Tax audits within criminal proceedings: unlawfulness, inadmissibility, consequences

26 October, 2016 Newsletters

Appointment of tax audits within prejudicial investigation of criminal proceeding has become quite common and even “trend” tendency, particularly in cases breached under Art. 212 on tax evasion and Art. 205 on sham corporation of the Criminal Code of Ukraine (hereinafter – the “CC of Ukraine”).

Whereas pressure of criminal cases is “normal” condition for doing business in Ukraine, appointment of audits by the investigating judge, unfortunately, has become something common and doesn’t set at a gaze.

To illustrate the range of such tool application, it is sufficient to apply to the court practice. As an example, in the Unified State Register of Court Decisions (hereinafter – the “USRCD”) we found 98 (!!!) adopted court rulings on appointment of unscheduled tax audits of legal entities within 2 months (from August 1, 2016 to September 30, 2016). That’s an average of more than 1.6 of such court rulings per day (98 court rulings within 61 days)1, taking into consideration weekends and holidays. Let’s note that the leading position in this issue belongs to Kyiv: 36 of mentioned 98 court rulings were adopted by the courts in Kyiv, that is, about 37% of the total number.

Quite often decision to conduct the audit regarding not one entity is adopted by such a court ruling. Even on this background the court ruling by which more than 1000 (thousands!!!) tax audits were adopted drew our particular attention (is available in USRCD by the link).

Appointment of tax audits by the investigating judges has become quite common tendency that, as a rule, no one even raises the question of the legality of such an appointment and therefore such audits conduct. Moreover sometimes audits are appointed even single-handed (without appeal to the investigating judges) by the investigators and prosecutors.

However, could tax audits appointed within criminal proceeding be considered legal?

The absence of the right for appointment

Now only provision of law, which generally refers to the possibility of the court/ investigator/prosecutor to appoint tax audit is subpara. 78.1.11 of the Tax Code of Ukraine (hereinafter – the “TC of Ukraine”) due to which the controlling authority conducts audit in case when court decision (of the investigating judge) on appointment of audit or resolution of authority that provides the operational investigations, the investigator, prosecutor, adopted by them in accordance with the law, is received”.

However, do really the court/investigating officer/prosecutor have such right for the tax audit appointment? 

1.

1.1.

Concerning the right of investigators/prosecutors for audit appointment.

In the previous Criminal Procedure Code of Ukraine of 1960 (hereinafter – the “CPC of 1960”), in particular, the right of investigator, prosecutor “to require inspections” was defined in part 1 of Art. 66. Such term as audit was not even mentioned in the CPC of 1960.

Despite this, the authorities of the prejudicial investigation had already begun to appoint unscheduled tax audits of legal entities, referring just to provisions of Art.66 of the CPC of 1960. But during the appeal such resolutions of investigation bodies were revoked by the courts referring that Art. 66 of the CPC of 1960 provides the right for audit appointment, which are conducted by the state financial control authorities, but not for tax audits (for example, the decision in USRCD is available by the link).

With the adoption of the CPC of Ukraine, the right of the investigator/prosecutor “to appoint inspections and audits in order determined by the law” was approved in para.  6) of part 2 of Art. 36 and para. 4) of Art. 40 of the CPC of Ukraine. It means that investigators/prosecutors received the supposedly “new” right to audits appointment.

However, it was the only mention in the code about this right, and the order of audit appointment by the authorities of prejudicial investigation has not been determined yet in the CPC of Ukraine. That is, in fact, there was no order, “defined by the law”, and respectively, there was no method defined by the law, adhering to which, the investigator/ prosecutor could act under Art. 19 of the Constitution of Ukraine.

In addition, with adoption of the Law of Ukraine No. 1697-VII as of 14.10.2014 “On Prosecutor’s Office” (hereinafter – “the law of Ukraine No. 1697-VII), para. 6) of part 2 of Art. 36 and para. 4) of Art. 40 were excluded from the CPC of Ukraine. That is the provisions provided the right to audits appointment for the investigator/prosecutor were excluded in 2014.

