Knew or should have known of VAT fraud

Combating VAT (turnover tax) fraud has been on the agenda of the European member states, including the Netherlands, for several years. Many rulings have been issued in recent years in particular by the Court of Justice of the European Union concerning the consequences of committing tax fraud. The line pursued in these rulings appears to be as good as complete now. In short, a taxable person is not entitled to invoke the right to deduction of input tax, apply the zero rate or obtain a refund if he knew or should have known of fraud elsewhere in the chain. In pursuing this line, the discussion on fraud cases will focus on the question of whether the taxable person knew or should have known of the fraud. I will discuss this in more detail below.

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Turnover tax levy

The Turnover Tax Act 1968 states that a tax is levied on all goods and services that are for sale in the Netherlands. Entrepreneurs charge the turnover tax (more commonly known as VAT) to the final buyer of the product or service. Often, before a product is purchased by the end consumer, it has gone through several links in the chain of entrepreneurs. ‘Something’ is added at each of those links by each of those entrepreneurs.

Every entrepreneur in the chain must charge VAT to his buyer (entrepreneur or consumer). The entrepreneurs in this chain collect the VAT from their buyers and pay this VAT to the Tax Authorities. On the other hand, the entrepreneur may then deduct the VAT charged to him. This ensures that the VAT levy between the entrepreneurs in the chain is tax-neutral and payment of the VAT ultimately rests with the end consumer. This is the person that ‘consumes’ the product or the service.

Example of a chain

Nederlands Engels
Leverancier grondstof Raw materials supplier
Producent van grondstof naar mobiele telefoon Raw material to mobile phone manufacturers
Groothandel mobiele telefoons Mobile telephone wholesaler
Winkel/verkoper mobiele telefoons Mobile phone shop/retailer
Consument die de mobiele telefoon koopt Consumer that purchases the mobile phone

 

The chain from entrepreneur to consumer does not have to play out only in the Netherlands. In practice, the chain regularly extends across Europe and the world. For example, the suppliers of the raw materials and the manufacturer are located in Italy and the wholesaler, retailer and consumer are in the Netherlands.

The assumption then is also that the VAT chain between the entrepreneurs VAT neutral. To facilitate this, intracommunity supplies and acquisitions of goods was incorporated into the VAT levy. The entrepreneur that supplies goods intra-communally to another entrepreneur (for example, the manufacturer to the wholesaler in the aforementioned chain example) does not have to charge VAT, but can deduct the VAT charged to him (with the purchase of the raw materials from the supplier) in advance. The VAT levy on the supply of the mobile phones is therefore actually moved from the manufacturer to the wholesaler in the example. The wholesaler then charges VAT to the shop/retailer. That link may also take place via the system of intra-community supplies and acquisitions.

What constitutes fraud?

The turnover tax system makes certain that VAT is susceptible to fraud. After all, the advance tax deduction is in no way linked to the payment of the relevant turnover tax. There is therefore a chance that, for example, the wholesaler does not declare the intra-community acquisition of the mobile phones, charge the shop/retailer VAT, and then does not pay that VAT to the Tax Authorities. In that case, there is a flaw in the VAT levy. The wholesaler has received the VAT, but does not declare it. This creates a financial advantage for him. In order to actually gain that advantage, the wholesaler disappears. This is often solved in the chain by establishing a new wholesaler, often with the same goal.

This type of fraud is generally called ‘carrousel fraud.’ There is no fixed definition for the concept ‘carrousel fraud,’ but various descriptions can be found. The core [1] of these descriptions is always that there is an invoice flow (real or not) that corresponds with trade transactions with at least one of the parties involved charging VAT in their own country, while he knows that he will not be declaring that amount on his tax return. The VAT that this party does not pay to the Tax Authorities will, however, be deducted by his buyer.

To match the description of a ‘carrousel fraud,’ it is no longer relevant that the goods go full circle (‘carrousel’). The crucial factor is that one party charges VAT, knowing that he is not going to declare it to the Tax Authorities and that his buyer will deduct the VAT that was charged to him. This seems to open the way for the case law that has been mainly set by the Court of Justice of the European Union to ensure that carrousel fraud cases also apply to all types of VAT fraud.

Apparently, the financial benefits of VAT fraud are lucrative enough that people are engaging in this on a large scale. This means that significant amounts of VAT cannot be collected. This is a cause of frustration for the European Union and the member states and they want to do their utmost to quash this type of fraud. This, however, may not involve taking rash action. The ‘good’ entrepreneurs should not have to suffer because of the ‘bad’ entrepreneurs’ actions. But what makes you a good entrepreneur? And when does the case law of the Court of Justice of the European Union apply to your ‘VAT fraud’?

Knew or should have known?

