asked for. He fulfills his duties, so he feels calm and by providing the necessary information he has a sense of duty well fulfilled. At some point, however, he receives the tax inspection report and suddenly it turns out that everything is not as he thought. How could this happen? Contrary to appearances, there are many possibilities.

Let's say that our entity has commissioned various construction works. The contractor issued us an invoice, the tasks were completed and everything seems fine... Then it turns out that all the work was actually performed not by this company, but by another one - and we already have a problem, because it was not the invoice issuer who performed this service. And what matters here is whether we exercised due diligence, i.e. whether, if we had checked the contractor better, we would have been able to find out that he was unable to provide the service.

Due diligence criteria are also important when the entrepreneur has purchased the goods. If the seller was a dishonest taxpayer who, after transferring the goods, did not settle the transaction, we can again expect problems with the tax office. Even more so if the contractor has never been in possession of the goods. 

We are at the same risk when selling goods abroad. Let's assume that there is an intra-Community supply of goods, so the tax rate is 0%; If we exported the goods, everything is fine. However, an economic risk may arise if the buyer comes to collect the goods himself, then assures us that he took them out of the country - he will even submit documents - and we later find out that the goods stayed in Poland and we should not apply the 0% rate. And in this situation, when the goods were delivered or the services were provided, we must be able to prove to the Polish tax office that not only were we not involved in the fraud, but that we could not even suspect that we were involved in it. And only this will save us.

So how can we effectively save ourselves and prove to the tax office that we have met all due diligence in commercial transaction criteria?

I must admit that the expectations of the Polish tax authorities are high. The problem is that we do not have a definition of "due diligence" or "good faith" in tax regulations (in the Act on Tax on Goods and Services). So we don't have a list on which we can check off individual steps.

Of course, when it comes to the obligation to exercise due diligence for VAT purposes, we have case law - both of the Court of Justice of the European Union and Polish administrative courts - and we can always draw certain premises from these sources. We also have a very interesting document titled "Methodology for assessing due diligence." Its content is not addressed to taxpayers, but mainly to office employees who will assess whether due diligence was observed in the verification of contractors, but there is nothing stopping you from using this text. Especially because it already contains a list of required activities. According to it, in order to meet the conditions for exercising due diligence in the selection of a tax contractor, we must:

• formally check the contractor - so check whether he actually exists and check him in various publicly available databases, such as the National Court Register.
• check whether the contractor is registered - first of all by finding him on the White List and (in the best case) receiving from him documents that confirm the legality of his actions or the authorization of the person contacting us to represent a given company.

Moreover, we must ensure that the shape of our business relations is – very generally speaking – normal. It's about maintaining order: if we sign a contract or other documents of this type (such as orders, assignments), we should make sure that we have written confirmation of this cooperation. Unless the nature of our business involves signing contracts - then we need to take care of other forms of documenting the legality of this cooperation, e.g. by maintaining electronic order confirmations.

If we buy goods, we must ensure that the payment is not in cash and strive to settle the transaction by transfer to a bank account - preferably to one that (in the case of domestic contractors) is on the White List.

But it is not everything. We also have to start "playing detective." It would be best if we went to the contractor, visited his premises and checked whether he actually runs a business there or whether it is just a "virtual" office... We should get to know him in person, check whether he works in a garage and whether the goods they sell have a place to be stored... I'm not joking - the methodology for assessing due diligence assumes that even detective activities are involved.

This means that not only the concept of due diligence in commercial transactions is unclear, but also the requirements set by the tax office. There is no obligation to have your own office - you can have a company registered in the so-called "coworking spaces". There is no obligation to have a warehouse - you can rent warehouse space for a given product, for a given time...

Exactly - for the Polish tax office, it is not enough for the taxpayer to look into publicly available databases such as the National Court Register (KRS) or the Central Registration and Information on Economic Activity (CEIDG). And yet contracts can be concluded at a distance, almost every entrepreneur today has an electronic signature - so we do not have to meet to sign the contract, which means that checking the contractor outside the government registers can be really difficult and time-consuming. That's why I say, with a slight sarcasm, about these "detective activities" that are somewhat contrary to what entrepreneurs want - the ability to run their business efficiently and without disruptions.

Taxpayers, of course, want to do business with reliable contractors - after all, if they pay for the goods, they want to receive it, so they want the contractor to be verified. But - let's not forget - an entrepreneur wants to make a profit, wants to do something well and quickly. If he has an order somewhere in Europe, a lot of time may pass before he downloads all these documents from the potential contractor and checks everything (apart from the fact that the contractor may be very surprised that he is asked for all this data). And the contractor can go somewhere else during this time. So the expectations of the Tax Office and the expectations of entrepreneurs are quite different.

Please note that it is not always necessary to check every single document and address. The tax office does not check whether the taxpayer has met the due diligence criteria by simply coming to the company and checking off in his notebook what has been done and what has not been done. Instead, it evaluates the entity's actions holistically, taking into account the entire set of factors. And you never know what might tip the scales in our favor or against us.

Still - basic activities (such as checking the contractor in the database, obtaining e-mail confirmation of the order, obtaining a description of the service provided, signing the contract and obtaining proof of transfer) are not enough. Especially if there are any unusual circumstances. In such a case, the tax office may decide that the entrepreneur could have been more vigilant and that a red warning light should have turned on, and if this did not happen - or he ignored it - then he must pay. The tax authorities most often make this assumption. At least in the courts we can sometimes encounter a slightly different approach...