In section 3 of the Explanatory memorandum to the Law of Ukraine No. 1697-VII was explicitly stated that “These changes will help to avoid duplication of authorities of  prosecutor’s office and other bodies with imposed authorities on supervision (control) over the completion of laws that will allow, on the one hand, to clearly understand which authority is responsible for the state of affairs in a certain field of ​​the social relations, and on the other hand – to reduce the number of audits and other activities that may have impact on the activities of individuals and legal entities, primarily in the field of business activity.

In other words, the possibility of audit appointment by the investigators and prosecutors was excluded from the CPC of Ukraine for the purpose to reduce the pressure on business.

Thus, as of 2014 neither the investigators nor prosecutors are entitled to tax audit appointment (and appointment procedure in general was not been stipulated by the law ever).

1.2.

In turn, the provision of subpara. 78.1.11 of the TC of Ukraine, which provides audits conduct under decisions of the investigators/prosecutors and the investigating judges, was conducted to the TC of Ukraine under the Law of Ukraine No. 4652-VI as of 13.04.2012 “On amendments to some legislative acts of Ukraine in connection with the adoption of the Criminal Procedure Code of Ukraine“.

That is, the provision of subpara 78.1.11 11 of the TC of Ukraine was adopted in connection with the adoption of the effective CPC of Ukraine in the original version, where the right of the investigator/prosecutor for audit appointment was approved in para. 6) of part 2 of Art. 36 and para 4) of Art. 40. In other words, this provision of the TC of Ukraine was actually tied to the mentioned provisions of the CPC of Ukraine.

So, whereas mentioned provisions even in 2014 were excluded from the CPC of Ukraine, subpara. 78.1.11 of the TC of Ukraine should be considered as one that simply was not led to compliance to effective legislation. In fact, it loosed even a theoretical possibility of its application, because now the law doesn’t provide the rights to issue the relevant court rulings and resolutions.

With appropriate application of the CPC of Ukraine the existence of rudiment – subpara. 78.1.11 of the TC of Ukraine – would have no practical significance, whereas neither investigators/prosecutors nor judges have procedural opportunities/rights to deliver the decision on the appointment of tax audits.

2.

Reasons for absence of prosecutors’ and investigators’ right for the appointment of tax audits is given above, and concerning the absence of the right for the appointment by judges (the investigating judges) can result in the following.

Under Art. 19 of the Constitution of Ukraine, state authorities (including courts as authorities of the judicial branch of state authority) are obliged to act only (i) under, (ii) within the authorities and (iii) the manner provided by the Constitution and the laws of Ukraine.

We begin with an appeal to the investigating judge with petition on audit appointment. Can the investigators, prosecutors lodge such a petition under the law?

Under para. 5) of part 2 of Art. 40 of the CPC of Ukraine is determined that the investigator is authorized to lodge a petition  to the investigating  judge with the agreement of prosecutor on:

(i) the application of measures to ensure the criminal proceeding,

(ii) implementation of the investigating actions and

(iii) the private investigating actions.

However, audit conduct does not refer to any measures of ensuring the criminal proceeding, as well as to the investigating actions and private investigation actions.

In particular, under part 2 of Art.131 of the CPC of Ukraine, measures to ensure criminal proceeding (paragraph “i” from the above mentioned list) are:

  • call by the investigator, prosecutor, court call and bringing to the court;
  • the imposition of a monetary penalty;
  • a temporary restriction in the special law application;
  • dismissal from office;
  • temporary access to the things and documents;
  • temporary seizure of property;
  • attachment of property;
  • detention of a person;
  • preventive measures.

The mentioned list is exhaustive. Appointment of audit is absent among this exhaustive list of measures to ensure criminal proceeding.

As to (ii) the investigating actions, part 1 of Art. 223 of the CPC of Ukraine considers it as actions intended to obtain (gathering) of evidences or audit of have already obtained evidences in a particular criminal proceeding under part 1 of Art. 223 of the CPC of Ukraine.