To determine if someone is a ‘good’ or a ‘bad’ entrepreneur, it must first be established if the entrepreneur in question is himself a fraud. If it is determined that this is indeed the case, this entrepreneur will, in fact, lose all this rights. As follows from the following paragraph, this entrepreneur will not be entitled to his right to deduct input tax in advance, to apply zero rate or a refund for number acquisition. However, it is usually not the ‘bad’ entrepreneurs that end up suffering the consequences of VAT fraud. These ‘bad’ entrepreneurs’ business is often set up with the goal of committing VAT fraud and making (a lot of) money before disappearing into the sunset. The chances of the Tax Authorities catching this ‘bad’ entrepreneur and recouping the wrongfully collected monies (or unpaid taxes) are therefore minimal.

It is therefore primarily ‘good’ entrepreneurs that have to deal with the adverse consequences of VAT fraud. The only way to avoid these adverse consequences is if the entrepreneur in question did not know and could also not have known of the VAT fraud.

These concepts of ‘knew’ or ‘should have known’ are not clear at a glance. Although the first concept, ‘knew,’ is clearer than the second, ‘should have known,’ it will have to be established what the knowledge of the entrepreneur was, using the facts and circumstances.

In the past, I made a comparison with ‘knew’ or ‘should have known,’ as it is used in the criminal and penalty law. For the ‘knew’ concept, a connection could be sought with the concept of ‘intent’. Intent is when someone knowingly and intentionally commits a finable or punishable offence. In other words, if someone consciously undertakes a specific action. If we apply this to VAT fraud, this means that the entrepreneur in question knows that VAT fraud is being committed, but that he nevertheless continues to participate in that transaction or in that chain in full awareness. In practice, it will not be this situation that gives rise to discussion between the parties, but the question of when a business owner ‘should have known’ of the VAT fraud in the chain.

For the explanation of ‘should have known,’ a connection may be sought with the concept ‘gross negligence’ from the penalty and criminal laws. Gross negligence is when the party involved did not want the relevant consequence, but it can be blamed on his negligence, carelessness, or neglect that the consequence has occurred. It can be deduced from this that a ‘good’ entrepreneur must be attentive and must act with due care. To comply with this, the entrepreneur has a certain obligation to investigate. This obligation to investigate means that an entrepreneur must do everything that may reasonably be expected of him to ensure that his actions are not part of a fraud chain (Court of Justice, Mahagében, 21 June 2012, joined cases no. C-80/11 and C-142/11 (Peter David).

Consequences of knowing of fraud?

It must be assessed for each taxable action whether the entrepreneur ‘knew or should have known’ that VAT fraud was being committed (Court of Justice, Optigen, 12 January 2006, joined cases C-354/03, C-355/03 and C-484/03). Within a chain, this may cause the entrepreneurs to be treated differently. One entrepreneur may have acted in good faith (did not know and also could not have known) and another entrepreneur may have known or should have known of the fraud.

If it is established that an entrepreneur knew or should have known of the VAT fraud, this will have significant consequences. It follows from the Italmoda ruling that in that case an entrepreneur is not entitled to the right to deduction of input tax, to apply the zero rate and/or obtain a refund for number acquisitions. These penalties even occur if the national legislation does not provide for this option. The Supreme Court even explicitly takes this into consideration in the ruling of 18 March 2016, no. 11/02825, ECLI:NL:HR:2016:442 (see ground for the decision 2.1 and 2.2).

If the entrepreneur has already exercised his right to deduction of input tax in the turnover tax return, he will receive an additional assessment to pay back the amount wrongfully deducted in advance to the Tax Authorities.

  1. The other possibility is that the entrepreneur exported the goods to another country with the application of the zero rate. If the entrepreneur can be charged with knowing about the VAT fraud, he will not be permitted to apply the zero rate, despite that the conditions ((i) right to dispose of the goods has been transferred, (ii) the goods are physically moved from one Member State to another and (iii) the goods have been supplied to an entrepreneur who has declared this as intra-community acquisition) have been fulfilled. The Court of Justice therefore rules that not all conditions have been fulfilled. The word ‘all’ refers to the fact that no VAT fraud must be committed. In this case, the entrepreneur will receive an additional assessment for turnover tax, in which the goods and/or services are taxed for VAT at the rate of 6% or 21%.
  2. Finally, there is the option to refuse a refund for number acquisition. In that case the entrepreneur has paid the VAT, but he is not entitled to a VAT refund.

The Court of Justice is of the opinion that VAT fraud must not pay off and that every effort should be made to combat and prevent such fraud. Should such fraud occur anyway, this may and should be dealt with severely, according to the recent case law of the Court of Justice. That this may possibly result in a breach of the fiscal neutrality in the VAT, the principles of legal certainty or the legitimate expectations is not important. Those principles, according to the Court of Justice, can and must be put aside if a taxable person knew or should have known of the VAT fraud in one of the links of his chain and in doing so jeopardised the proper functioning of the common VAT system.

At this time, there is still on-going discussion as to whether the Tax Authorities can handle all three possibilities for one taxable person simultaneously, i.e. refuse the deduction of input tax and the zero rate and the refund. If the Tax Authorities were allowed to apply all three options alongside each other, this would create a double or triple tax. This cannot and could not have been the intention of the Court of Justice’ ruling. After all, the entrepreneur will then be ‘punished’ twice or thrice. The entrepreneur, for example, does not get deduction of input tax for the same goods and moreover, instead of being able to apply the zero rate, has to pay 6% or 21% VAT to the Tax Authorities. That would be a double charge.

