Legal and Tax aspects of VAT

YEtax Partner Rany Schwartz talks VAT Taxation

Duns100 Interviews Partner Rany Schwartz on VAT Taxation issues. The below is a translated transcription of the original online Hebrew publication 2.08.22

Listen to the podcast (in Hebrew) here

 

Problems involving taxes can be an expensive matter. What can cause these kinds of issues?

No one likes being audited. Even if you’re certain you’ve operated entirely above board, when someone actively looks for issues they’re likely to find them. Sometimes these are just small deviations, but often we’ll discover that we’ve been operating long-term in a way that, in hindsight, turned out to be problematic. Whether this is the result of poor advice or just an innocent mistake, it’s liable to cost us a lot of money – this is essentially an opportunity for the tax authorities to collect money that belongs to the State.

How does the VAT system work?

I collect value added tax (VAT) for the State, hold it, and then transfer it to the tax authorities. After that, any retroactive claims by the authorities can result in a considerable deficit on my part, since I’ve already spent that money.

Our experience allows us to identify the major flaw in this method: you can’t truly know who you’re doing business with. Generally, we don’t have the ability to do comprehensive due diligence, which that means we need to be very cautious. For example, if I work with a vendor and know they are in financial straits, what’s most important to me is understanding that if I pay them for services rendered, I must be certain they transfer that VAT.

Even after I’ve already paid the VAT to them?

That’s exactly the point, it’s input VAT! I paid VAT to the vendor out of my own pocket in order to receive a service, and in turn they must pass that VAT on to the tax authorities. If they haven’t done so, I am expected to pay an indemnity to the State. While it is possible to defend against these charges in some cases, it isn’t in others. It depends whether I made a point of looking into the client or vendor beforehand – whether or not they are a registered business, who is receiving the service. Invoices must be issued only to the service recipient, not the payer. Otherwise, the tax authorities can label them fictitious invoices. This term has lost a lot of its meaning!

What else can create VAT problems?

Here’s another common example: it may turn out, after the fact, that an invoice issued for services provided lists the details of a licensed dealer that are not those of the vendor itself.

Why does this happen?

It may be that the vendor wants to provide a certain service but has not licensed to do so due to some sort of limitations. They may use external companies that “assist” by providing invoices on their behalf – at best, this practice is a legal gray area; in extreme cases, they could be using fake invoices outright. You may ask, why should this concern me as the service recipient? In fact, the Supreme Court ruled that it is the responsibility of the service recipient to ensure that the issuer of the invoice is a licensed dealer. For instance, if someone provides me with an invoice issued by “Company X Ltd.” – who is Company X Ltd.? It is my responsibility to verify whether the person providing me with the service is authorized to do so.

What are other classic VAT pitfalls?

Is my transaction subject to regular VAT or is it VAT exempt? I, of course, assume that it’s a zero-rate VAT service. Why? Because I read it somewhere. I’m joking, obviously – but the fact is that it would be to my benefit to assume so since zero-rated VAT means I can reduce my prices by 17% and be more competitive. But what happens if it turns out afterwards that the service I provided was in fact subject to regular VAT? I’ll be forced to absorb that loss, since I can’t reasonably approach my customers and demand additional payment. Therefore, it’s prudent to thoroughly check the legalities.

Which businesses are at highest risk to be audited?

In terms of VAT fraud, the businesses involved are most often service-based and less frequently trade in goods. Two industries at high risk are human resources and construction services. When it comes to trade in goods, transactions on certain high-VAT goods may have a high number of fraudulent invoices – for example fuels and precious metals. Particular caution is needed when using a manpower service, such as a cleaning service. These need to be a serious part of the risk calculation for any contractor or dealer.

How can I lower my risk?

They should instruct and assist you with a high level of service and consideration, so you’ll be able to call on them at any time for advice on day-to-day dilemmas you encounter. The challenge is that many times people are more focused on doing successful business and less on the compliance. That’s why having an adviser available to keep track on those issues. Someone you can really depend on.

Second, do your homework and know what you’re dealing with. Launching a business is a responsibility that goes beyond simply waking up every morning and selling a product. You also a responsibility to maintain a bookkeeping system and understand how to use it, whether that means producing receipts and invoices in a timely manner or managing a computer system.

What should I check in tax invoices?

An invoice must be legally valid. That sounds simple, but here’s where it can become complicated: “legally valid” means both from a formally and substantively. Formally, that means the invoice must contain all the details required by law. First, you must have a licensed dealer number and contact information. Second, the invoice must be addressed to the recipient of the service or goods, including their official details as registered with the authorities. The invoice must contain full details of the nature and scope of the service provided in the transaction, or the types and quantities in the case of goods.

Substantively, the invoice must reflect the transaction between the parties actually providing and receiving the services, otherwise it is not legal, and therefore considered fictitious. This is dramatically significant.

Sometimes it’s just a matter of simple human error that ends up being labelled as fictitious, which seems like an overstatement.

To the average person, “fictitious” implies dishonesty or something that doesn’t actually exist. Obviously, there is a big difference between an intentionally fictitious, or fake, invoice and those that meet that legal definition. But in our professional sphere, invoices with errors are considered legally noncompliant and therefore fictitious. I’ll discuss the consequences of a flawed invoice that is determined to be illegal or fictitious. There is a range of outcomes, starting with the fact that the invoice cannot be used to offset the input taxes included in the transaction. Other consequences are more severe, including invalidation of the business’s books, which has much more significant financial consequences and possibly even criminal liability. After all, tax offenses are criminal offenses for all intents and purposes. As such, the consequences can be severe.

The State has created more and more systems for taxation. Obviously, it’s better to avoid problems. But if I did end up with a problem as a result of human error and discovered that I owe back payment on VAT, what could be done to manage the damage?

Let’s tackle this question in two parts.

In one scenario, let’s say this was the result of a bona fide mistake. Should you try to fight? Absolutely. It’s not the end and it is unequivocally worth the effort. The tax authorities often assume auditees will not fight the findings of an audit. The authorities’ goal is to recover as many taxes as possible, so they have a vested interest in interpreting any legal gray areas that turn up in the course of an audit in the most restrictive way possible. However, that does not mean the auditee must immediately accept their conclusions without question and pay. Legitimate differing interpretations of tax law are the basis for legal deliberations like these, and therefore there is little risk in appealing the conclusions in most cases. You can insist on your legal interpretation, and even if an assessment is issued, there’s no reason to panic. Assessments can be appealed, and failing that, an appeal as of right can then be issued to the district court, and the disputed taxes don’t need to be paid during this process.

On the other hand, these problems could be the result of poor judgement rather than an unintended mistake. Unlike the previous scenario, the auditee does have a lot at risk in this second scenario. Rather than just the taxes being at stake, the consequences now are much more severe sanctions, potentially even criminal prosecution resulting in heavy fines or even curtailing of freedoms in the extreme cases. Therefore, it’s critical to proceed with caution in this scenario. There is a significant difference between specialists in the field of taxation, and at this point the interpretation and legal protection required makes it a matter for lawyers rather than accountants.

Any final VAT advice?

My recommendation is not to leave anything to chance. Don’t assume you’ll get lucky and avoid being audited. Instead, assume you will need to be prepared for an audit at any moment and manage your taxes with the appropriate level of thoroughness and care.

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