Is it worth defending yourself against the accusation of failure to exercise due diligence in commercial transactions when entering into a court dispute with the tax office?

Let's start with the fact that before we even go to court, there are a few important steps ahead of us, because first we receive the tax audit report and we find out that our contractor was not honest and the tax office would like money from us. Because we deducted something incorrectly or applied the 0% rate to goods that did not leave the country, so we were not entitled to this rate. In such a situation, we must decide: whether we correct the declaration, pay the tax and additional tax liabilities (so-called "VAT sanctions"), or whether we enter into a dispute and fight with the tax office.

If we choose the first option, we simply pay, make appropriate corrections to the documents, transfer to the tax office and the case is closed.

We will definitely have more work if we take the path of dispute and start fighting for ourselves. To do this, we must first write our objections to the inspection report. The office will usually reply that it does not agree with our objections, which means that we will then only have to wait for the initiation of tax proceedings (which the tax office has the right to initiate within 6 months).

And this is a procedure in which - firstly - we know what we are accused of (because we have read the report and we already know the arguments of the tax authority) and - secondly - we have the opportunity to show initiative and look for additional documents that work on our benefit and confirm that we have checked the contractor. Moreover, in such tax proceedings we may also request the hearing of witnesses - both ourselves and other people who have appropriate knowledge about the transaction and are familiar with our relationship with the contractor.

If this does not work - and despite our efforts, the tax authority still stands by its position - we can take the next step, which is to start appeal proceedings. Within this framework, the second-instance tax authority will consider the case. And only if the tax office's decision is upheld, do we take our tax dispute to court.

Here again it varies, but let me give you an example: a case from 2023, the judgment of the Provincial Administrative Court, in which it was stated that the Tax Office and the Director of the Tax Administration Chamber were right - the taxpayer did not exercise due diligence. It was about construction services (the work was obviously performed, because if it had not been performed, we would not be talking about due diligence).

When I read the justification for the judgment, I realized that the entrepreneur did not verify the contractor because he was simply not interested in it - he wanted specific services to be performed in accordance with the signed contract. The work progressed according to plan, in stages, and that was what the entrepreneur focused on. By common sense, everything was going according to plan. There was a contract for some work and the work was carried out in accordance with it. Then there was an acceptance report, everything was fine, everything was paid by this taxpayer... Only later did he find out that it was not the company that issued the invoice that performed the work - it was a completely different person. The entrepreneur did not check in advance whether the company employs any employees or has the equipment needed to perform the services specified in the contract.

But again - how can an average entrepreneur check whether someone employs workers (or whether he employs workers who are qualified for such work - after all, you can employ 15 office workers who will not lay the road). The same with equipment, no one has to own the equipment - they can rent it. You do not have to be the owner of the equipment to be able to perform construction work.

VAT deduction and due diligence – what if the taxpayer reports to the tax office himself?

There is also good news - the Polish tax office is not always right. Recently I came across an interesting judgment of the Provincial Administrative Court in Szczecin (it is not final yet, so we will see how the Supreme Administrative Court will react). It is true that this situation is slightly different because it concerns tax interpretation.

The entrepreneur established a relationship with a contractor from Great Britain. A person contacted him and - after the goods had been exported - it turned out that there was no payment for the invoice. The taxpayer tried to contact this specific person, and when this failed, the taxpayer tried to contact the company. And then it turned out that the person in question did not represent this company.

The entrepreneur, ensuring that due diligence was maintained in the assessment of the transaction, had previously checked the company itself - he reached out to these publicly available databases and also checked everything in Great Britain. Unfortunately, the person who committed the fraud disguised himself well - he had an e-mail address that clearly suggested that he was associated with an English company, even an appropriate-looking e-mail footer. The taxpayer, of course, reported this event to the law enforcement authorities and at the same time requested an interpretation because he wanted to know whether he could apply this 0% rate in such a situation - whether, in the opinion of the tax office, due diligence had been observed. 

The Director of the National Tax Information replied that absolutely not. He argued that the verification of the contractor was not carried out properly, that the entrepreneur contacted the contractor only by phone and e-mail, and if he had deepened the verification, he would certainly have noticed something and become suspicious. And here we have a happy ending - at least for now. The Provincial Administrative Court in Szczecin indicated that what the taxpayer did was sufficient to conclude that there was no negligence in exercising due diligence in the selection of a tax contractor in this case.

It turns out that in Poland the risk of being accused of failing to exercise due diligence in commercial transactions is very high. What can you do to avoid it?

Due diligence in domestic and foreign transactions is unfortunately a big challenge, especially for entities that want their goods to be quickly and properly delivered to their contractors. To achieve the best results, it is definitely worth preparing your internal procedures, creating an internal checklist and implementing it. It may seem that it is not much, but even such an action will allow the entrepreneur to feel safer and not be surprised 2-3 years later when the Polish tax authority decides that something is wrong.

It is best to keep all documents proving the taxpayer's diligence until the statute of limitations expires. After all, tax audits up to 4 years ago are not uncommon in Poland...