The basic premise should therefore be that the Tax Authorities must choose from the three options. The Tax Authorities must refuse either the deduction of input tax, or refuse to apply the zero rate or refuse to grant the refund. That this should be the point of departure also follows from the way in which the Court of Justice has formulated the answer to the stated prejudicial questions. In answering these questions, the Court of Justice includes “refusal of the right to deduction, exemption or refund of the tax on the added value” (underlining ML). By using the word ‘or,’ the Court of Justice shows that a choice must be made from the three options.

This reading/explanation of the Court of Justice’s ruling on the decision to be made is also shared by A-G Ettema in her conclusion of 1 February 2016.

Scope of ‘knew or should have known’

I have already explained that ‘knew or should have known’ of the VAT fraud has considerable consequences for an entrepreneur. The entrepreneur may lose his right to deduct input tax or to apply the zero rate. But can this case law of the Court of Justice be applied one on one in every situation? I wonder.

What if a tax consultant or a lawyer assists a foreign entrepreneur in a Dutch VAT fraud case. This tax consultant or lawyer will send a bill to the entrepreneur in question. It is likely that the service provider knew or should have known of the possible fraud being committed by his client. After all, the service provider will have received procedural documents with an explanation of the suspicion (if it is a criminal case) or the corrections by the Tax Authorities (if it concerns a fiscal correction and a fine). Can the service provider still be ‘careless’ in his declaration in applying the zero rate and send it to his client? Can the service provider be confronted with the refusal to deduct input tax for, e.g. the paper that the declaration is printed on, or the pen he used for his signature?

The Court of Justice has not given a definite answer to these questions yet. The procedures that have been presented to the Court increasingly looking like ‘genuine’ cases of fraud. The inspector and also the prosecutor, like to quote the phrase, ‘Surely it could not be that…’. I think that phrase equally applies to this. Surely it could not be that a service provider is confronted with the case law of the Court of Justice in the area of VAT fraud and therefore loses his right to apply the zero rate or to deduct input tax because he provided legal representation to an entrepreneur who is suspected of/confronted with VAT fraud.

Conclusion

 VAT fraud is a cause of frustration to both the European Union and the member states. With assistance of the Court of Justice, every possible effort is being made to reduce VAT fraud and, in the best-case scenario, to prevent it. Although a distinction is made here between ‘good’ and ‘bad’ entrepreneurs, this distinction is very flimsy. Only an entrepreneur who did not know or could not have known that VAT fraud was taking place will be immune from this problem.

 It is therefore also important that even if entrepreneur is doing everything right himself, but he does know or should have known that one of the links in his chain is committing VAT fraud, the entrepreneur will not get off scot free. He knows or should know of fraud and can therefore also be confronted with the adverse consequences, namely:

  • refusal of the application of the zero rate, in which case the entrepreneur still has to pay the regular rate of 6% or 21% to the Tax Authorities, or
  • refusal of the right to deduction of input tax, in which case the entrepreneur must pay back VAT deducted in advance, or
  • refusal of the refund for number acquisition, in which case the entrepreneur has paid the VAT but does not have it refunded.

Due to this hard line in the case law, the core of the discussion with the Tax Authorities in VAT fraud cases will increasingly focus on the question of whether the entrepreneur ‘knew or should have known’ of the VAT fraud. So far, these concepts have not been given sound definitions, so there is room for the entrepreneur to escape the adverse consequences of VAT fraud in his chain.

[1] Dr. R.A. Wolf, LLM, Carrouselfraude, Fiscaal Wetenschappelijke Reeks (Carrousel Fraud, Fiscal Science Series), no. 15, SDU publishers, chapter 3.

Marloes Lammers, Attorney at Law

 

Reduction of the default penalty: how to achieve that?

Every year, millions of Dutch people receive a request from the Tax Authority to declare their income by filing a tax return. This declaration must be submitted within a period set by the inspector (usually by 1 April). A taxpayer may request an extension. If the declaration is not received on time, the inspector will send a reminder. If the taxpayer still does not respond or responds too late, the inspector may impose a default penalty. This default penalty can be a substantial amount. If you or your client has received a default penalty, read here how – under what conditions – that penalty can be significantly reduced.

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Obligation to file a tax return

For income tax and corporate tax, a taxpayer is invited by the inspector to make a declaration. The taxpayer is then obliged (AWR, Article 8) to respond to this to this invitation. The deadline for this is at least one month. In practice, this means that the income tax return must have been filed before 1 April. This year taxpayers were given a longer deadline, namely until 1 May. A corporate tax return generally has to be filed before 1 June. A taxpayer and/or his tax consultant may ask the inspector to extend the deadline for filing the income tax and/or corporate tax return (AWR, Article 10).

