How to verify a contractor to avoid being involved in a tax fraud (part 4)

Przemysław POWIERZA
Tax Partner at RSM Poland

In the previous parts of this series, we discussed assumptions behind evaluating due diligence at the onset of cooperation with a contractor. The criteria of analysing due diligence for continued collaboration with the current supplier of goods constitutes the next topic.

Let us recall that starting cooperation with a contractor will include not only business transactions with a new entity, but also cases of entering into such transactions with the current supplier that are different from those entered into before, i.e. they involve goods either from a different industry or typical for a different business profile. Thus, what should be understood by continued collaboration with a contractor? This is about entering into regular purchase transactions involving goods that are typical for the industry or the business profile of our supplier. Hence, we are not dealing with a new situation by any means , and for this reason alone, it is a very difficult element of every hedging procedure. You must detect weak warning signals without straining your business relationships with the existing business partners. After all, after years of collaboration it is difficult to ask a question like: “Hey, listen, are you really an honest entrepreneur?”

The Ministry of Finance has pointed out that for collaboration with a contractor, the credibility assessment should be adjusted to the existing business relationship between the taxpayer and the supplier. It was indicated that formal and transaction criteria for regular contractors defined in the Methodology can be applied, provided that it is ascertained that no breach of formal and transaction criteria addressed to new suppliers we wrote about in previous posts took place in the earlier transactions with the supplier (available here: part 1, part 2, part 3). This means that if you have failed to verify your supplier at the onset of cooperation according to the criteria put forward by the MF, then you should still do it anyway when you continue this collaboration, so that you are ready to prove that neither formal nor transaction rules were breached in earlier transactions.  

Verification of current suppliers

Under the Methodology, the type of criteria for checking the cooperation with regular contractors is almost the same as the method of investigating new suppliers. What we have here again is the division into formal and transaction criteria. However, if the taxpayer is to prove that they have exercised due diligence, there is more to it than just documenting that suppliers of goods have been verified once in line with the Methodology. The taxpayer should additionally monitor both their contractors and the cooperation with them with a view to the circumstances which may bring the risk of exposure to tax fraud. What should we focus on when checking our contractors? How often should we be doing it? You can read about it below.

Formal criteria

What is fundamental for any formal verification of a contractor is that it must be performed on a regular basis. What steps should be taken by a taxpayer who continues their cooperation with a given contractor? What should be verified on a regular basis is whether:

1. the contractor is still registered as an active VAT payer: check the contractor’s status on the Tax Portal;
2. the contractor has been entered to the list of taxpayers removed from the VAT register maintained by the Head of the NRA, unless the contractor was registered again at a later date;
3. the contractor still holds the required licenses and permits;
4. persons concluding the contract/entering into the transaction are still duly authorised to act for and on behalf of the contractor.

The basic question is: how often does ‘on a regular basis’ mean? Unfortunately, the Ministry of Finance has failed to define this. Since it has been stated that, for collaboration with the contractor, the credibility assessment should be adjusted to the existing business relationship, then the taxpayer should define for themselves how often they should investigate the formal criteria in respect of their regular suppliers. What should be taken into account here is the type of business and the industry in which they operate, the number of domestic suppliers of goods or the volume of turnover with the contractor. After all, the frequency of verification is going to be different for regular key suppliers and different for business partners from whom we purchase small quantities on rare occasions. We should also consider our administrative and organisational resources here. No entrepreneur is able to check whether their contractor has not lost any of the aforementioned attributes by any chance on a 24/7 basis. In turn, checking whether the contractor still holds valid licenses and permits and whether the person with whom we agree transaction terms and conditions is still duly authorised by the contractor to do so requires soliciting information directly from the supplier, which may turn out to be burdensome, as well. Based on the analysis of all these circumstances, the taxpayer should determine how regularly they will be checking if the formal criteria are being met. You must remember to document any supplier verification you have carried out, so that in the event of a tax audit you can prove that you have performed it on a regular basis.      

Transaction criteria

The most crucial factor in evaluating the contractor’s credibility is the presence of any change – without economic justification – in the cooperation terms and conditions applied so far. In such a case, the contractor’s intentions play a decisive role. The remaining circumstances which indicate a possible lack of proper due diligence exercise are as follows:

• concluding a transaction without economic risk;
• making a cash payment or getting a reduced price for cash payment if transaction value exceeds PLN 15,000;
• making a payment for the goods to two separate bank accounts (this does not apply to the split payment mechanism), a third party’s bank account or a foreign account;
• purchasing goods at a price considerably different from the market price without economic substantiation;
• purchasing goods that belong to a different industry than the one in which the contractor operates and that had not been purchased by the taxpayer from this contractor before, without economic substantiation;
• payment term being shorter than a standard payment term offered by other suppliers in this industry – without economic substantiation;
• transaction terms and conditions failing to guarantee the security of trading, according to standards in place for a given industry;
• supplied goods failing to comply with quality requirements;
• transaction not documented in a contract, purchase order or any other confirmation of terms and conditions;
• the fact that in previous transactions the contractor changed the method of transporting goods without any substantiation (e.g. the goods were supposed to be delivered from Poland, but are transported from the territory of a different country).

Wrapping up, the most essential risk factors connected with monitoring the collaboration with the contractor which may be targeted by the NRA are that the taxpayer has failed to verify the formal criteria on a regular basis and that the earlier terms of cooperation between the taxpayer and their contractor have changed without any economic substantiation. All the aforementioned premises (except for the last one) the NRA officials will be guided by when evaluating whether the taxpayer carried out proper due diligence have been discussed in detail in previous parts of this series; if you are interested, we encourage you to do a close reading and contact our advisors.

Is there anything else can you do to safeguard yourself from sanctions imposed by a tax authority? What does the split payment mechanism have to do with due diligence? I am going to discuss this in my next post.