The exhaustive list of the investigative actions with the representation of the grounds and order for their implementation is contained in chapter 20 of the CPC of Ukraine and includes: (1) examination; (2) presentation for identification; (3) entry into housing or other property of a person; (4) search; (5) inspection; (6) the investigative experiment; (7) certification of a person; (8) expert examination.

In other words audit appointment is not applied to the investigating actions defined in the CPC of Ukraine.

Then appointment of tax audits is not applied to (iii) the private investigating actions, the exhaustive list of which is contained in Chapter 21 of the CPC of Ukraine, moreover, that none of the tax audit cannot be “non-public” conducted, that is, without the knowledge of the person, which is examined.

Thus, appointment of tax audits is applied neither to the investigating actions/the private investigating actions nor to the measures to ensure criminal proceeding, therefore, the CPC of Ukraine does not provide the right of the investigator to appeal to the investigating judge with application on tax audit conduct.

The CPC of Ukraine doesn’t have examination procedure for such applications, as for example opposed to examination of applications on temporary access to the things and documents, applications on attachment of property, etc.

In turn, under part 2 of Art. 370 of the CPC of Ukraine, the legal decision is delivered in accordance with the provisions of the substantive law “in compliance with the requirements regarding the criminal proceeding provided by this Code”.

Whereas the CPC of Ukraine doesn’t provide the right of the investigator /prosecutor to appeal to the court with applications of this type, the CPC of Ukraine does not stipulate procedure for consideration of such applications by the investigating judge, so that they should not even be considered, the judge must refuse in opening proceeding.

However, contrary to the provisions of the law, for now the investigating judges open the proceedings and consider essentially applications on the appointment of tax audits. That is the investigating judges as representatives of the judiciary branch of authority act not under, not within the authorities and in a manner defined by the law, by which massively violate the provisions of Art. 19 of the Constitution of Ukraine.

At the same time the appointment of tax audit by the court is also duplication of the tax body’s authorities. That is, in fact, the court goes outside the bounds of his discretionary authorities and assumes the authorities delegated by the TC of Ukraine to the authorities of the controlling bodies – executive bodies.

3.

However, even in the case of appointment of tax audit by the investigating judge/prosecutor/investigator within criminal proceeding, the results should not have legal value.

In particular, the actual data obtained from such audit cannot be considered as evidences for the purposes of the CPC of Ukraine, because under part 1 of Art. 84 of the CPC of Ukraine:

“1. Evidences in the criminal proceeding are actual data obtained in the order provided by this Code … “.

Data obtained via tax audit conduct, appointed by the court, as mentioned above, are not that obtained in the order provided by the CPC of Ukraine, so, are not evidences in the understanding of the CPC of Ukraine.

This is confirmed by the fact that, under part 2 of Art. 93 of the CPC of Ukraine, this method of collection of evidences by the prosecuting attorney, as the appointment of tax audit, is not provided:

“2. The prosecuting attorney gathers evidences via implementation of investigating actions and the private investigating actions, of demand and obtain from public authorities, local authorities, enterprises, institutions and organizations, officials and individuals of things, documents, facts, expert opinions, professional findings, inspection reports and inspection acts, implementation of other procedural actions provided by this Code”.

The maximum that is provided – it is right to demand the acts of audits (which have already been conducted and acts on which have already been made!) as the relevant documents (of procedure source of evidences under part 2 of Art. 84 of the CPC of Ukraine), not to initiate and conduct (or to obligatory demand of conduct) of audits.

We will emphasize again that the demand of audit appointment and its conduct within criminal proceeding may not be considered also as the investigating actions.

As mentioned above, among the list of the investigating actions, defined in the CPC of Ukraine, there is no right to appoint/conduct tax audit.

In addition to that tax audit is never conducted and cannot be conducted as well as the investigating action because during this audit specific requirements for the investigating actions are not fulfilled which stipulated by Art. 223 of the CPC of Ukraine, for example, such as obligatory interpretation of   the rights and obligations under the CPC of Ukraine before the investigating action for involved persons. Mentioning on such interpretation before audit initiation have not been noted in any inspection act for the purpose of the court.