If the inspector has not received the tax return before the end of the deadline, the taxpayer will be sent a reminder (AWR, Article 9). In this reminder, the inspector will provide the taxpayer with an additional deadline for filing the tax return. If the taxpayer still does not file the tax return form or is late in doing so, the inspector may impose a penalty. That penalty may be a default penalty or a financial penalty.

A default penalty is imposed if a tax return is not filed or not filed on time. If a tax return is intentionally not filed, the inspector may impose a financial penalty. This blog examines the default penalty for not filing, or the late filing of, tax returns in more detail.

Default penalty

If the tax return is not filed, or filed late, the inspector may impose a default penalty. In order to be able to do this, the inspector, as already mentioned earlier, will have already reminded the taxpayer to file a tax return. If the taxpayer ignores this reminder as well, he is in default.

Article 67a of the AWR stipulates that the maximum amount of the default penalty for not filing, or late filing of, the tax return is € 5,278. Further requirements connected to imposing a default penalty are set out in more detail in the Administrative Fines (Tax and Customs Administration) Decree (BBBB).

Paragraph 21 of the BBBB regulates that the inspector will impose a default penalty of 7% of the maximum, i.e. € 369.46, if the taxpayer has not filed, or is late filing, the income tax return. If it is a company that has not filed, or is late filing, its corporate tax return, the default penalty will be 50% of the maximum, € 2,639.

Absence of all blame

The inspector can and may not impose a default penalty if the taxpayer cannot be held responsible (BBBB, paragraph 4). If the inspector only realises this during the objection phase, he will render the imposed default void. The reasoning behind this is that if the taxpayer cannot be held responsible, he has also not been in default. When is the taxpayer at fault? Who has to prove that?

The burden of proof, in the sense of demonstrating that there is an ‘absence of all blame’ rests with the taxpayer. He must present the facts and circumstances on the basis of which it can be concluded that, under the given circumstances, he has tried to ensure in all reasonableness that the tax return was filed on time (HR 15 June 2007, no. 42687, ECLI:NL:HR:2007:BA7184).

It follows from case law that it is difficult for a taxpayer to tackle this burden of proof. In the majority of cases, an appeal made by the taxpayer based on the ‘absence of all blame’ is rejected by the tax court.

One example of where the appeal was granted concerned a taxpayer who had not thought of having to file a tax return during his illness. The ’s-Hertogenbosch Court ruled that the taxpayer could not be held responsible for filing the tax return late. This ruling concerned both the circumstance that the taxpayer had not thought of filing the tax return and the circumstance that he had not made any arrangements for a ‘replacement’ before he became ill. In the case of the latter, it was important that the taxpayer had, in fact, been caught unawares by a hernia, the necessary operations and the duration of his illness.

Another example of a successful appeal based on the absence of blame is the company that had engaged a consultant to file the corporate tax return on time. This consultant had asked the inspector for an extension for filing the tax return, using a new software package. It transpired later on that an incorrect tax number had been used. On receipt of the reminder (a reminder had been sent first) and the final notice, the company contacted its consultant. In turn, this consultant phoned the tax information line. The tax information line employee informed the consultant that without any notice to the contrary, he could assume that the reminder had been wrongly sent. Despite this, when calculating the corporate tax, a default penalty was imposed. The company objected to this. The court and the court are of the opinion that, considering the consultant’s responses, the company could assume that the reminder and the final notice had been wrongly sent. Because the company reacted decisively to the receipt of the reminder and the final notice, the court and supreme court ruled that the company acted with the due care reasonably expected of it. The company, according to the court and the supreme court, did not have to go so far as to check the statements of its consultant. The default penalty was rendered void.

 The imposition of a default penalty should be done on an individual basis

Proving an ‘absence of all blame’ is subject to strict testing. In practice, tax payers often appeal on this basis to no avail. Nevertheless, imposing a default penalty should be done on an individual basis. The BBBB affords the inspector some freedom in determining the amount of the default penalty. That freedom may or may not work in the taxpayer’s favour.

If a taxpayer consistently neglects to file the tax return time and time again, the inspector may increase the default penalty to the maximum of € 5,278 (BBBB, paragraph 21.6). This increase is higher for the income tax than it is for the corporate tax, because the starting points for both taxes are different.

The taxpayer who has received a warning from the inspector that the tax return has yet to be filed has three options: respond on time, respond late or not respond. If the taxpayer does not file the tax return within the additional period, but does so before the inspector calculates the assessment or decides on an objection, the inspector will reduce the default penalty (BBBB, paragraph 21. 8, BBBB). The taxpayer will then be given a default penalty of 1% of the maximum (€ 52.78) for the income tax and 5% of the maximum (€ 263.90) for the corporate tax.

Work agreements

It has now transpired that the Tax Authority and the Ministry of Finance have made other agreements than those provided laid down in the BBBB. These work agreements were initially not announced. To force this announcement, a request was submitted under the Government Information (Public Access) Act (WOB), with success. This WOB request ensures that the government, in this case the Tax Authority, must announce the work agreements on the reduction of default penalties. The Tax Authority has now done this.

