Issuance of a Tax Notice-Decision to an IT Company: Tax Consequences and Appeals

The active development of the IT business in Ukraine has led, and continues to lead, to the registration of a large number of enterprises, primarily limited liability companies and individual entrepreneurs. These forms of conducting business have proven to be those most commonly preferred by Ukrainian IT professionals and foreign investors. This is mainly due to such factors as the relative simplicity of registration and business operations, a comparatively moderate tax burden, flexibility, and familiarity for foreign partners, since equivalents of limited liability companies, such as LLCs and Limited companies, exist in most modern popular jurisdictions.

At the same time, attractive tax rates and the apparent simplicity of doing business do not mean that a company is free from risks. One of the factors that is often underestimated or not noticed at all until a critical situation arises is tax audits and their consequences in the form of additional tax assessments. Even if it may seem that a company is outside the risk zone provided that its tax, accounting, and HR records are professionally maintained, this is far from the case. Due to the specific nature of the activities of regulatory authorities in Ukraine and the inconsistent practice of applying tax rules, it is almost impossible to guarantee with 100% certainty that no claims will be raised against a company during inspections by public authorities.

In this article, we propose examining the circumstances in which a Ukrainian IT company or individual entrepreneur may become subject to a tax audit, the violations that may be identified, their consequences, and the available methods of appealing decisions adopted by the tax authority.

What Is a Tax Notice-Decision?

A tax notice-decision is issued by the tax authority following an audit if a violation has been identified during the audit. A tax notice-decision is an official written decision of the regulatory authority determining the amount of the taxpayer’s monetary liability, including penalties. Such a decision constitutes a direct demand requiring the taxpayer to pay the additionally assessed amounts. But how and when are audits conducted?

A tax audit is a legally established form of tax control carried out by a regulatory authority to verify the correctness of tax and fee calculations and the timely payment of taxes and fees by the taxpayer. Under the provisions of the Tax Code of Ukraine, tax audits are divided into three types: desk audits, documentary audits, and factual audits. Depending on the grounds for their appointment, documentary audits are classified as scheduled or unscheduled and, depending on the place where they are conducted, as on-site or off-site audits.

For limited liability companies and individual entrepreneurs providing IT services, documentary and desk audits are the most relevant. A desk audit is conducted automatically in relation to all submitted tax returns. For individual entrepreneurs, declarations relating to the single tax, unified social contribution, personal income tax, and military levy are reviewed. For limited liability companies, corporate income tax or single tax returns, VAT returns, and reports concerning taxes on payments to employees are reviewed.

A documentary audit is the most significant type of audit for an IT business. During such an audit, the authorities may review agreements with customers and contractors, acceptance certificates or other documents confirming the provision of services, bank statements, the correct recognition of income and expenses, transactions with non-residents, and the payment of taxes on salaries and other payments. A scheduled audit is conducted when the taxpayer is included in the audit schedule based on tax risks, while an unscheduled audit is conducted where grounds provided by law exist, such as discrepancies in tax reporting, failure to provide documents in response to a request from the State Tax Service, or termination of business activities.

Following either a desk audit or a documentary audit, a tax notice-decision may be issued if the regulatory authority establishes a violation that provides grounds for determining a monetary liability, imposing a penalty, or adjusting tax indicators.

Which Violations May Serve as Grounds for a Tax Notice-Decision in the Case of IT Companies?

It is practically impossible to completely exclude the possibility of a tax audit throughout the entire period of a company’s operations. At the same time, the mere fact that an audit is being conducted does not automatically mean that a violation will be established or that a tax notice-decision will be issued. Such a decision may be issued if the State Tax Service considers that the identified circumstances have resulted in an understatement of tax liabilities, an overstatement of expenses, a negative tax value or tax credit, or a failure by the company to fulfil its obligations as a tax agent.

The following main areas of tax risk may be identified for IT companies:

