Services received – how to prove their tax deductibility?
Do you receive services from intracompany or external providers whose actual substance is uncertain or whose benefit for your company is doubtful? The tax authority may no longer regard the mere provision of such a service’s tax document as sufficient: increasingly often it may become necessary to prove much more when claiming expenses for tax purposes.
Whereas in previous years the tax authorities mainly paid attention to services provided by related parties, now they increasingly often also focus on services received from unrelated parties.
Why do tax administrators actually challenge expenses for received services? Two reasons are most frequent: first, a failure to sufficiently document that a service has been delivered (in the period in which it is accounted for) or adequately prove its actual substance; second, a failure to prove that the service recipient has generated the desired benefit, i.e. that the service has served or could/should have served to generate, assure and maintain the recipient’s taxable income. We should also not forget the price charged for the provided services, which should be at arm’s length, even in the case of third-party relations. If the tax administrator comes to the conclusion that the appropriate contractual relationship has been entered into for the primary purpose to reduce the tax base or increase tax losses, the contracting parties may be regarded as related parties even without any interconnection through capital or personnel.
Let us get back to the proving of services as such. The tax authorities’ conclusions in reports on procedures to remove doubt or tax inspections often include a statement more or less similar to the following: “During the proceedings, the tax administrator identified circumstances leading to doubts whether expenses had been rightfully claimed as tax deductible, as the tax administrator had not been provided with sufficient evidence proving that services had actually been delivered or confirming other facts, such as the time of delivery, the specification of services, the scope of services, the quality of provided services, or documenting that the services were provided to assure and maintain the recipient’s taxable income.” After reaching such a conclusion, the tax authority usually assesses additional tax plus appropriate sanctions for the taxpayer’s failure to bear the burden of proof.
After an interval of several months or years, it is quite hard to retrospectively prove the nature and the result of the provided services. Naturally, a much harder task might be to retrospectively prove the specific benefits for the service recipient (i.e. benefit test). In practice, this means that for each received supply, corporations should be able to document that expenses incurred for this supply generated some benefits, while these need not necessarily involve a direct increase in revenues but may have resulted, for example, in cost savings, risk mitigation or improved efficiency.
The Supreme Administrative Court often tends to agree with the tax authority’s views, confirming that the mere provision of an invoice or a contract for the services at issue does not in any way prove that the services have really been delivered or that the recipient has really generated benefits from such services.
How to avoid any unpleasant discussions with the tax authority in this respect? The starting point is to take all this seriously. The approach that everything will somehow prove itself when the tax authority comes for an inspection does not usually work, as it is not that simple. During an actual tax inspection, it often happens that those who remember the services under review are no longer working for the company and any related evidence of the services has vanished with them and their computers. And even if the appropriate personnel is still present, it may nonetheless be quite difficult to find relevant supporting documentation in an overflow of data. The ideal solution is to implement internal processes ensuring the keeping of the best possible documentation for received services and benefits already at the moment the services are delivered, as well as ensuring that this documentation is kept in a safe place and easily accessible at a later point in time.
We cannot but recommend that evidence of all received services be collected and archived on a timely and consistent basis. The evidence may include e-mail communication, task appointment, minutes from phone conversations or meetings, the service provider’s timesheets and outputs, etc. Moreover, where the scope of received services is significant, it is also appropriate to continuously evaluate and document the benefits for a corporation (i.e. to be able to provide benefit tests).