Probably, most of us remember from the foreign films so-called “Miranda rule”, according to which during arrest the man, who is arrested, shall be informed of his rights and he should answer that he understood those rights. All said by apprehended until it cannot be considered as evidence.

So there we have something like this.

Under part 1 of Art. 86 of the CPC of Ukraine “evidence will considered as admissible if it is obtained in the order stipulated by this Code”.

Accordingly, whereas the CPC of Ukraine does not provide the order for obtaining evidences by tax audits appointment neither by the investigative judges nor by prosecutors/ investigators – the results of audits appointed within investigation of the criminal proceeding, e.g. Certificates/Acts of audits for the purposes of the CPC of Ukraine are not the evidences at all or are not valid evidences, and, under part 2 of Art. 86 of the CPC of Ukraine, should not be used during taking procedural/judicial decisions within criminal proceeding.

Why actions that have no legal sense are performed?

Conclusions

(i)

Tax audits within criminal proceeding, in general, cannot be conducted under the law because they are not provided by the CPC of Ukraine.

Such audits cannot be acknowledged and directed to conduct the investigation or obtain of evidences, because under the law (the case for the lawyers, protection) they should be found inadmissible as evidences.

(ii)

In addition, these audits will have no effect on the budget in terms of the potential tax surcharges implementation whereas the act of audit, adopted upon the results of illegally audit, should not have any consequences for the payer. For ratification of this we may refer, for example, to the Resolution as of 27.01.2015 of the Supreme Court of Ukraine (is available in USRCD by the link), in which the Court concluded that “failure to enforce requirements of the law on appointment and conduct of tax audit leads to the recognition of audit illegality and to the absence of the legal consequences of such audit”.

Such approach is corresponded with the practice of the European Court of Human Rights (hereinafter – “ECHR”), under which in order to ensure the rule of law the appropriate order and procedure stipulated by law must be unconditionally complied with.

Let’s remind that under subpara. 78.1.11 of the TC of Ukraine, the appropriate decision of the court or the resolution of the investigator, prosecutor on the audit conduct must be delivered “in accordance with the law.” As investigated in this review, today the law does not provide this.

(iii)

Therefore, it can also be the ground for the tax authorities to withhold such audits conduct. Especially as they are not conducted so often. Indeed, as mentioned at the beginning of this review, only within two months courts have been appointed the audit of thousand subjects. Perhaps it is physically impossible for the tax authorities to conduct all of them,, even if they leave the rest of the controlling and auditing work. Therefore, all appointed is not performed. And when in one case is performed, and in another – is not (even for objective reasons on lack of resources), the question arises: who and on what grounds shall take a decision on the actual conduct of such audits? Whether the corruption component is in this process?

We can also say that such actions actually make a mess and somewhere paralyze the planned controlling and-auditing work of the tax authorities and audits conduct, including unscheduled audits, under the actual decision of tax authorities. It appears that the tax authorities even without it have sufficient tools (including unscheduled audits conduct in case of the presence of the grounds provided by the TC of Ukraine) for appointment and conduct of audits in case of detection of suspicious situations (getting about this relevant tax information) on their own motion. Attempts to bring decision-making process of the audits conduct to a large extent beyond the scope of the Tax Code (including the circumvention of limitations on audits conduct adopted by the Code) to some extent negate the meaning of the Tax Code as a “constitution” of tax relations, narrow the scope of actions of the Tax Code provided in subpara. 1.1. of Art.1 of the Code.

A significant number of audits appointed within criminal proceedings, conduct of the controlling and auditing work, in fact, to large extent under the “guidance” of the investigating authorities can also be seen as evidence primarily of the punishing direction of the controlling and -auditing work of the tax authorities. And this is hardly a factor that contributes to the investment climate in Ukraine.

(iv)

Considering the abovementioned, the question arises: For what purpose tax audits within criminal proceeding are appointed and conducted? It turns out that such audits are not more than an abuse with the purpose of making pressure on the business entities.

