Tax fraud schemes: “invoice factory”

By the end of this article, you’ll understand how to avoid getting involved in VAT fraud schemes.

In recent years we’ve been increasingly approached by entrepreneurs who have fallen into the chain of tax fraud (the so-called “invoice factory," in Estonian - “arvetevabrik”). In these cases, the Estonian Tax Department charges the entrepreneur additional taxes: return of input VAT and income tax, considering the payment of such invoices as an expense unrelated to business.

The claims of a tax administrator are usually that when buying a service or product from a company that is considered to be an “invoice factory”, i.e. a company without real business activity and only issuing invoices, and, what is important, not paying VAT to the budget, the entrepreneur becomes a participant in tax fraud, since the seller could not sell a service or product without real business activity, which means that a deal with him was fictitious, and the entrepreneur knew or should have known about it.

To avoid such situations the tax administrator strongly encourages to examine the transaction counterparty (credentials of representatives, the VAT number of a seller, the ability to sell goods or service and so on). Such recommendations are fully justified, but their template use leads to a distorted application of the law and violation of the rights of entrepreneurs. It is a well-known fact that many taxpayers agree with tax claims only to avoid long and often expensive disputes. It is important to remember that despite the overall value of the recommendations above, binding is the law and not the recommendations of the tax administrator, even when they are given in the form of instructions. Therefore, I want to share with you the key points of the court practice in matters of additional tax claims due to falling into VAT fraud chain.

Diligence obligation of the buyer when deducting input VAT
The tax administrator considers the absence or insufficiency in verification of the transaction’s partner as the basis for assigning additional tax claims. The case law has repeatedly explained that if it is impossible to dispute the fact of receiving a product or service, i.e. the goods were actually delivered and the service was provided, although this was done not from the seller indicated on the invoice, the tax administrator is obliged to prove the buyer's malicious intent, and if the buyer was diligent, there are no grounds for limiting his right to deduct input VAT. It is important to note that the prudence of the buyer is assumed to be “by default”, except when the tax administrator has a reasonable suspicion that the buyer himareself is involved in tax fraud, for example, he knew or should have known that the seller does not have real business activity.

Diligence obligation of the buyer is briefly as follows:
1) the buyer must, upon receipt of the invoice, verify its compliance with the requirements of form and content (Value Added Tax Act § 37), and
2) whether the seller is entered in the register of VAT taxable persons.

If the above requirements are met, it is wrong to require that the buyer would verify the credentials of the seller’s representatives, whether it pays taxes, etc. Such a requirement is considered unreasonably burdensome, and its implementation is not always possible.

What I want to summarise here: to minimise VAT risks, it is always wise to check the information about the seller, the circumstances of the transaction, and keep this information, but do not be afraid to challenge the opinion of the tax administrator if you think that you behaved honestly and responsibly, but for some explainable reasons you did not check the seller extensively, but confined only to minimum the law requires. The tax administrator’s attempt to charge you additional (in this case the seller’s VAT obligation) taxes not always justified and legally correct.