How to verify the contractor to avoid being involved in a tax fraud (part 1)

Przemysław POWIERZA
Tax Partner at RSM Poland

In the last Tax Alert, we informed you that a Methodology had been published to present common guidelines addressed to tax officials and concerning the evaluation of due diligence compliance by the taxpayer. Today I am going to present my first post dedicated to this topic, in which I will discuss the guidelines set forth in the Methodology and outline potential risks that may arise if you ignore the Ministry’s guidelines for the National Revenue Administration officials.

In order to observe due diligence, the taxpayer should verify the contractor (supplier of goods) and analyse the circumstances of the transaction they are entering into. The Methodology offers guidelines on how to verify your contractor, yet it fails to provide a comprehensive list of methods. On the one hand, this is good news for taxpayers, because a failure to implement actions (all or only some) provided for in the Methodology is not going to immediately result in a refused right to VAT deduction. The taxpayer can prove that they have observed due diligence in another way. There is the other side of the coin, though. As there is a multitude of situations the practice of economic life may bring. The tax authorities may take completely different transaction circumstances and actions taken by the taxpayer, not defined in the Methodology, into account. Thus, there is always a risk that following only the guidelines defined in the Methodology will not be enough. The NRA officials may decide that you should have done more and you should have known that you were a party to a transaction that was part of a fraud scheme or VAT abuse. Theory? No way, let’s get down to the details.

Starting cooperation with a contractor

Starting cooperation with a contractor should be understood as a situation in which the taxpayer enters into a business transaction involving goods with an entity that:

• has never been their contractor in such transactions before or
• has already been their contractor in some transactions, but the new transaction covers goods from different industries or typical for a different business profile, and the taxpayer had not purchased such goods before.

Formal criteria

The first and fundamental action the taxpayer should take when verifying the contractor is to check if the entity in question really exists. So what should we do? Firstly, verify if the contractor is:

• registered with the National Court Register (KRS) or the Central Registration and Information on Economic Activity (CEIDG) – provided that such registration is required in the first place;
• registered as an active VAT payer: check the contractor’s status on the Tax Portal and see whether they have been registered or removed from VAT (using MF lists).

In addition, we should check whether:

• the contractor has the required licenses and permits concerning the goods involved in the planned transactions;
• persons authorized to act on behalf of the contractor are duly authorised (using data available in KRS or CEIDG).

Apart from taking the aforementioned steps, we should remember to document them, e.g. as screenshots, print-outs from the register or e-mails. The documentation (whatever its form) must include the date as proof that we have performed a given verification effort before starting cooperation with the contractor.   

Transaction criteria

When creating a list of transaction circumstances, the MF was guided by the “too good to be true” rule. In a nutshell, if transaction conditions are too good to be true, we should be suspicious and take action to avoid being involved in a tax fraud. We must bear it in mind, however, that when deciding if given business decisions are justified or not, we should always apply the taxpayer’s perspective: it is the taxpayer that is taking a certain risk, independently goes for a given solution and, finally, it is the taxpayer that is aware of possible loss or profit when taking the risk. The idea behind any business activity is not about paying taxes, but making an acceptable net profit (already after tax).

Concluding a transaction without economic risk

If something is too good to be true, it is probably part of a tax fraud. At least this is the NRA’s line of thinking. In business transactions, it is an unusual circumstance for our supplier to immediately designate a potential buyer, being a client who would buy the goods from us straightaway and pay a price higher than our costs of purchase. What is more, the buyer would pay for the goods before we pay our contractor. According to the MF, such a situation completely eliminates any economic risk for the taxpayer, because it does not require our initiative in pursuing transactions or any involvement of our own financial assets (we pay with money obtained from the new buyer of the goods). The MF pointed out that there is a risk of being involved in tax fraud if instant bank transfers are used to make payment for the goods. Let us bear it in mind that the said conclusion is hedged with a wide range of assumptions, and an advance payment for the goods received from a recipient known well in advance does not automatically prove a fraud. The reasons for this kind of transaction arrangement can be different and have absolutely nothing to do with any VAT fraud. However, it should be considered that with this type of business terms, we can almost be sure to be targeted by the NRA, and for this very reason it is worth to be ready to provide a reliable substantiation.

Making a cash payment or getting a reduced price for cash payment, if the transaction value exceeds PLN 15,000

If the transaction value exceeds PLN 15,000, making a cash payment, getting a discount that hinges on a cash payment or consenting to an artificial division of the transaction into a number of payments smaller than PLN 15,000 may be frowned upon by the tax authorities (rightly, as a matter of fact). This is because we have an obligation to make a payment to the entrepreneur’s bank account whenever a single transaction value exceeds PLN 15,000 (Article 19 of the Act of 6 March 2018 Law on Entrepreneurs). Therefore, if the contractor requires a cash payment or offers a discount for a payment made in cash in the event in which the transaction value is higher than PLN 15,000, you need to show increased vigilance or preferably opt out of the transaction. A trivial saving will cause a lot of problems, and solving these problems can cost us dearly. Non-cash payments help eliminate fraud (not only tax fraud); hence every honest entrepreneur and taxpayer has no interest in avoiding such payments. Let us remember that fraudsters are not only robbing us, but also spoiling the market. They offer lower prices in a dishonest way.

Payment for the goods to two separate bank accounts, a third party’s bank account or a foreign account

We should exert extreme caution also if the contractor demands payment to be made to two separate bank accounts, a third party’s bank account or a foreign account, unless there is an evident economic substantiation. According to the Ministry of Finance, what is chiefly suspicious is a situation in which the net price for purchased goods is supposed to be paid to one bank account and VAT to another bank account designated by the contractor. The thing is that this type of payment is not necessarily proof of fraud. Sometimes entrepreneurs make a payment for a given transaction in two different currencies. On the invoice, the VAT amount is defined in PLN. This is a requirement set forth in the tax legislation. This amount is then paid to the PLN bank account, whereas the net price may be provided in a different foreign currency (this amount being paid to a foreign currency bank account). This effort is necessary if the supplier minimizes the foreign exchange risk. They avoid currency conversion and potential unnecessary losses, if the VAT must be transferred in PLN. Non-standard payment methods are sometimes used for debt recovery services or factoring, as well. Fortunately, the MF has noticed that it is a usual practice to make payments to a third part’s bank account or a foreign account, among others in the case of a factoring or assignment agreement. Thus, in this case there are no foregone conclusions.

The remaining assumptions behind observing due diligence at the onset of cooperation with a new contractor will be discussed in the next episode of our series; therefore I would like to encourage you to follow our blog. However, it would be a good idea now to consider preparing an internal verification procedure. It greatly helps to minimize both the risk of being involved in fraud and the necessity to spend a lot of money defending your reputation, not to mention the losses resulting from the payment of someone else’s tax. Our Team of experts will be happy to support you in the preparation of necessary protection tools. If you are interested, feel free to contact us.