Supreme Court rulings in tax disputes: what to look out for

On 8 December 2023, the Law of Ukraine No. 3453-IX of 9 November 2023 came into force, which effectively restored the state tax authorities’ ability to fully exercise their control and audit powers, which had initially been restricted by the COVID-19 pandemic and subsequently by the Russian Federation’s military invasion. Entrepreneurs in Groups I and II of the simplified taxation system have retained temporary immunity from tax audits until 1 December 2024.

In view of the resumption of tax audits, the issue of resolving tax disputes—which will inevitably arise as a result of the audits conducted by the tax authorities—has become a matter of urgency. To avoid futile legal disputes and, conversely, to confirm their own legal position, it is essential for both taxpayers and lawyers to be aware of the Supreme Court’s current legal positions on tax disputes.

In this article, we propose to examine the most interesting, in the opinion of the members of Synegor Law Firm, rulings of the Supreme Court in tax disputes throughout 2023.

Refusal to allow an audit and confirmation of the validity of an administrative seizure of property

In its ruling of 23 February 2023 in Case No. 640/17091/21, the Supreme Court, sitting as the Judicial Chamber for the Consideration of Cases Concerning Taxes, Levies and Other Compulsory Payments of the Administrative Court of Cassation, concluded that Article 283 of the Code of Administrative Procedure of Ukraine had become an ‘ineffective’ procedural mechanism for implementing the institution of administrative seizure of property, which is not actually applied in the sphere for the settlement of which it was introduced. This case concerned the question of confirming the validity of the administrative seizure of a taxpayer’s property in the event of a refusal to allow tax officials to carry out an audit. It should be noted that, until now, there had been established case law under which the court would refuse to confirm the validity of an administrative seizure under Article 283 of the Code of Administrative Procedure of Ukraine, solely on the basis of the taxpayer’s application to the court seeking a declaration that the order to conduct an audit was unlawful and/or its annulment. The Supreme Court justified the need to depart from existing judicial practice on the grounds that it creates the conditions for the abuse of the rights granted to the taxpayer through the delaying of the audit by refusing to allow authorised representatives of the supervisory authority to carry it out.

In issuing its ruling upholding the appeal on points of law, the Supreme Court noted that when considering applications to confirm the validity of the administrative seizure of a taxpayer’s property, the administrative court assesses the validity of the tax authority’s decision regarding the administrative seizure of the taxpayer’s property by verifying the existence of grounds for adopting the relevant decision and the correctness of the legal classification of the taxpayer’s actions that formed the basis for such a decision. A taxpayer’s challenge to an order to conduct an audit constitutes a challenge to the circumstances that led the tax authority to submit the relevant application, but does not constitute a dispute over the law within the meaning of paragraph 2 of Part 4 of Article 283 of the Code of Administrative Procedure of Ukraine and does not preclude the consideration of an application seeking confirmation of the validity of the administrative seizure of the taxpayer’s property. The validity of the taxpayer’s grounds for refusing to grant access to tax authority officials to carry out a tax audit forms part of the subject matter of proof in cases provided for in paragraph 2 of Part 1 of Article 283 of the Code of Administrative Procedure of Ukraine.

In other words, from now on, the taxpayer will have to prove the groundlessness of the administrative seizure of property and, consequently, the lawfulness of the refusal to allow tax officials to carry out an audit, within an extremely short timeframe. This is because, in accordance with the provisions of Article 283 of the Code of Administrative Procedure of Ukraine, the court must rule on the merits of the claims no later than 96 hours from the moment the circumstances giving rise to the applicant’s appeal to the court are established.

The Supreme Court’s legal position set out above, coupled with the risk of the tax authorities issuing a decision that a VAT payer meets the risk criteria (relevant to VAT payers) in the event of refusal to allow an audit effectively remove from the taxpayer’s arsenal of legal remedies the option of refusing to allow the audit to take place.

The circumstances indicating the taxpayer’s guilt and the intentional nature of their actions cannot be established within the scope of a desk audit

A fairly common breach of tax legislation by taxpayers is the failure to meet the deadlines for payment of an agreed financial obligation. Since May 2020, under the Tax Code, when holding a taxpayer liable for such a breach, the tax authority was required to take into account the intentional nature of the act; and where circumstances indicating intent were established, the amount of the penalties was increased by a factor of 2.5 to 5. At the same time, the timeliness of payment of agreed tax liabilities is, for the most part, the subject of a desk audit, i.e. the audit is conducted on the basis of information contained in tax returns and the tax authority’s databases. When conducting such audits, the tax authorities generally justify the presence of intent regarding late payment of taxes by the fact that the taxpayer is fully aware of the deadline for payment of a particular tax.