These work agreements pertain to the situation that a taxpayer has not filed, or has been late filing, the income tax return and/or corporate tax return.

If the taxpayer has not filed the tax return and he then receives an estimated assessment, he can respond to this in two ways. First, he can object to the estimated assessment. That objection will then be processed by the inspector. The second option would be for the taxpayer to go ahead and file the tax return. The inspector will also regard such action as an ‘objection’.

In the first situation (objecting), the inspector will ask the taxpayer to still complete and file the tax return. The taxpayer will be given six weeks to do this. If the taxpayer fulfils this request, the inspector will assume that the taxpayer will improve his tax compliance behaviour (in the future). The imposed default penalty after the tax return has been filed (in principle, € 369.46) will then be reduced to € 49. In the case of corporate tax, the default penalty (in principle, € 2,639) will be reduced to € 246.

In the second situation (late filing of the tax return), the default penalty will be immediately reduced to € 49 (income tax) and € 246 (corporate tax).

It seems that a taxpayer who only files the tax return during the objection phase is treated better than the taxpayer who files the tax return before the estimated assessment is calculated, (although late). Paragraph 21.8 of the BBBB stipulates that in that situation a default penalty of 1% – € 52.78 – (income tax) or 5% – € 263.90 – (corporate tax) will be imposed.

To counter this unequal treatment, it is incorporated into the work agreements that in this situation the default penalty will also be reduced to € 49 (income tax) and € 246 (corporate tax). The Tax Authority’s system should process this automatically.

By filing the income tax and/or corporate tax return late, a taxpayer can reduce the imposed default penalty considerably. So, a big financial gain for little effort.

Conclusion

A taxpayer who is invited to file a tax return, must file it on time. If the taxpayer does not do this, he will receive a reminder to do so. If the taxpayer ignores this, the inspector may impose a default penalty. This default penalty is generally € 369.46 (income tax) or € 2,639 (corporate tax).

If the taxpayer cannot be held responsible for not filing the tax return, or for not filing it on time, a default penalty cannot be imposed or the imposed default penalty must be rendered void. The burden of proof of this ‘absence of all blame’ is difficult. However, this does not make the case hopeless for the taxpayer. The default penalty can be substantially reduced in a relatively simple way. How? By simply filing the tax return form. The inspector will then assume that the taxpayer has improved his tax compliance behaviour and as a reward for this the default penalty will be reduced to € 49 (income tax) of € 246 (corporate tax).

Mr. M.H.W.N. (Marloes) Lammers

Tax inspection: what are the rules of play?

Sooner or later all entrepreneurs are confronted with an inspection by the Tax Authority. This inspection may not only focus on the entrepreneur’s liability to pay tax, but also that of a third party (e.g. his customer or supplier). The Tax Authority has several possibilities for inspecting an entrepreneur. For example, the inspector may conduct an audit, visit the company or carry out an on-site observation. Experience shows that the Tax Authority is currently inspecting entrepreneurs’ balance sheet item, turnover tax. The strategy applied by the Tax Authority indicates that this inspection primarily focuses on investigating an entrepreneur’s culpability. That should set off the entrepreneur’s alarm bells immediately. What are our rights and obligations during a Tax inspection? Is the entrepreneur obliged to cooperate in establishing his/her culpability? I deal with these topics in this blog.

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Various inspection possibilities

The tax inspector has several possibilities for conducting an inspection on an entrepreneur. Firstly, the inspector may conduct an audit. The purpose of an audit is usually to inspect the entrepreneur’s tax returns and administration. The inspector may opt to audit a specific period or specific components of the tax returns and/or administration. The inspector usually spends (part of) a day at the entrepreneurs place of business to conduct the inspection. The inspector may also ask the entrepreneur questions during the inspection. The inspector also uses this inspection, for example, for the (latest) examination of an entrepreneur’s balance sheet item, turnover tax.

Another possibility is that the inspector wants to gain insight into the entrepreneur’s company and business procedures. In most cases, the inspector will visit the entrepreneur’s business premises.

The inspector may also carry out an on-site observation. The inspector does this to establish with his/her own eyes what actually takes place within the company on a day-to-day basis. The inspector does not give advance notice of this visit and it can therefore be labelled a ‘surprise visit.’ This strategy is frequently applied in hotel and catering establishments.

Finally, the inspector may conduct a so-called third-party investigation. This third-party investigation may focus on the taxation of the entrepreneur him/herself or that of a third party (e.g. one of the entrepreneur’s suppliers or customers). In the latter case, the entrepreneur will be confronted with a third-party inspection. In the first case, a third party, one of the entrepreneur’s customers or suppliers, will be confronted with an inspection by the inspector.

An entrepreneur has rights and obligations with respect to all of these inspections conducted by the Tax Authority. It is important to bear that in mind, so that no information can be provided involuntarily that the inspector may use against the entrepreneur later on.