We will hope that in order to prevent this, the legislator will decide to exclude subpara. 78.1.11 from the TC of Ukraine (in other words make an action contrary to the action on the inclusion of this provision in the Tax Code in April of 2012, because primarily this provision in the TC of Ukraine was not), that will conform the TC of Ukraine in this part with the Constitution of Ukraine and the CPC of Ukraine (where relevant provisions are absent as of 2014).

(v)

And before legislators will supposedly work, we also see the following opportunities:

(a)

Firstly, to appeal decision of the investigating judge on tax audit appointment in the Court of Appeal as soon as you become aware of it,.

Although an exhaustive list of court rulings of the investigating judge, which can be appealed in the appellate order (Art. 309 of the CPC of Ukraine), does not provide appeal of court ruling on tax audit appointment – this circumstance is caused by the fact that appointment of tax audit by the investigating judge of the CPC of Ukraine is not provided.

Therefore, taking into consideration the principle of access to justice, defined in Art. 21 of the CPC of Ukraine, courts of the appeal instance must consider such appeal claims and cancel illegal decisions of the investigative judges on tax audits appointment.

The mentioned above follows from the practice of the ECHR concerning Art. 6 of the Convention on Human Rights and Fundamental Freedoms, when the court says that it is not obliged to create courts of appeal, but if they exist- the access right to them should be provided (para. 22 decisions of the Decision on case “Sokurenko and Strigun against Ukraine”).

In case of withholding, including the matter of fact, you can try to apply to the Constitutional Court of Ukraine. Thus, the constitutional reform made changes to the Constitution of Ukraine, according to which any person may apply to the Constitutional Court of Ukraine.

In particular, now under Art. 151-1 of the Constitution of Ukraine it is stipulated that:

“The Constitutional Court of Ukraine solves issues on the correspondence of the Constitution of Ukraine (constitutionality) with the Law of Ukraine on the constitutional complaint of a person who considers that the Law of Ukraine applied in the final judgment decision in his case contradicts the Constitution of Ukraine. The constitutional complaint may be lodged in the case, if all other legal remedies have been exhausted“.

In turn, the controlling authorities’ duty to conduct tax audit under decision delivered by the investigating judge, prosecutor, or the investigator, the provided subpara. 78.1.11 of the TC of Ukraine, contradicts to the Constitution of Ukraine under Art. 19 it is stipulated that:

“The legal order in Ukraine is based on the principles according to which no one can be forced to do something that is not provided by the legislation.

The state authorities, local authorities and their officials are obliged to act only under, within the authorities and in the manner provided by the Constitution and the laws of Ukraine“.

In this case, we can say that para. 78.1.11 of the TC of Ukraine contradicts to the Constitution of Ukraine and on these grounds you can try to appeal to the Constitutional Court of Ukraine.

(b)

We can try to prevent the audit conduct under para. 78.1.11 and to appeal the order of tax authority on such tax audit conduct.

(c)

In criminal proceeding, if audit under decision of the investigating judge/prosecutor/the investigator within the criminal proceeding was conducted and the act of audit was made upon the results, it is necessary to declare the inadmissibility of such evidence because it was obtained in order that is not provided by the CPC of Ukraine. And to fight about this until the appeal to the Constitutional Court, inclusively, as it was mentioned above.

(d)

You can be confined to not only national remedies, but eventually consider, for example, the application to the ECHR too.

Do not let the investigative judges/prosecutors/ the investigators to illegally appoint tax audit within criminal proceeding, and the controlling authorities to conduct such audits. It is the “tacit agreement” of business entities, in fact, allows today such lawlessness and violation of the rights. It is necessary to fight and defend your violated rights.

Let’s propose to familiarize with the commentary of Alexander Minin, Senior Partner of “KM Partners”, on the increasing of the number of tax audits within criminal proceedings on Hubs.ua business portal.

The above commentary presents the general statement for information purposes only and as such may not be practically used in specific cases without professional advice.

Footnotes:

1A selection of these decisions for convenience is available on our website by the link.

Kind regards,

© WTS Consulting LLC, 2016

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