In resolving a tax dispute on a similar issue, the Supreme Court, in its ruling of 3 August 2023 in Case No. 520/22505/21, concluded that ‘within the scope of a desk audit, it is not possible to establish circumstances indicating the taxpayer’s culpability and intent, since a desk audit is conducted exclusively on the basis of the data specified in tax returns, and data from the relevant electronic systems, which objectively cannot confirm or refute the taxpayer’s reasonableness, good faith and due diligence, which are necessary to establish their guilt. Thus, the failure to prove the claimant’s culpable actions constitutes sufficient grounds for recognising the unlawfulness of imposing a penalty on the claimant amounting to 50 per cent of the sum of the unpaid (or late-paid) financial liability, and therefore the contested tax assessment notice is unlawful and must be set aside by the court’.

In the aforementioned court ruling, the Supreme Court noted that the universal provision applicable in all cases of late payment of an agreed tax liability, regardless of the reasons for the taxpayer’s late payment, is paragraph 124.1 of Article 124 of the Tax Code of Ukraine (imposition of a penalty ranging from 5 per cent to 10 per cent of the settled tax debt, depending on the number of days’ delay).

Proving the inability to fulfil tax obligations

Due to the full-scale aggression by the Russian Federation, and with a view to supporting domestic businesses, the legislature introduced a mechanism in September 2022 designed to exempt taxpayers who were unable to fulfil their tax obligations imposed on them from 24 February 2022, provided that these obligations were fulfilled within 60 calendar days from the first day of the month following the month in which such capacity was restored. The procedure for confirming the inability to fulfil tax obligations is set out in the regulations approved by the Ministry of Finance of Ukraine. A decision confirming a taxpayer’s inability to fulfil their tax obligations, or confirming their ability to do so, is taken by the state tax authority based on the application submitted by the taxpayer and the supporting documents. A taxpayer may appeal against such a decision if they disagree with it.

On 4 October 2023, the Supreme Court issued a ruling in Case No. 160/19575/22, which contains a legal opinion regarding the confirmation of a taxpayer’s inability to fulfil their tax obligations in a timely manner. Unfortunately, this ruling was not in the taxpayer’s favour, and the Supreme Court noted that, in order to exempt the taxpayer from fulfilling their tax obligations, the circumstances giving rise to such impossibility must be genuine and objective, rather than merely formal. The taxpayer must provide a comprehensive list of documents confirming the existence of circumstances that make it impossible to carry out business activities and fulfil tax obligations. Evidence confirming the taxpayer’s inability to fulfil their tax obligations includes, in particular, evidence confirming that, at the claimant’s place of registration—where the relevant damage occurred—any business activity was being carried out, and that documents, machinery and/or equipment were stored there; reports on the loss (destruction or damage) of computer and other equipment must contain details of exactly which computer equipment and financial and business documentation were destroyed, and must demonstrate that the destroyed computer equipment and documentation were used in business activities and contained up-to-date information necessary for submitting reports for the current periods of business activity. Furthermore, the absence of funds in the taxpayer’s bank accounts indicates an inability to fulfil tax obligations.

As we can see, the Supreme Court’s position on this matter cannot be described as favourable to taxpayers, particularly as the taxpayer is not exempt from fulfilling their tax obligations at all, but is in fact merely granted the opportunity to fulfil them at a later date — within 60 calendar days following the month in which such capacity is restored.

A natural person’s systematic activity aimed at generating profit, for tax purposes, must be classified as entrepreneurial

The Supreme Court’s ruling of 4 December 2023 in Case No. 480/4636/19 resolved a dispute between an individual and the tax authority concerning the declaration of unlawfulness and the annulment of a tax assessment notice—a decision which imposed a financial liability on the claimant in respect of personal income tax.

The dispute arose because, over a certain period of time, the claimant had constructed 23 properties with a total area of approximately 25,000 square metres and had sold them. In assessing this activity, the panel of judges noted that the construction of such a large number of similar properties (buildings) and their subsequent sale indicates an intention to make a profit from such activities, rather than to satisfy the citizen’s own (personal) needs, and constitutes a systematic pattern. A series of consecutive, purposeful actions aimed at the construction and subsequent sale of identical properties for the purpose of making a profit indicates that, for tax purposes, the claimant’s activities should be classified as business activities, and therefore the transactions in question are subject to taxation in accordance with the relevant provisions of the Tax Code of Ukraine at a rate of 18 per cent, irrespective of the taxpayer’s specified types of economic activity.

At the same time, the Court reached this conclusion even taking into account the fact that the claimant had independently paid personal income tax on the sale of immovable property as a natural person at a rate of 5 per cent of the amount (value) and 1.5 per cent military levy in accordance with Articles 167 and 172 of the Tax Code of Ukraine.

Authors: Kostiantyn Nosov and Maksym Arkhanhelskyi

Read the article on the “Yurydychna Gazeta” website via the links below.