Obligations

The point of departure for an entrepreneur’s obligations is the obligation to file a tax return in Articles 6 to 10 inclusive of the General Tax Act (hereafter referred to as: AWR). These are also called the primary obligations. In the majority of cases the primary obligations will not be addressed during a tax inspection, but rather the additional obligations of Articles 47-56 of the AWR. The most familiar additional obligations are: the obligation to provide information (AWR, Article 47) and the obligation to keep records and the obligation to retain (AWR, Articles 52 and 53).

Obligation to provide information (AWR, Article 47)

The obligation to provide information means that the entrepreneur is obliged to answer the inspector’s questions that are relevant for the imposition of taxes. This seems straightforward enough, however, in practice, it is not quite as straightforward as it seems. The inspector may, for example, only inquire about the facts and not the entrepreneur’s opinion. The inspector is not allowed to ask the question ‘Was trade in clothes the source of income?’ Instead, the inspector asks the entrepreneur to qualify certain facts (source of income). The inspector is allowed to ask ‘Have you purchased or sold clothes?’ This could be followed with: If yes, ‘for how much did you purchase or sell the clothes?’ etc., etc.

Another obstacle that may arise is the question how should the entrepreneur respond if the question is relevant for imposing taxes as well as for imposing a punitive fine. Any entrepreneur would, of course, be quick to say that they are not obliged to cooperate in their own conviction. But can he or is he entitled to do so? Unfortunately not. The entrepreneur is obliged to answer the so-called ‘mixed’ question. The only restriction is that the inspector is not allowed to use the answer to substantiate the fine. The entrepreneur is only entitled to invoke his/her right to remain silent on questions that are directly related to the imposition of a fine.

Under Article 47 of the AWR, the entrepreneur is also obliged to allow the inspector to examine the accounts, documents and other data carriers at its request. This obligation does not, however, entitle the inspector to an unlimited right to inspect. I discuss this in more detail under the entrepreneurs ‘rights.

Obligation to keep records and obligation to retain (AWR, Articles 52 and 53)

The entrepreneur’s obligations to keep and retain records are laid down in Article 52 of the AWR. Article 53 of the AWR subsequently stipulates that the entrepreneur is obliged to allow the inspector to examine his/her administration for the purpose of his/her own taxation and/or that of a third party.

The obligation to keep records enables the inspector to easily check that the entrepreneur complies with his/her rights and obligations for the tax levy. How the administration has to be set up and what it should include is not provided for in the legislation. What exactly should be included in the entrepreneur’s administration depends on the nature and size of the business. The administration may include:

  • cash transactions and receipts;
  • financial statements, like purchase and sales ledger;
  • incoming invoices and copies of outgoing invoices;
  • bank statements;
  • contracts, agreements and other arrangements;
  • agendas and appointment books;
  • correspondence.

The obligation to retain – in short – means that the entrepreneur is obliged to retain the administration for 7 years. Data on immovable property (deed of sale and civil-law notary invoice) are even subject to a retention period of 9 years.

Rights

In addition to the abovementioned obligations, the entrepreneur also has a number of rights. While the obligations are clearly set out in Articles 47-56 of the AWR, the entrepreneur’s rights are mainly to be found in the case law and the general principles of sound administration.

The most significant right that will spring to everyone’s mind is the right to remain silent. In tax audits, an entrepreneur can avail of this right sporadically. As already explained, an entrepreneur is obliged to answer the inspector’s questions. The entrepreneur is only entitled to invoke his/her right to remain silent on questions that are directly related to the imposition of a fine. The inspector shall caution the entrepreneur before asking a question that is directly related to a fine, so that the entrepreneur knows that he/she is not obliged to answer.

As already mentioned, the inspector assesses entrepreneurs’ balance sheet item for turnover tax. The inspector has drawn up a contingency plan for this inspection. According to this contingency plan the inspection of the balance sheet item, turnover tax, that is conducted at the entrepreneurs place of business is really only to establish the entrepreneur’s culpability (the liability). It is also noted in the contingency plan that, depending on the outcome of the inspection, a fine will be imposed on the entrepreneur. It can be deduced from this that if the inspector asks the entrepreneur any questions during the examination of the balance sheet time, turnover tax, these questions will only be pertinent the (possible) imposition of a fine. Consequently the entrepreneur is entitled to invoke his right to remain silent during this inspection.

Another right that the entrepreneur has is in fact a ban that the inspection has, namely the ban on browsing and/or the ban on fishing expeditions. The inspector may not, for instance, take it on himself to open or enter filing rooms looking for documents that may be interesting for tax purposes. The inspector will have to ask the entrepreneur have a specific document. Nor may the inspector sit behind the entrepreneur’s computer to look for documents that may be interesting for tax purposes. On the contrary, the inspector may ask to link his computer to the entrepreneur’s computer to facilitate the transfer of data.

