What You Need to Know About On-Site Tax Audits?

An on-site tax audit (hereinafter also referred to as OTA) is the most effective form of tax control, as it not only gives the supervisory authority the opportunity to study a company’s documentation in detail, but also literally opens the doors to all premises of the taxpayer; provides the right to seize necessary documents and files from work computers; conduct expert examinations; and interrogate company employees, including former ones.

And since 2017, a number of internal documents have legalized and consolidated mutually beneficial cooperation between tax and law enforcement authorities.

Of particular interest to entrepreneurs is the Letter of the Federal Tax Service of Russia dated July 13, 2017 No. ED-4-2/13650@ “On sending methodological recommendations for establishing, during tax and procedural audits, circumstances indicating intent in the actions of taxpayer officials aimed at non-payment of taxes (fees),” together with the “Methodological Recommendations ‘On the investigation and proof of facts of intentional non-payment or incomplete payment of tax (fee) amounts.'”

The above document conveys the joint position of tax officials and investigative authorities, according to which evasion of taxes and (or) fees is possible only with direct intent for the purpose of their full or partial non-payment.

I quote: “establishing during an audit and reflecting by tax authorities in tax control materials evidence of intentional non-payment or incomplete payment of tax (fee) amounts entails not only an increase in the amount of the tax penalty, but also improves the criminal law prospects of materials that are sent to investigative authorities for deciding on the initiation of a criminal case.”

Considering that inspectors see intentional tax evasion in every case, there is a risk that any such audit may smoothly transition into a criminal case.

Since the line between tax and criminal liability is currently very thin, we recommend that entrepreneurs whose business has become subject to an audit use the assistance of lawyers specializing in this area of law (so as not to improve the criminal law prospects of the audit materials).

Any OTA proceeds in several stages:

1. The audit itself, which involves the tax authority conducting a series of measures to collect information, documents, and evidence.
2. Recording the audit results in a corresponding act.
3. Submission by the taxpayer of objections to the act.
4. Issuance of a decision to hold the taxpayer liable (in fact, in theory there is also a decision to refuse to hold liable).
5. Appeal of the decision to hold liable to a higher authority (Federal Tax Service Department).
6. If point 5 is not successful – appeal of the decision to court.

At each stage, it is important to respond to the actions of the tax authority in a timely and competent manner.

At the first stage, the foundation for the future decision to hold you liable is laid: evidence is collected.

The times when the tax authority formed its position based on written evidence are long gone. Current practice demonstrates that tax officials have moved away from formalism, and now the emphasis is on witness testimony. Interestingly, the Tax Code has given inspectors carte blanche in this matter: almost any person can be interrogated (except minors and mentally ill persons). A lawyer also cannot be interrogated, since all information received from a client constitutes professional secrecy by direct indication of the law on advocacy.

The skill of inspectors conducting interrogations of your employees, your former employees, your counterparties and competitors is also growing. Psychological manipulation, leading questions, veiled hints, distortion of answers in the protocol – this is common practice that we encounter during interrogations. Often witnesses “set up” managers without wanting to, due to credulity, nervousness, or inexperience.

How to minimize pressure during interrogation? Our experience shows that with a witness who appears at this event with a lawyer, inspectors behave within the law. Therefore, we advise you to go through this adventure with a person who will provide you with legal and psychological support before, during, and after the interrogation.

Special attention should be paid to such a document as a tax authority demand. By default, for each lawful demand received as part of a tax audit, the taxpayer is obliged to respond. The key word here is “lawful,” because a significant portion of the demands you receive are drafted in violation of the law. Such a trick by tax officials allows them to obtain the necessary documents and information with virtually no effort.

What other tax control measures can a taxpayer encounter during an OTA?

The very name of the audit implies the possibility for inspectors to conduct the audit directly on the taxpayer’s premises. In practice, these powers are implemented through inspection and seizure.

During an inspection, tax inspection employees have the right to access computers, folders, files, software, databases, information carriers, safes, any documents and objects belonging to the company. Challenging such actions is useless – the court supports tax officials in this matter, indicating that within the framework of an OTA, the taxpayer has an obligation to facilitate this audit.

If a recalcitrant taxpayer refuses to provide access voluntarily, inspectors are assisted by such a tool as seizure of objects and documents. Since seizure is coercive in nature, let’s dwell in more detail on the rules for conducting this measure. So, seizure:

— is possible only in relation to objects and documents related to the subject of the audit;

— is conducted on the basis of a reasoned decree of an official of the tax authority, approved by a decision of the head (deputy) of the tax authority;

— is conducted in the presence of interested parties;

— before the seizure begins, the official must present the decree on conducting the seizure and explain to those present their rights and obligations;

— must be conducted in the presence of witnesses;

— is prohibited at night;

— is possible only after the taxpayer refuses to surrender the sought object voluntarily;

— during seizure, it is prohibited to unnecessarily damage objects (doors, locks, etc.);

— seized objects and documents must be presented to witnesses and other participants for viewing, stitched, numbered, sealed with the taxpayer’s seal;

— in case of seizure of original documents, the tax authority is obliged to provide the taxpayer with certified copies of such documents;

— seizure is recorded in a protocol with a detailed list of seized objects and documents, a copy of which is handed to the interested party.

An on-site audit ends with the delivery to the audited party of a corresponding certificate, not the issuance of an act, as many mistakenly believe.

Based on the results of an on-site tax audit, within two months from the date of drawing up the certificate, authorized officials of tax authorities must draw up an act of tax audit in the established form.

The person in respect of whom the audit was conducted has the right to submit objections to the act within one month from the date of receipt of the latter.

It is extremely important to submit reasoned objections to the tax audit act, since subsequently, when making a decision, the head of the tax authority considers the act itself and the taxpayer’s objections regarding the arguments presented.

It is important to form a legal defense position already at this stage and present the necessary evidence in support (documents, expert examination results, lawyer surveys, responses to lawyer requests, etc.).

We do not recommend surprising tax officials and judges by providing all evidence in the last court hearing on the case of appealing the tax authority’s decision. Following this tactic, you risk being accused of abusing your procedural rights and will only cause reasonable distrust on the part of the servants of Themis.

Judicial appeal of tax inspection decisions deserves special attention not only due to the existence of preclusive procedural deadlines. Judicial practice has always been unstable, and much depends on a competently formed position at the stage of conducting tax control measures directly (interrogation, document requests, inspection), which were discussed above. Currently, the court is increasingly inclined to interpret any doubts and conflicts of tax legislation in favor of the state authority.

And to win the arbiters over to their side, the taxpayer needs to take care of their legal position while still “on shore.”