7 practical tips for checking counterparties properly

By Ekaterina Kalinkina, Head of Branch Office Intercomp Ryazan

Even bona fide companies may be a part of numerous tax schemes, and doing business with such companies could result in large financial losses and increase the risk of disputes with tax authorities. Counterparties therefore need to be checked properly.

Ekaterina Kalinkina
Head of Branch Office Intercomp Ryazan

We offer 7 practical tips to help identify male fide counterparties, or rather make sure that you are dealing with reliable partners. 

1. What signs are worth noting? And what exactly do they indicate? 

A ruling on the evaluation by commercial courts of the validity of obtaining tax benefit is one of the first documents in which unreliability and bad faith criteria were outlined (Ruling No. 53 dated October 12, 2006 of the Supreme Commercial Court of the Russian Federation). The Ministry of Finance and the Federal Tax Service have subsequently described many times the signs that should be considered closely when choosing counterparties and what these signs indicate specifically (Federal Tax Service Letter No. ЕD-4-15/10588, Ministry of Finance Letter No. 03-12-11/2/39116 dated June 21, 2017). 

Signs of fly-by-night companies:

  • P.O. Box address;
  • No information about actual location, location of warehouses and/or production or retail premises, etc.
  • No documentary confirmation of the powers of the company’s head or his/her representative, no copies of identity document;
  • No obvious evidence that contractual terms can actually be fulfilled and reasonable doubt of actual fulfillment of contractual terms taking into account the time necessary for delivery, production, work performance or provision of services.

Sign of unlawful business activity:
  • No information about state registration in the State Register of Legal Entities/State Register of Individual Entrepreneurs; 

The above list of criteria is not exhaustive and expands all the time on account of the latest tax and court practice.

And what about actual practice? 

In addition to the criteria listed above, we noted from our practical experience a number of other signs of fly-by-night companies:

  • When asked documents necessary for verification, such companies are not willing to provide information referring to trade secret or employee personal data protection to conceal their reluctance to submit documents;
  • They provide “flawed” financial statements with data that could give grounds for field tax audits (tax deductions greater than permitted, salaries below industry average, low profitability, small tax burden (Federal Tax Service Order No. ММ-3-06/333 dated May 30, 2007));
  • The same person performs management functions in a large number of unrelated companies;
  • Frequent change of address without objective reasons;
  • Low average number of employees with substantial turnover;
  • No material resources (fixed assets, inventory) for contract performance;
  • Many court cases as defendant and plaintiff.

2. What documents should be requested from counterparties and what should be verified in these documents? 

To minimize risks when choosing a counterparty, the Ministry of Finance and the Federal Tax Service recommend requesting certified copies of the following documents (Ministry of Finance Letter No. 03-02-07/1-43 dated February 04, 2010; Federal Tax Service Letter No. 3-7-07/84 dated February 11, 2010): 

  • Copies of incorporation documents (charter and decision or minutes for establishment of legal entity);
  • Copies of certificate of registration in the State Register of Legal Entities or State Register of Individual Entrepreneurs;
  • Copies of certificate of registration with tax authorities;
  • Copies of license (if a license is required for the activity performed by the counterparty);
  • Copies of power of attorney or order confirming the head’s right to sign documents;
  • Information on whether the organization’s head has been subject to tax or administrative liability.
The validity of certified copies of documents received from counterparties must be verified. This can be done relatively easily as a great number of official services are currently offered and available.

3. What data can be found on the Federal Tax Service website? What services offered by the Federal Tax Service do you recommend? And what should we look for? 

The service “Business Risks: Check Yourself and Counterparties” offered by the Federal Tax Service on its website allows:

  • Obtaining an electronic extract from the State Register of Legal Entities/State Register of Individual Entrepreneurs;
  • Finding out about the company’s activities (main and additional);
  • Reviewing the amendments introduced by counterparties to their incorporation documents;
  • Finding out whether counterparties use a P.O. Box address for their business activity;
  • Finding out whether it is possible to contact them at their specified address (location);
  • Finding out whether a decision of exclusion from the State Register of Legal Entities has been issued for a particular company;
  • Finding out about executive bodies: do they include any disqualified persons? Do they include anyone barred by a court to participate in/manage any organization?
  • Fnding out about tax arrears and tax reporting.
The service “Transparent Business” was supposed to be available on the website of the Federal Tax service on July 25, 2017, but its launch was postponed to June 01, 2018. This service will provide even more information about counterparties, in particular:
  • Average number of employees per calendar year;
  • Amounts of revenues and expenses according to financial statements;
  • Amounts paid for each tax, charges, social insurance contributions;
  • Amounts of arrears and penalty arrears;
  • Information about tax offenses with total fine amount.

4. What other services are available? 

We recommend additional official services to obtain information about counterparties. 

The Federal Register of Bankruptcy provides information about the bankruptcy of legal entities and individuals. 

The Procurement Information System provides information from the register of unscrupulous suppliers and contractors. 

The Federal Statistics Service allows getting and reviewing data from the financial statements of legal entities as well as audit reports on companies subject to mandatory audit. 

The State Registration Bulletin provides information about bankruptcy, cancelation of powers of attorney and other important matters. 

The Federal Bailiff Service provides information about the debts of legal entities, individuals and individual entrepreneurs. 

The Electronic Justice Service provides information from the Supreme Commercial Court of the Russian Federation on whether or not legal entities are involved in litigation. 

The main department for migration of the Ministry of Internal Affairs of Russia provides information about the validity of passports. 

The Federal Tax Service provides information about disqualified persons.

5. What additional data can be requested from counterparties? 

To ensure greater protection in practice, we recommend requesting also the following:

  • Order for appointment of chief accountant;
  • Bank signature sample card for first and second signature;
  • Financial statements (Forms No. 1 and 2) for the reporting year preceding the year of contract conclusion;
  • Tax returns stamped by tax office;
  • Certificate of no tax arrears;
  • Registers evidencing the availability of fixed assets, stocks and other resources necessary for fulfillment of contractual terms;
  • Extract from staffing list evidencing the availability of HR resources;
  • Letters of recommendation from other companies;
  • Documents supporting that employees have appropriate qualifications to fulfill contractual terms.

6. What to focus on when reviewing accounting and tax reporting? 

When reviewing a counterparty’s accounting and tax reporting, the following should be noted:

  • Small tax burden;
  • Low profitability;
  • Excessive expenditure;
  • High VAT deductions;
  • Wages under industry average. 

Finding the above in the counterparty’s reporting is one of the signs of unreliability, and it will give rise to greater scrutiny from state authorities.

7. What consequences most often arise from insufficient verification of a partner’s reliability? 

When the reliability and good practice of counterparties are not sufficiently verified, this often gives rise to disputes with tax authorities and accusations from state authorities of absence of due diligence and care as well as receipt of unjustified tax benefit. 

Such disputes very often result in rejection of reduction in taxable profit by deducting the expenses incurred for goods, work and/or services provided by such counterparties, rejection of deduction of the VAT they charged, as well as the imposition of fines and penalties for profit tax and VAT. 

As part of our financial consulting, we would be pleased to provide additional information, verify as accurately as possible the reliability of your counterparties as well as conduct reconciliations with counterparties from any business sectors.