Anna Vynnychenko gave a comment in the “Mirror of the week” newspaper regarding due tax diligence.

Anna Vynnychenko gave a comment in the “Mirror Weekly” newspaper regarding the ruling of the Higher Administrative Court from March 26, 2014, which caused quite a stir in the legal community.

On March 26, 2014, the Higher Administrative Court issued a ruling in case No. К9991/26540/11. This ruling caused a significant uproar in the legal community, as the controlling authorities immediately adopted it as a guideline.

The controversy was sparked by the conclusions that a taxpayer should be reasonable and diligent when choosing a counterparty, and that checking the supplier’s state registration and tax authority registration does not characterize the business as a good faith taxpayer.

Thus, the court believes that the responsibility for a dishonest counterparty lies with the taxpayer, who did not sufficiently gather information about the counterparty and its officials before entering into agreements with them.

Based on this position, the taxpayer is expected to investigate the counterparty’s market reputation, which, in practice, can be difficult due to time and resource limitations.

This ruling expresses a position that is contrary to the previously established practice of the Higher Administrative Court. For example, in the decision of the Higher Administrative Court dated January 10, 2012, in case No. К/9991/81953/11, it was stated: “Article 18 of the Law of Ukraine dated May 15, 2003, No. 755-IV ‘On State Registration of Legal Entities and Individuals—Entrepreneurs’ establishes that if the information that is to be entered into the Unified State Register has been entered, it is considered reliable and can be used in disputes with third parties until changes are made. If the information entered is unreliable, third parties can rely on it as reliable in a dispute unless they knew or could have known that the information was false. From the case materials, it is evident that the claimant relied on such information in contractual relations with LLC ‘T.A.V.-Engineering’.”

Moreover, as the claimant reasonably states in the cassation appeal, current legislation does not oblige or empower legal entities to verify the compliance with legislation and the accuracy of the constituent documents, certificates of their counterparties in agreements, or the authenticity of their signatures. The claimant, as a taxpayer, acted within the framework of the applicable legislation, unaware of the counterparty’s intentions, and is not responsible for its reporting. In addition, the courts unreasonably disregarded the claimant’s arguments that they had no right to request documents from the counterparty to prove who performed the accepted works or to verify the number of employees of the counterparty, and thus there were no violations of the current tax legislation on these grounds.

According to the letter from the Higher Administrative Court “Problematic issues of applying legislation in cases involving state tax service bodies” No. 1112/11/13-10 dated July 20, 2010, it states: “In this regard, violations of tax discipline committed by the taxpayer’s counterparty are not grounds for denying the right to tax credit and budget reimbursement for value-added tax. Furthermore, the termination or annulment of a counterparty’s value-added tax payer status does not constitute grounds for declaring the taxpayer’s operations as unlawful. All transactions conducted by the taxpayer’s counterparty before the termination of such counterparty cannot automatically be considered as invalid legal acts simply because the legal entity has ceased to exist or its tax status has been revoked.”

Moreover, the position expressed in the ruling of March 26, 2014, in case No. К9991/26540/11 contradicts the country’s fundamental law, which states that the legal liability of an individual is of a personal nature (Article 61 of the Constitution of Ukraine).

Tax legislation also specifies that the taxpayer is responsible for non-performance or improper performance of tax obligations, except in cases defined by the Tax Code or customs laws (Section 36.5, Article 36 of the Tax Code of Ukraine).

Paragraph 2 of Article 8 of the Code of Administrative Procedure of Ukraine dated July 6, 2005, No. 2747-IV, provides that the court shall apply the principle of the rule of law, taking into account the case law of the European Court of Human Rights.

To date, three decisions of the European Court of Human Rights can be noted regarding the mentioned issue. These include decisions in the cases of Interspflav v. Ukraine (2007, application No. 803/02), “Bulves” AD v. Bulgaria (2009, application No. 3991/03), and Business Support Center v. Bulgaria (2010, application No. 6689/03).

In the case of Interspflav v. Ukraine (para. 38 of the decision), the European Court of Human Rights ruled that a taxpayer cannot be deprived of the right to budget reimbursement of VAT in the absence of evidence that they were involved in illegal activities related to unlawful receipt of budget reimbursement.

Specifically, the practice of the European Court of Human Rights, which is a source of law according to Article 17 of the Law of Ukraine “On the Execution of Decisions and Application of the Practice of the European Court of Human Rights,” indicates that if government agencies have information about abuse in the taxation system by a particular company, they must apply the corresponding measures to that entity specifically, rather than extending the negative consequences to other individuals (European Court ruling of January 9, 2007, in the case “Interspflav” v. Ukraine).

Thus, based on the current legislation of Ukraine and the practice of the European Court of Human Rights, it can be argued that a VAT taxpayer does not lose the right to tax credit and budget reimbursement in the event of abuses by their counterparties, not by themselves. The taxpayer also does not have to verify the business reputation of a counterparty if they have state registration and registration with the tax authorities, let alone prove in court the efforts they made to establish the counterparty’s market competitiveness, as under Article 71 of the Code of Administrative Procedure of Ukraine, in administrative cases regarding the illegality of decisions, actions, or inaction of an authority, the burden of proof regarding the legality of the decision, action, or inaction lies with the defendant if they oppose the administrative claim.