The role of due diligence in tax planning

At the same time, this undefined due diligence is required by CIT and PIT regulations, as well as – in practice – VAT. All this means that maintaining due diligence is currently a big challenge for companies operating in dynamically changing economic conditions. So how can we meet the requirements of tax authorities and at the same time efficiently deliver goods and services?

Due diligence – an attempt to define

Taxpayers may feel that the concept of due diligence is vague and its essence remains elusive. The situation is not improved by the fact that this term appears in the context of numerous requirements set by tax offices, while at the same time there is no list of specific criteria that taxpayers should meet. There is no clear definition of due diligence in tax regulations, and an extensive analysis of case law in this area reveals a rather vague picture of the obligations that a taxpayer should fulfill in order to comply with it. The scope of due diligence depends on the opinion of a specific official. What is important is that the requirements of tax authorities seem endless, and taxpayers are often unable to meet them. The lack of definition allows tax authorities to constantly tighten the conditions for exercising due diligence – conditions that differ significantly from economic realities.

A breakthrough in defining due diligence was to be brought by the publication in 2018. by the Ministry of Finance “Methodology for assessing due diligence by purchasers of goods in domestic transactions”, which is a document intended for officials. However, this document is not a ready-made procedure – in addition, it only applies to commodity transactions and does not contain examples of all transactions.

To sum up, taxpayers still do not have a full definition of due diligence that clearly defines the obligations to be fulfilled. This means that the risk of failure to comply with it is a kind of “spook” for entrepreneurs who, despite their best efforts, still feel that they are “wandering” in the thicket of official requirements.

Due diligence in practice – how to minimize the risk of failure to comply?

According to the guidelines contained in the Methodology, entrepreneurs who want to avoid accusations in this matter from the tax office should meet formal and transactional and business criteria (i.e. tailored to the specificity of a specific business).

Formal control of the contractor includes verification of whether the contractor appears in the databases of business entities (e.g. KRS), whether he actually exists, and whether he operates legally. The taxpayer should also check whether the contractor has licenses and permits regarding the goods being the subject of the transaction. Another important element in this procedure is verification whether the persons concluding the contract and participating in the transaction are authorized to act on behalf of the given contractor. The taxpayer’s doubts about the contractor’s honesty should, for example, be raised by: too low a price for goods or services, reluctance to conclude contracts in writing or the unusual nature of a given transaction.

In practice, however, the requirements of tax authorities go further. Officials expect that the taxpayer will remember each contractor and the circumstances of concluding the transaction – even if this situation took place 5 years ago and the taxpayer has already had hundreds of contractors since then. Tax authorities are suspicious of the lack of extensive verification of the contractor, e.g. failure to check whether the contractor’s business is actually conducted at the registered office address indicated in the National Court Register and whether more entities are registered at that address. Mere verification of the entity in the National Court Register and on the white list of VAT taxpayers is no longer sufficient for the tax authorities. Expectations are sometimes so high that it seems that entrepreneurs should consider starting permanent cooperation with detective agencies.

The position of Polish administrative courts

Due to the “flexible” criteria for exercising due diligence, differences of opinion between the taxpayer and the tax authorities often lead to the need for the dispute to be resolved by an administrative court.

The number of judgments of administrative courts regarding this issue proves how many doubts arise in defining due diligence. Their analysis does not allow for excessive optimism.

For example, in the judgment of the Provincial Administrative Court in Gliwice of January 9, 2020, ref. no. No. I SA/Gl 1443/19, the court found that the company did not exercise due diligence because it did not carry out a detailed verification of the contractor, i.e. it did not check its registered office, did not verify how long it had been on the market or what its organizational base was. However, in the judgment of September 6, 2022, the Supreme Administrative Court found that the company did not exercise due diligence because it did not formally verify the contractor, and that the company should additionally be questioned by the fact that the contractor offered prices of goods (meals) lower than market prices. In turn, in the judgment of September 16, 2021 regarding intangible services, ref. no. No. I FSK 548/18, the court found that payment in cash and lack of due diligence in verifying the contractor and documenting services deprived the company of the right to deduct VAT. In the judgment of July 9, 2021, ref. no. no. I SA/Po 230/21, the Provincial Administrative Court in Poznań stated – referring to the so-called small anti-tax avoidance clause (Article 22c of the CIT Act) – that the company should establish the status of the beneficial owner in order to be able to assess whether the structure leading to the payment dividend is not artificial and tax exemption applies.

Therefore, the analysis of administrative court judgments shows that a taxpayer concluding transactions with a contractor should not only comply with a number of formal requirements (verification of the contractor in databases, checking his website), but also pay attention to competitive prices offered by the contractor – and it is best to go to his headquarters. and check what it looks like, how many employees are there and whether the whole thing gives a credible impression.

What does the CJEU have to say about due diligence?

As can be seen from numerous judgments of the CJEU (e.g. judgments of July 6, 2006, Kittel and Recolta Recycling, ref. no.: C-439/04 and C-440/04, point 59; of June 21, 2012, Mahagében and Dávid, reference number C-80/11 and C-142/11, point 45; of October 16, 2019, Glencore Agriculture Hungary, reference number C-189/18, point 35), the right to deduct VAT will be deprived not only of the taxpayer who committed the fraud, but also of the taxpayer who, when concluding the transaction, knew (or should have known) that, by purchasing those goods or services, he was participating in a transaction related to VAT fraud.

The key phrase “should have known” means precisely the presumed exercise of due diligence – he would have known if he had exercised due diligence. And under what circumstances should a “warning light” come on? We don’t know – the regulations don’t apply to this.

Consequences of failure to exercise due diligence

Taxpayers who do not exercise due diligence must take into account not only financial consequences (for example, the application of a higher withholding tax rate or the inability to deduct input VAT), but also joint and several liability with the supplier of goods.

Concluding a transaction with a dishonest contractor may result in the taxpayer being accused of participating in the so-called tax carousel. For many taxpayers, the inability to deduct VAT from key transactions (or the need to pay tax from the source at a higher rate) means problems with financial liquidity and, ultimately, even the need to declare bankruptcy. It is difficult to fight the accusation of failure to exercise due diligence precisely because of the vagueness of this concept. Therefore, it is worth doing everything to minimize such risk.

Prevention is better than cure

In a situation where officials increasingly accuse taxpayers of failing to exercise due diligence, the implementation of appropriate procedures in this aspect becomes necessary. A good due diligence procedure should be tailored to the needs of a specific client and the specific nature of its business. To minimize the risk of failure to exercise due diligence, it is worth introducing a two-stage verification, covering not only activities within the company, but also activities carried out by independent specialists who will constantly check whether the taxpayer concluding transactions with contractors does everything in a way that does not raise any objections from the tax authorities.

To sum up, the age-old maxim that ignorance of the law is harmful is true. In this case, the imprecise definition is also harmful, allowing for different interpretations of the provisions. And this is rarely beneficial for taxpayers. When it comes to due diligence, “more is more” – especially peace of mind for the entrepreneur.