Preliminary business due diligence – verify your business partners
Our experience shows that the tax authority has recently been requiring taxpayers to carry out more thorough – at first sight even excessive – and more extensive business partner due diligence. However, if we take a better look at the capacities of our prospective partner and the fulfilment of the necessary personnel and material criteria, we can minimise future tax risks for ourselves. Moreover, in many cases, the clients/customers themselves suspect that the partner's operational background may be problematic.
It should be taken very seriously that an invoice issued by a partner is only grounds for tax deduction if it is issued in connection with a taxable economic activity – one that entitles the taxpayer to tax deduction – and if it is authentic in terms of content, i.e. all the data are true and correct.
As regards the authenticity of the content, the tax authority examines in particular whether the invoice was issued by a real taxable person, whether the economic event stated in the invoice took place and, if so, whether it took place between the taxable parties stated in the invoice, whether the invoice correctly contains all the data required by the VAT Act, and whether tax evasion occurred during the performance of the economic event.
These parameters are the subject of a preliminary business partner verification procedure, and it is therefore advisable for all companies to draw up a contracting process and to include the “due diligence" of the prospective partner.
The business due diligence procedure
The business due diligence procedure is designed by the taxpayer to suit the specific nature of the economic activity and they choose the method, but it must essentially follow the entire transaction, from contact with the issuer of the invoice, through ordering, to performance and financial settlement.
If the business due diligence procedure fails and our partner indeed committed tax avoidance, the tax authority will – in the absence of evidence of our due diligence – make findings at our company too in VAT or even corporate income tax.
What checks are recommended when establishing a business relationship?
As a first step, if you are planning to carry out a major economic event with your partner, it is recommended that you conclude a written contract, considering the following:
- the contract should always be signed on behalf of the partner by the managing director or, on the basis of an authorisation, by the authorised employee,
- the contract should specify the way of liaising,
- the designated contact persons are named in the contract.
The contracting party may be expected to know how the representative's capacity has been verified and also how the natural person representing the partner acts, under what title, on the basis of what legal grounds and in possession of what documents.
The verification of the procedural capacity of the persons involved in the conclusion of the contract is of particular importance in the event of a tax audit. It may seem interesting, but the existence of a business card or website of a prospective partner can and should be part of the business due diligence documentation.
Nowadays, the audit practice of the tax authority suggests that taxpayers are required to carry out more thorough and complex preliminary business verification, in addition to the steps that were previously considered as basic requirements.
In the tax authority's view, the measures that the taxpayers are reasonably expected to take include the following:
- verification of the registered office and permanent establishment of the issuer of the invoice,
- requesting references and quotations,
- requesting a certificate of good standing,
- checking the profit and loss account and balance sheet, and
- carrying out checks on the number of the partner's reported employees.
It is important to bear in mind that the tax authority expects a new entrant to be subject to a more thorough check than a partner who has been active in the market for 20 years. Furthermore, there are sectors where more complex checks are required based on the nature of the activity. These include, for example, the construction industry, security companies and traders in electronic products.
At the time of contracting, partners should be checked in the e-business register and in the public databases available. It is also worth considering whether in the future there will be an event that requires proof that a business due diligence has been carried out. A possible solution is for the taxpayer to establish an internal policy for the verification of business partners and act accordingly, and it may even be possible to require the prospective partner to provide supporting documentation to meet tax authority requirements.
This is why it is important to know about free databases. The tax authority also uses these data for the preliminary risk analysis, so taxpayers are advised to use them too. It is important that the data collected as a result of the business due diligence should be kept by the invoice recipient by the end of the limitation period and presented to the tax authority in a certified form if necessary.
In addition to public databases, it is also useful to check your business partner on the Internet, for example, whether they have a website, whether they can be found on social media, and what information and references they publish about themselves.
It is expected that this year the tax authority will make public the interfaces and applications that will allow taxpayers to access the data available to the tax authority through machine-to-machine communication, thus taking the preliminary business due diligence procedure to a new, digital level.
If you have a large number of business partners, the use of the databases below will take a significant amount of time and energy from your company's life, but in monetary terms this is negligible compared to the tax risks that would otherwise arise. Our tax advisors can recommend solutions that can consolidate and store information from several public databases for future reference.
The involvement of experienced tax experts can be of great help in designing the business due diligence procedure and making it compliant with tax authority requirements.