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Courts Consider Substance of Transactions In Tax Disputes


The Higher Administrative Court of Ukraine (HACU) has an authority to provide guidance to administrative courts regarding application of relevant legislation. In the letter of 2 June 2011 HACU presented directives to the administrative courts regarding application of Tax Code rules in tax disputes, focusing on the establishment of facts when proving the reality of transactions. Taxand Ukraine highlights HACU position and comments on its importance for businesses.

Substance over form?
Historically the Ukrainian administrative courts have been inconsistent regarding the evaluation of the importance of documents supporting a relevant transaction. In many cases, courts have been taking a position that if documents are prepared in a proper form, there is no ground for challenging the tax treatment of a transaction (form over substance). At the same time, there were cases (mainly at level of the Supreme Court and HACU) where the position was that if there is evidence of the fictitiousness of the transaction, underlying documents should be viewed void.

It appears that in recent directives HACU builds a platform for forcing courts to look at substance and facts relevant to a specific transaction rather than make a judgement on correctness of the paperwork.

Specifically, the following statements indicate that HACU is implementing "substance over form" approach when evaluating facts and documents in the course of tax disputes:

  • Primary documents: Primary accounting documents are the basis for tax treatment of transaction. However, if the transaction has not been conducted, supporting documents cannot qualify as valid primary documents even if such documents satisfy formal requirements.
  • Expenses and business transaction: VAT and corporate expenses tax deduction can be claimed if underlying expense is incurred and supported by proper documents, which reflects the reality of the business transaction.
  • Reality of business transaction: In order to verify the reality of the business transaction, courts shall check physical, technical and technological capabilities of the supplier to conduct specific transactions. For instance, the availability of competent personnel, assets including transport vehicles or manufacturing and storage facilities required for a specific activity; the possibility of transactions with certain volume of goods, the availability of licenses or permits required for the performance of certain types of business activity. Absence of license is not absolute evidence of the illegality of the transaction. However, this may indicate that a relevant entity had no capabilities / competence for performance of specific actions.
  • Importance of Civil Law: The validity of a contract according to article 204 of the Civil Code is irrelevant for tax purposes. Instead, the Tax Code's concept of presumption of the validity of a taxpayer's decision should apply. This means that taxpayer's tax treatment of a business transaction remains valid until the tax authorities prove otherwise, including the situation of transactions without substance.
  • Business purpose of the transaction: While considering substantiation for deductions, courts must verify the existence of a business purpose for the transaction. For deduction purposes, existence of purpose is sufficient and the actual result of the transaction regarding the purchase of goods and services has no importance. The latter element of the HACU position reflects a massive practice of disputes arising due to challenge of deduction just on the ground that a specific transaction resulted in losses for the taxpayer or where purchase of services does not bring any benefit for the service recipient. Effectively the HACU says that the courts should be critical in evaluating tax authority's arguments and focus on the purpose of the transaction rather than accepting tax authorities' position that the loss is the evidence of absence of business purpose.

Taxand's Take

The position of the HACU will affect court practice and more attention will be paid to the evidence presented to the court by either side of the dispute. Whilst the quality of documents remains an important factor of the taxpayer's risk management, it may be expected that the tax authorities will focus on improving quality of evidence they gather during tax audits. Given the fact that the tax authorities focus on cross border transactions / intra-group transactions, foreign investors operating in the Ukraine via subsidiary should identify potential weaknesses in support documents and take corrective measures, prior to tax audit.

Your Taxand contact for further queries is:
Vladimir Didenko
T.+380 44 492 8282

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Taxand's Take Author