In most cases, the entrepreneur will avail of the services of an accountant, tax consultant, civil-law notary and/or lawyer. Lawyers and civil-law notaries have a legally arranged right to non-disclosure (AWR, Article 53a). If the entrepreneur has received any correspondence and/or advice from a lawyer and/or civil-law notary (the latter is subject to some restrictions), the inspector is not at liberty to ask for these to be made available for inspection. Not even if the entrepreneur has included this correspondence and/or advice in his administration. This does not apply in the case of accountants and tax consultants. The do not have a legally arranged right to non-disclosure. Nonetheless, the inspector may not request that correspondence and/or advice from the accountant or tax consultant is made available to him for inspection if the object of that request is to advise the entrepreneur about his tax position. The fair play principle precludes the inspector from requesting to inspect.

It is important for an entrepreneur to take stock of these rights. During an inspection, the inspector is usually extremely eager to obtain as much information as possible. The accusation that the inspector is quick to make is that entrepreneurs look for loopholes in the law. The inspector understands what it is to be human. The inspector often treads the borderline between what may and may not be asked into order to obtain as much information as possible. So, be on your guard!

Conclusion

The abovementioned is a brief outline of the various types of inspections that may be conducted by the Tax Authority. I also briefly discussed the obligations and rights that an entrepreneur has during such an inspection. It is important that an entrepreneur is aware of these, so that he does not involuntarily provide information to the inspector that can be used against him later. This situation may arise when the inspector is examining the entrepreneur’s turnover tax balance sheet item. The contingency plan drawn up for such inspections shows that the only reason for conducting the inspection is to determine the culpability of the entrepreneur. This means that the entrepreneur is entitled to invoke his right to remain silent. If he does not do this and voluntarily provides information to the inspection, the inspector may use that information against him to substantiate the fine. For more information on this subject, please refer to the Tax Inspection guide, which you will find here.

Mr. M.H.W.N. (Marloes) Lammers

The Panama Papers – naming and shaming

This week the news services are falling over themselves regarding the information that they want to publicise about the Panama Papers. The reporting initially covered the working method employed by the Panamanian service provider, but as time goes by, more and more names of the service provider’s customers are being disclosed. But what is the relevance of publicising these names? What is keeping them from presenting the facts in a negative way? In short, the reporting ties in perfectly with naming and shaming.

Stand, sun, sea, palm beach chair. So one imagines a tax haven.

Panama Papers

The Panama Papers are documents from the service provider’s (internal) administration in, you’ve already guessed it, Panama. This service provider provides legal advice and trust services to its customers. As the press releases show, the customers are from a variety of backgrounds. Not only heads of governments would avail of the service, but also the butcher around the corner.

The Panama Papers would divulge the service provider’s working method. That working method would entail the service provider setting up an offshore company for a natural person. A share of the natural person’s assets would be incorporated into this offshore company. What is the advantage of that? The most straightforward advantage that comes to mind is – of course – that various tax rates can be used. In most cases, the offshore company will be established in a country where the tax rates are somewhat more attractive than in the country where the natural person resides. But that is not by a long shot the reason why all natural persons invest offshore. Other reasons could be spreading the risks or protecting the natural person’s estate.

The current press releases only bring the initial benefit (reducing the tax burden) to light because this is obviously ‘juicy gossip’ and sells well. This is quickly followed by the fact that it would not be quite so easy to derive from the information from the offshore companies which natural person is hiding behind the company. While normally speaking that would be a ‘disadvantage’, or as Johan Cruijff used to say ‘every disadvantage has an advantage’ of this working method, this is not the case with the Panama Papers. After all, it seems from the news reports that the cooperative of journalists were able find out which natural persons are behind the offshore companies relatively easily based on the information known to them.

How the documents from the service provider’s administration wound up in the hands of Süddeutsche Zeitung is still a mystery. That newspaper has in turn shared the files with the ICIJ (The International Consortium of Investigative Journalists), an international association of journalists. This association, which includes the Dutch newspapers the Trouw and the Financieele Dagblad, is working on analysing the documents. Bit by bit, information is being disclosed to the outside world.

The journalist association shrouds itself in mystery, while the service provider takes the stand that the computers have been hacked. This immediately raises the question whether the Tax Authority should be allowed to use the information in a legal proceeding or has this information been obtained by illicit means. Given the case law in the area of microfiches from the KBLux bank affair, this will most likely not be the case with the tax authority and will be glossed over as usual.

Tax avoidance vs. tax evasion

A man is but a man and (apparently) every man, big or small, fat or thin, preferably wants to pay as little tax as possible. Given that there are also people at the top of all large international companies, this also explains why these companies are keen to avail of complicated constructions and advance certainty by means of tax rulings, etc. A lot has been said about this in the past months.

The country where a natural person has to be pay tax depends on his/her place of residence (Article 4 of the Dutch State Taxes Act). To reduce the tax burden a natural person will have to initiate a working method that ensures that part of his assets are transferred, so that this can be accommodated elsewhere (read: in a country with a more lucrative tax system). That is also the direct crux of the Panama Papers.

