Counterparty selection and due diligence: key aspects based on court practice

Counterparty selection is one of the most important stages in business, which can significantly affect a company’s financial results. However, despite the importance of this process, many businesses face problems with additional value added tax (VAT) charges. In this context, it is interesting to note a case where a court ruled that the additional VAT charge on a transaction was unlawful, which emphasises the need for due diligence when choosing counterparties.

The essence of the case

In the case in question, the tax inspectorate assessed additional VAT based on the assumption that the transactions were fictitious and the counterparties were technical. The inspectorate argued that the taxpayer had failed to exercise due diligence in selecting a counterparty. However, the 17th Arbitration Court of Appeal did not support the tax authority’s conclusions, which showed that the taxpayer had fulfilled the necessary requirements to confirm the bona fides of the transaction.

Due diligence: what is it?

Due diligence is the process of checking and analysing information about a counterparty before concluding a transaction. It includes obtaining extracts from the Unified State Register of Legal Entities, analysing open sources of information and carrying out other measures aimed at minimising risks.

In this case, the taxpayer fulfilled these measures by obtaining an extract from the Unified State Register of Legal Entities and information from the Transparent Business service. The analysis of open data did not reveal any risks, which confirms its good faith.

The court proceedings

The court proceedings showed that the counterparty had been registered 2.5 years before the transaction and was located at the place of registration. The main type of activity – wholesale of non-specialised goods – was also not suspicious.

Despite the fact that the counterparty filed declarations with minimal amounts and submitted income tax reports only for the general director, the court found no grounds to conclude that the transactions were fictitious. It is important to note that at the time the materials were considered in court, the counterparty was still operating and there was no information about the unreliability of data in the Unified State Register of Legal Entities.

Business customs

It is also worth mentioning that the transaction was formalised only by universal transfer act without a contract, which is in line with business customs. This once again confirms that the taxpayer acted within the framework of normal business practice and had no grounds for enhanced diligence. The amount of the transaction was only 1.25 per cent of all purchases for the quarter, which also indicates that it was an ordinary small transaction.