Settlements on Pleading Guilty of Sham Business by Supplier Companies as a New Trend for Additional Tax Accruals

On 17.02.2015 the Higher Administrative Court of Ukraine (hereinafter – the HACU) passed the Decision in Case No. К/800/24186/14[1], by which the Plaintiff was denied the right to the formation of tax credit on the ground that its contractor’s official, having previously pleaded guilty and having entered into a settlement on pleading guilty with the prosecutor, was sentenced for a crime under Part 2 of Article 205 of the Criminal Code of Ukraine – sham business.

The above Decision of the HACU is a manifestation of the latest trend in tax disputes, namely of additional tax accruals made on the basis of a settlement entered into by the official of the taxpayer’s contractor with the prosecution on pleading guilty of a crime under Article 205 of the Criminal Code of Ukraine.

The novelty of this trend is that such criminal sentences regarding suppliers’ officials under Article 205 of the Criminal Code of Ukraine made on the basis of settlements on pleading guilty do not only refer to the convicted person’s admitted guilt of sham business. Statements that no business was transacted, no contracts or primary documents were signed by the director as well as that all the supply transactions were allegedly “unreal”, with detailed descriptions of buyer contractors, banking details of the relevant contracts and of supply particulars, are transferred to such sentences from the relevant settlements on pleading guilty.

For instance, the motivational part of the sentence confirming the settlement on pleading guilty, which became the basis for the above Decision of the HACU, detailed the Plaintiff’s particulars – its name and EDRPOU code, the total amount of “sham” transactions as well as the VAT amount.

While understanding the existence of “sham” businesses in Ukraine in general, it is worthwhile adding that in practice there are cases of such settlements on pleading guilty of criminal offense both on the part of contractors and of the real sector of economy. It is believed to be easier for a contractor’s founder/director to enter into such a settlement agreement and to plead guilty with a relatively small fine and to have the relevant proceedings with stricter liability under criminal law terminated in exchange.

Such “evidence” obtained by tax authorities as a sentence under Article 205 of the Criminal Code of Ukraine passed on the basis of a settlement on pleading guilty significantly increases the risks for the taxpayers that are buyers of such “sham” suppliers in the following respects:

  • Tax risks – the taxpayer’s deprivation of the right to VAT credit and expenses;
  • Criminal risks – possible criminal prosecution of the taxpayer’s officials for criminal offences under Article 191 or Article 212 of the Criminal Code of Ukraine or other alternative qualifications.

Taxpayers that fall under the above described risks due to settlements on pleading guilty entered into by suppliers’ founders/officials have to pay attention, inter alia, to the following:

  • Provisions of part 7 of Article 474 of the Criminal Code of Ukraine prohibit the approval of a settlement on pleading guilty, if such a settlement impairs third parties’ interests. In other words, such settlements on pleading guilty basically may not contain any legal assessments regarding the actions of customers of such “sham” suppliers. At the same time, procedural legislation does not provide for any mechanisms for third parties to appeal a sentence approving a settlement on pleading guilty, which affect the interests of such persons;
  • The corpus delicti under Article 205 of the Criminal Code of Ukraine ends as soon as a business entity is registered and may not apply to actions taken after such registration. That is, even if the so-called “unreal” supplies would take place, the relevant facts should be investigated in criminal proceedings regarding completely different elements of crime.

For more details please see http://yur-gazeta.com/publications/practice/podatkova-praktika/problemi-tilki-pochinayutsya.html.

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Kind regards and best wishes,

Kateryna Gupalo

Counsel, Head of Tax Disputes Practice