Our post is about the tax compliance of contracts. We present the main criteria related to contracts and also mention fictitious contracts.
How to avoid tax penalties
Contracts are fundamental elements of economic life, but they are also suitable for regulating legal relationships between private parties. Of course, the legislation defines a number of requirements for contracts in general and in relation to various types of contracts, but there are also criteria that must be kept in mind specifically for tax law considerations. The tax authority pays special attention to the inspection of contracts in order to filter out tax evasion and further violations. In our article, we will review what you need to know about NAV-compatible contracts.
What are the general elements of a contract?
„A contract” is defined in our Civil Code as a mutual and consistent legal statement of the parties, which creates an obligation to perform a service and an entitlement to demand a service. The Civil Code defines countless types of contracts, for example, sales contracts are very common in everyday life, and rental or commission contracts are also not uncommon. However, it is important to note that, in our civil law, there is freedom of type, meaning that elements of different contract types can be combined and new types can be created.
Which contracts should be given special attention?
NAV primarily examines contracts that carry a significant tax risk. Accordingly, in several respects, special attention is paid to the purchase price in real estate purchase contracts, for example, which is often not stated in accordance with reality by private parties, for which NAV may impose a heavy fine. This serves as the basis for determining income, and thus the tax base, and is also important from the perspective of commercial real estate sales. In this context, it is important to highlight that the sale of even a single property can be considered commercial if the sale results in a significantly high income compared to the person’s usual financial circumstances. In this case, the sale takes place within the scope of economic activity, and is therefore subject to a higher tax burden (since in this case, for example, the private individual also becomes subject to VAT).
In addition to the above, when preparing contracts, it must also be taken into account that, in certain cases specified by law, the tax is paid by the purchaser of the product or the recipient of the service. In the case of transactions between domestically registered taxable persons, it must be stated in the contract and on the invoice forwarded to the National Tax Authority that it is subject to the so-called reverse charge.
It should also be mentioned that NAV pays special attention to employment contracts and agency contracts, as the characteristics of these two legal relationships can easily be confused, thus creating agency contracts disguised as employment contracts and aimed at evading tax and contribution obligations. In terms of distinguishing the types of contracts from each other, it is particularly important that the employer’s right to instruct is much broader, extending to the organization of work, while the contractor is typically entrusted by the principal with the performance of a specific task, which he can perform at his own discretion within certain limits. In order to ensure that the contract is not objected to by the tax authority during a possible audit, it is necessary to pay attention to the details and structure the contract accordingly.
What about fictitious contracts?
In addition to legal compliance, audits conducted by the tax authority are often aimed at filtering out so-called fictitious contracts, which provide for unreal economic events or were not concluded between the contracting parties. Thus, the Tax Authority often also examines whether the transaction included in the contract is economically reasonable or whether there is a relationship between the parties that could affect the validity of the contract. The Tax Authority naturally also places great emphasis on the consideration for the service, such as rent or wages and, in this regard, may also inspect bank transactions. In addition, the lack of appropriate documentation, such as the lack of performance certificates or inadequate monitoring of financial movements, can also lead to serious problems, as it makes it much more difficult to prove the validity of the contract during a possible audit.
What consequences could the inspection have?
If any violation of the law is established, various legal consequences may be applied against the taxpayer, including measures such as seizure or cancellation of the tax number, but even a tax or default fine may be imposed, and a late payment penalty may also arise. It is also important that the legal transaction affected by the fictitious contract may be considered budget fraud, in which case criminal proceedings will also be initiated against the taxpayer.
Overall, it can be stated that it is necessary to place special emphasis on the adequacy of contracts not only for economic reasons, but also for keeping in mind the legality aspects examined by the Tax Authority. Compliance with the legislation and maintaining appropriate documentation are essential in order to avoid fines and other sanctions, so we recommend that you always seek the assistance of a lawyer who is also experienced in tax law issues when concluding a contract.