The bottom line is that the working method of the Panamanian service provider is that an offshore company is set up for the natural person. The core of the working method is that a share of the natural person’s assets is incorporated into the offshore company. Consequently, the tax levy of the natural person’s country of residence no longer applies, but that of the country where the offshore company is established. The tax levy of this country is usually considerably lower than that of the natural person’s country of residence. This therefore offers a direct advantage.

The question that then remains to be asked is whether the financial advantage gained qualifies as tax avoidance or tax evasion. That qualification is extremely important because everyone is within their right to avoid tax (reduction of the tax burden within the boundaries of the la), while tax evasion (reduction of the tax burden outside the boundaries of the law) is a criminal offence.

While not all of the facts and circumstances of the issues surrounding the Panama Papers are known yet, we all have to make do with the information exposed by the journalists, the media is already screaming ‘blue murder’ and every effort is being made create the impression that it is all about tax evasion. That conclusion, however, cannot be reached just like that.

Tax avoidance only applies if the reduction of the tax burden is effected outside the boundaries of the law. It may well be the case that the natural person incorporates a share of his/her assets in an offshore company and does not declare his/her stake in that company on his/her income tax return. Whether this involves the Panamanian service provider’s customers, is not known. That information is only known to the relevant customer and possibly the Tax Authority of the natural person’s country of residence. While the customer concerned does not feel the need to justify its financial wheeling and dealing publically, the Tax Authority is bound by the obligation of confidentiality (AWR, Article 67) and will therefore also have to ‘keep their mouths shut’. In short, that’s playing right into the hands of the journalists, because this gives them ammunition to continue to speculate and make assumptions, which the majority of people believe to be true.

Naming and shaming

As I already mentioned, the initial publication on the Panama Papers focus on analysing the Panamanian service provider’s method of working. The first names of this service provider’s customers were quickly publicised. While these were foreigners yesterday, as of today, there are also Dutchmen among them. But is it necessary to publicise the service provider’s customers by name and in doing so give the impression that this is a matter of tax evasion? And what do we stand to gain by publicising these names?

If it is a case of tax evasion, is it any worse if it concerns a footballer or a former member of the Supreme Court? I don’t think so. Article 69 of the AWR states that “anyone that intentionally fills out a tax return provided for under the Tax Act incorrectly or incompletely (…) whereby they do not pay enough tax, that person will be fined, punished (…).” This legislative text does not make any distinction between different tax obligations. Be it the butcher on the corner, the footballer or a former member of the Supreme Court, if he/she files an incorrect or incomplete tax return, he/she is equally liable to punishment.

This does not exclude dubious reporting of information. The information that is provided on the former member of the Supreme Court initially suggests that the member in question has used his/her Supreme Court membership for an offshore company. However, on closer examination (insofar as all the facts are known) it transpires that the offshore company was only set up 11 years after the Supreme Court membership ended. Even so, public opinion will not bear this in mind, but rather emphasise that even a former member of the Supreme Court has made use of an offshore company to reduce his/her tax burden.

The only reason for naming the names of the service provider’s customers in newspaper articles is therefore within the context of ‘naming and shaming’. ‘Naming and shaming’ basically comes down to certain, unsatisfactory situations being exposed publically. In this case, the natural person is exposed by a publication (naming) and the announcement and/or information is portrayed in this publication in a bad light (shaming). That is exactly what has happened in the current news coverage. Customer names are publicised, and the information painted in such a light that any random reader will think that the person in question has evaded tax and is therefore a villain.

While freedom of the press goes too far, that same freedom is still subject to certain boundaries. You see, the press hounds may not injure a person’s good name or reputation. The Supreme Court deems rumours being presented as facts and the accuracy of the information not being first verified as the deciding factor for defamation. So, before going to press, certain information has to be verified to ensure its accuracy. Whether that was also done in the case of these Panama Papers is doubtful. A number of reports did indeed point out that the Tax Authority was asked to respond, but the Tax Authority have an obligation of confidentiality and are unable and will not provide any information on the accuracy of the information. There is nothing to indicate that the customers concerned, who have been now been named and shamed, have been asked to respond.

In short, as interesting as the information from the Panama Papers may be, the cooperative of journalists would do well to disclose this information in an accurate and proper manner. To my mind, that manner should be such that naming and shaming is avoided. After all, that does not in any way whatsoever contribute to the tax levy in, for example, the Netherlands. Hopefully the cooperative of journalists will take this into account before publishing the information.

Conclusion

The world is in turmoil after announcement of the Panama Papers. The manner in which this information is being exposed raises the necessary questions. The cooperative of journalists are not afraid to name and shame. In doing so, the Panamanian service provider’s customers are shunned as tax fraudsters, while there are known facts that do not (yet) give any cause for this. Making use of an offshore company does not automatically imply tax evasion (a criminal offence), but may qualify as tax avoidance (everyone’s right, because this falls within the boundaries of the law). The latter may well not strike a positive chord either, but it doesn’t necessarily mean that anyone involved is a villain or fraudster