THE NEW TREND IN TAX AUDITS OF INDIVIDUALS

THE NEW TREND IN TAX AUDITS OF INDIVIDUALS

The beginning of 2016 started with many legislative changes, and these changes inevitably affect the tax audits of individuals. The main changes are related to the introduction of the widely discussed "Weekend" tax, which aims to tax the personal use of company assets. However, what did not receive significant attention are the changes in the Tax and Social Security Procedure Code (TSSPC) regarding the limitation periods for individuals’ and legal persons’ tax and social security obligations. From the TSSPC, the absolute limitation period (10 years) has been removed. The absolute limitation is a legal concept allowing that after a certain period - in this case, 10 years, regardless of any interruptions and suspensions of the limitation period, obligations are extinguished, and then the NRA authorities cannot forcibly collect these obligations. With the changes in the TSSPC, this legal possibility for debtors of the NRA is removed.

The next change from the beginning of 2016 is associated with the practice of mass tax audits of individuals, who are accountable to their creditors (including the NRA) unlimitedly with all their movable and immovable property.

Weaknesses of individuals in tax audits and why is that so?

I point out that individuals are quite vulnerable in two aspects.

The first aspect is that individuals are unlimitedly responsible with all their property. The second aspect is that individuals most often do not maintain detailed accounting of their income and expenses. The only thing individuals do is at the end of every financial year they declare their income from non-employment relationships (rent, civil contracts, donations, sale of real estate, etc.) in their annual tax return. Most individuals do not keep "accounts," and for this reason, they cannot immediately provide, upon request, detailed and systematized information on what funds have been received in cash and bank, from whom what they have spent, whether they have given loans and to whom, in what amount, and other similar issues. Because they cannot provide this information, the NAA (National Revenue Agency) authorities use the so-called "consumer basket" or, in other words, an average monthly amount required for the maintenance of a household based on the number of its members and its standard of living as a criterion for expenses during tax audits of individuals. At the moment when the proven income declared in the annual returns of the individuals is below this consumer basket or, in other words, if the received funds are below this amount perceived by the NAA authorities, the auditors decide that the audited individual has necessarily received undeclared funds in their tax return.

Another focus of tax audits on individuals is shopping (with credit and debit cards) of goods and services, as well as tours that require the spending of funds if the individual cannot explain where they got these funds.

Another emphasis in tax audits of individuals concerns people who join marketing structures for direct sales or multi-level marketing (MLM companies). Tax authorities check whether the individuals have declared all their income from such sources in their annual returns and whether they have taxed these earnings wherever applicable—with taxes and social contributions.

The most common results of tax audits of individuals

Ultimately, the results of tax audits of individuals are that tax authorities often find that the individuals they audit (considering their standard of living and consumer basket) cannot afford this standard of living with the declared income. Then they conclude that the audited individual has undeclared income from economic activity, taxing this undeclared income retroactively with PIT, social contributions, and interest for late payments. As a result of these audits, large tax assessment acts are issued to individuals. Then their accounts are frozen, their properties are restrained, and the tax assessment acts are handed over to the Public Executor for forced collection of obligations.

This problem during tax audits of individuals could be partially solved if the individual declares the so-called initial balance. This means that at the beginning of the audited period, the individual should declare that they had a sufficiently large sum of money from which they could support themselves over the next 5-6 years, and these funds should have a proven origin.

Possible resolution to the situation

For this purpose, 1) the object of tax audits of individuals must declare how the funds were obtained, and if their source was subject to declaration at the time of receipt, this declaration should have been made; 2) the individual can also state to NAA authorities that they received the funds from a source that was not subject to declaration in a sufficiently distant period of time.

When talking about income sources, you may recall if and when you have sold an apartment, house, received inheritance, donations from your relative (be aware that for gifts, a 5% gift tax is owed except between certain categories of relatives and excluding regular gifts), loans, and other similar matters.

Our strong recommendation is if you find yourself in a situation of an individual being tax-audited, to consult a tax specialist and accountant to guide you on what to say, what to write, what to prove and what not, and be completely frank with them, even if their questions may seem too material. Keep in mind that these specialists aim for your protection. You should also gather information for the reviewed period and "account" all your income and all your bank accounts without waiting for the end date of the review and the opinion of the auditing authorities.

In place of a conclusion

In parallel, keep in mind that for every transaction you claim to have made like a sale, rent, loan, donation, etc., taxes are owed, and we advise you to be careful with what written explanations you provide for income for past periods. In a joking context, only thefts are not taxed, and thefts are extinguished after a 15-year absolute limitation (according to the main provision of the Penal Code), after which pre-trial proceedings cannot be initiated by the prosecutor's office and the individuals are not criminally liable.

We hope this has been helpful for those currently in a situation as audited individuals and that we have managed to guide you at least a little on how to structure your defense.

Author: Marina Muchakova