Tax audit can be scarry or worrying for some, but if you know the fundamental rules you are on the safe side during the tax audit. Here, we will discuss what are the basic rules to be implemented at the early stage in order for your company or business to remain compliant with tax law and not to face any difficulties in this field.
To begin with, it is recommended to have a tax manager or tax lawyer with knowledge of international tax law in-house or to establish contractual relationships with professional (individual or consulting company), who work in this area. Since the tax law is rapidly changing, you need to have a professionally educated and experienced professional by your side since the beginning or your operations and long before the possible tax audit may appear.
Secondly, it is necessary to identify the transactions of the company, and, evaluate the tax risks and ways of mitigating them. For example, the company starts with receiving a financing in the form of a loan from its mother company – holding company. Then, this transaction should be prepared in compliance with arm-length principle and the contract should include the interest defined according to that principle. There should be prepared a separate analysis of the financing terms available on the market from at least 3 independent financing providers in order to prove that the loan granted by the holding company is in compliance with arm-length principle.
Similarly, if the subsidiary enters in the management services contract, provided by the holding company, the same approach should be done in this case. And, if one company in the group provides services or supplies goods to the other sister company, the transfer pricing rules should be applied as well. These examples demonstrate that today is not enough to have only a lawyer and an accountant in-house, the current international and national laws require to have a well-trained professional tax lawyer or tax manager by your side.
Cross-border transactions are quite common these days and tax authorities check them thoroughly. Their major points of interest include: the right to apply a reduced tax rate as per double tax treaties, transfer pricing compliance, value added tax (VAT), corporate income tax (CIT), beneficial ownership issue, taxation of digital services and all related issues. As an example, due to the fact that loan interest and management fees are expenses for the paying company, they would decrease its taxable base, therefore, it should be carefully established and justified. At the same time, the holding company can be questioned by the tax authorities why the loan interest or management fees are “so low” (in the opinion of tax authorities), which would lead to the low corporate income tax in the country of holding company. Therefore, to have an analysis with justification for both companies would be a right decision.
Third, have all the legal, accounting and tax documentation supporting each transaction. It should be carefully prepared and stored throughout the activity of the company and after the cessation of its activities. Since tax audit may happen any time or even after 7 years in some countries, no one will remember what happened at the times. Moreover, the people engaged in the operations might not work any longer in the company, and, to prepare or find the valuable proof will be quite a difficult task and enormous stress.
Another point, if you have legal and accounting services outsourced, the contracts and accounting records should be thoroughly checked before signing them, because all these documents were produced by the people and mistakes can happen. It is not recommended to rely simply on the brand name of the professional provider, or simply knowing that “he is a lawyer, he knows better”, try to understand what are the requirements by the law and ask questions if you “feel” that something is not clear. Do not be afraid to ask the questions, a professional will be grateful for that, because next time it will save the time for both, the professional and the company’s representative.
Fourth, be tax and accounting compliant. If the company enters the new market, outsources legal, tax and accounting services, you should have a specialist (specialising in finance, accounting or tax) in-house who would control all these providers. Such control lies in establishing the procedure, which would clearly identify the steps of documentation exchange: the company provides the bank statements, invoices, contracts, whereas, the provider generates monthly P&L, payroll calculations, submits income and VAT declarations.
How would you know that the you are tax compliant? First, ask for all the dates when the declarations, financial reports should be submitted and taxes should be paid. Include them into the calendar and ask the provider to send you the declarations together with accounts ledger min 5 days before the deadline for your checking. Agree with external accountant to receive from them a P&L account on the monthly basis to trace the records monthly. Furthermore, for yearly reports ask the provider to prepare the reports during the first 2 months after the end of the reporting period. Once, the declaration is submitted, ask the provider to send you the confirmation of submission. These simple steps will eliminate any inconvenient situations, when the provider forgot to submit the document intime or made a mistake in the accounting records. Consider, if your company needs a voluntary audit with an independent auditor, which would prepare your company for the tax audit.
Lastly, once you had received a notice from tax authorities that there will be a tax audit, prepare and check all the records and documentations, and think of any possible questions from the tax authorities. You should be ready to have answers to all questions, including how the price was formed, where the goods are stored, why the company conducts the business its way. The answers should be logical and understandable, in such way that it will prove that the company is in good hands and conducts its activity in line with the tax law. The reward comes when you realize that all the hard work you’ve done of controlling the documentation, accounting records, tax compliance, was absolutely necessary in order to get the positive outcome of the tax audit.