How to verify a contractor to avoid being involved in a tax fraud (part 3)

Przemysław POWIERZA
Tax Partner at RSM Poland

In the previous post, we have managed to discuss most assumptions behind observing due diligence at the onset of cooperation with a new contractor. However, this is not all you can do in order to protect yourself against negative ramifications of dubious transactions. What else should be done? You will find the answer to this question below.

The payment term is shorter than the standard payment term offered by other suppliers in this industry – without economic substantiation

The goal behind fraudulent transactions is to disappear without remitting VAT to the tax office. It can only be successful if the goods are sold as fast as possible: for criminals, time is clearly not on their side, because the tax authorities are getting more and more effective in detecting any such activity. The obligation of the regular submission of VAT SAF-T has contributed to this, and the Clearing House ICT System (STIR) has just been launched. Therefore, ‘the faster, the better’. For this reason, I advise you to stay away from contractors who impose much shorter payment terms than those usually applied in a given industry, on a given market and in a given time, as this may cast a shadow of suspicion on such a transaction. It is a different story, however, if prepayments are a common practice for supplies of given goods; in such situations, as a rule of thumb, we should not be afraid of dealing with a fraudster. Entrepreneurs who operate in industries offering fast-moving goods (hence very short standard payment terms) are those in the most difficult position. The fact that a fraudster wants to receive payment quickly is not as clearly visible then. It explains, among others, why the greatest frauds have been made so far in the trade of fuels or e.g. food products with a short sell-by date.

Transaction terms and conditions fail to guarantee the security of trading – according to standards in place for a given industry

In the Methodology, the Ministry of Finance has defined a couple of typical situations that may suggest that a transaction with a given contractor is aimed either at violating the law or a fraud. The presence of any of the below circumstances may (but does not have to) imply that transaction terms and conditions fail to guarantee the security of trading:

• the possibility of making effective complaints about purchased goods is limited;
• there is a lack of product insurance and warranty despite their high value, unless other forms of safeguards have been introduced; 
• including additional safeguards in the contract, e.g. contractual penalties is not possible;
• making arrangements concerning the transport, e.g. the transport of goods from the taxpayer is always performed by the contractor or the next purchaser is not possible, defining the conditions of transport, storage or the place of receipt of goods is not possible;
• accurate verification of product quality is not possible, e.g. any opening of the outer packaging is forbidden, product serial numbers must be entered on the outer packaging and cannot be compared with the actual numbers on the products.

The main conclusion that can be drawn from the above hints is that the factor responsible for the fact that transaction terms and conditions are very much different from those in place in a given industry is a clear economic advantage of the supplier of goods, which impacts, among others, the negotiating options as regards transaction terms and conditions. If the business offer is very tempting, but the underlying terms and conditions leave you with limited powers of changing the transaction conditions and your position as the purchaser of goods is plainly weaker (which is rather unusual as such), it may mean that the contractor has dishonest intentions. Such a transaction may be a part of a tax fraud.

Supply of goods that fail to comply with quality requirements

This assumption applies to particular industries that impose specific quality requirements on goods, and a failure to meet these requirements results in penalties for entrepreneurs. The MF provided fuel trading as an example of goods with many quality requirements. When purchasing this type of goods, we should receive documents attesting their quality from the contractor, so if the supplier refuses to furnish relevant documents, it probably means they do not have them. And this, in turn, greatly increases the exposure to tax fraud.

The transaction is not documented in a contract, purchase order or any other confirmation of terms and conditions

The Ministry of Finance has acknowledged the present dynamics of business operations and noted that in some cases it may be difficult to conclude an agreement in writing. The traditional waiting for a signed contract to be delivered makes the entire process of purchasing the goods and finalizing the deal much longer. Therefore, the MF allows for documenting the transactions in electronic form (e.g. in the form of e-mails or scanned contracts or purchase orders). The most important thing is that in the event of a tax audit we must be able to prove and confirm the business terms and conditions of purchasing given goods. If the contractor makes it difficult for us to document the transaction properly, i.e. it is not possible to conclude a contract ‘on paper’ or obtain, even by e-mail, the general terms and conditions of cooperation setting down in black and white the scope of obligations of each party, the subject of the transaction and the price, then we should ponder upon the intentions of our contractor. Is there any economic and rational explanation why our supplier refuses to define the terms and conditions of cooperation? If the taxpayer cannot explain it reasonably, refraining from the purchase of goods from the entity in question should be considered. In such situations, the risk of being involved in a tax fraud can be very high.

The contractor, being a shareholding company, has a share capital that is disproportionately low in comparison with transaction circumstances

According to the Ministry of Finance, a possible indication of being involved in a tax fraud is the fact that our contractor, being a shareholding company (either a joint-stock company or a limited liability company), has a grossly low share capital in relation to transaction circumstances. In the case when the contractor’s share capital is low, concluding transactions of high monetary volume may adversely affect their credibility and professionalism. The value of share capital reflects the assets owned by the company, and safeguards the interests of prospective creditors of the company. Thus, if the transaction value greatly exceeds the value of the contractor’s share capital, it may mean that the contractor does not have sufficient cash to hedge the transaction. As a result, this transaction may be subject to tax risk; nevertheless, everything should be analysed with due consideration for the circumstances of a given transaction. It should also be remembered that at present the share capital is no longer the only guarantor of the contractor’s reliability and solvency. The business credibility is now measured with a number of parameters; what is essential is that in case of doubt we should be able to demonstrate the factor (or factors) we considered to hedge our risk sufficiently. We can also imagine situations in which greater risk is simply acceptable; let us not forget that risk is an indispensable element of any business.

Contractor does not have a website with information corresponding to the scale of their business, even though it is commonplace in a given industry

There is a saying “If you are not on the Internet, you do not exist”. In the era of the Internet, having a website or a social media profile is commonplace in most industries. However, it is not always the case, as the MF has justly noted. Therefore, this circumstance should be evaluated with due consideration for the specific nature of the industry. It happens that the operation of certain enterprises is based solely on what is known as whispered marketing or recommendations from other contractors. In such situations, not having a website is not suspicious at all. Thus, if our contractor does not have a website (or is not present in the social media), there are two possible scenarios: 1 – their enterprise is thriving and they do not care about publicity, 2 – they are tax evaders. When making this judgement, we should consider the remaining transaction circumstances and perform a thorough analysis of the contractor.

That is all as regards the assumptions behind observing due diligence at the onset of cooperation with a new contractor. According to the Ministry of Finance, the circumstances set forth in the Methodology constitute rational measures that can be required from honest entrepreneurs. Is this really the case? Even though the list is long, it acknowledges the current realities and a growing number of tax evaders. Despite the fact that following the recommendations presented in the Methodology is not going to ensure 100% protection for you, ”forewarned is forearmed”, as the old saying goes. Therefore, we would like to encourage you to take these steps and prepare an in-house contractor verification procedure. Our Team of experts will be happy to help you with this. If you are interested, please contact us.

How to protect yourself from being involved in a tax fraud when you continue your cooperation with a contractor? We will try to answer this question soon in the next episode of our series.