Risk factor	Possible position of the State Tax Service	Potential consequences
Receiving services from individual entrepreneurs	If the actual relationship involves compliance with the company’s internal rules, a permanent work schedule, regular fixed remuneration, control over the working process, and a lack of independence on the part of the service provider, the State Tax Service may regard it as a concealed employment relationship.	Additional assessment of personal income tax and military levy, as well as penalties and late-payment interest. The unified social contribution may be assessed separately, and sanctions may be imposed for violations of labour legislation. An adjustment of corporate income tax is not automatic and may occur, in particular, if the State Tax Service also challenges the documentary substantiation of the expenses.
Formalising relationships with individuals under works or service agreements	Civil-law relationships may be reclassified as employment relationships if their actual subject matter is not a specific result but the continuous performance of an employment function under the company’s control. Indicators of employment similar to those applicable in the case of individual entrepreneurs may also be taken into account.	If the company has failed to fulfil its obligations as a tax agent, personal income tax, military levy, unified social contribution, penalties, and late-payment interest may be additionally assessed. If the relevant payments were already calculated correctly, the main remaining risk may consist of sanctions under labour legislation.
Insufficient detail in agreements and primary documents	If, in the opinion of the State Tax Service, the agreements, acceptance certificates, and other documents do not make it possible to determine the substance, scope, period, and result of the services provided to or received by the company, the State Tax Service may question whether the business transaction actually took place.	Disallowance of expenses and an increase in corporate income tax; reduction of the VAT tax credit, if such a credit was generated in connection with the relevant transaction; penalties and late-payment interest.
Absence of employees	The State Tax Service may question which labour resources the company used to perform the declared volume of work. This is particularly risky if the company also has no properly formalised relationships with contractors.	This does not in itself constitute a violation and does not automatically result in tax consequences. However, together with other circumstances, it may be used to establish that transactions were fictitious or that concealed employment relationships existed.
Absence of the company’s own premises, equipment, or other material resources	The State Tax Service may question the company’s ability to actually perform the work if the company cannot confirm its use of leased equipment, coworking facilities, cloud services, or equipment belonging to employees or contractors.	The likelihood of a tax notice-decision being issued solely because the company does not own assets is low. However, this factor may be used together with other evidence to disallow expenses or the tax credit.

What Happens During an Audit by the State Tax Service?

Fortunately for taxpayers, the procedure for conducting tax audits is regulated in detail by Ukrainian legislation. A desk audit essentially consists of reviewing tax reports in real time without adopting separate decisions and without the company’s knowledge or consent. The very fact that a business submits its tax reports results in their subsequent review as part of the regulatory authority’s ordinary activities.

A documentary audit may be scheduled or unscheduled and may be conducted on-site or off-site. A scheduled audit is conducted in accordance with the audit schedule of the State Tax Service. The taxpayer must be notified of the audit no later than ten calendar days before it begins by being sent or served with a copy of the audit order and a written notice specifying the audit commencement date.

An unscheduled audit may be conducted only where grounds established by the Tax Code of Ukraine exist. These grounds generally include the failure to submit tax reports, the submission of inaccurate tax reports, the identification of discrepancies or potential violations, the liquidation or reorganisation of a taxpayer, complaints concerning the failure to formalise employment relationships, and similar circumstances. There is no general ten-day notification period for such an audit. However, a copy of the audit order must be served on the taxpayer before the audit begins.

During an on-site audit, inspectors arrive at the taxpayer’s location or at the location of the relevant facility. Before commencing the audit, they must present the audit authorisation, a copy of the audit order, and their official identification documents. An off-site audit is conducted at the premises of the State Tax Service on the basis of documents provided to or obtained by it, and the taxpayer’s presence is not mandatory.

During the audit, inspectors analyse tax reports, agreements, primary documents, bank statements, and other materials relating to the subject matter of the audit. Based on the results, an audit report or certificate is prepared, and if violations are identified, a tax notice-decision may be issued.

Is It Possible to Prepare for an Audit?

It should also be taken into account that a company may learn about a scheduled documentary audit in advance, even before receiving an official notice of the audit. The tax authority officially publishes information about planned audits in the form of a table listing enterprises and the month of the year in which each audit is scheduled.

The schedule is prepared on the basis of criteria relating to the risk of non-payment of taxes or violations of legislation. However, even companies with an insignificant degree of risk may be included in the schedule no more than once every three years. Therefore, one area of preparation may be the establishment of a process for periodically monitoring the audit schedule for the relevant year. It is important to bear in mind that the schedule is not fixed for the entire year and may be amended during the year.

The situation is more complicated in the case of unscheduled audits, since it is only possible to know with certainty that such an audit will be conducted after receiving the relevant notice from the State Tax Service. In practice, such notice may be provided at the very moment when inspectors arrive at the place where the company conducts its business activities to commence the audit.

At the same time, the legislation provides, in particular, for the following main grounds for conducting an unscheduled documentary audit:

• receipt of tax information concerning possible violations;
• failure to submit mandatory tax reports;
• identification of inaccurate information in tax returns;
• termination, liquidation, reorganisation, or bankruptcy of the taxpayer.

Therefore, when any of these circumstances arise, the possibility of an audit being initiated should be taken into account.

Control by the State Tax Service may be particularly unexpected when procedures for closing a business are initiated. In practice, there are situations in which an IT company operates for years without receiving any claims from the tax authority and, accordingly, assumes that no violations exist. The owners subsequently decide to liquidate the company and, seeing no risks, hastily initiate the company’s termination.

However, under such a scenario, the regulatory authority acquires an unconditional ground for conducting an audit, which it actively uses, since the state is not interested in allowing the termination of a company that has outstanding tax debts. As a result, a business that is confident that no problems exist and has not taken any preparatory measures may face a rather thorough audit covering up to the previous five years of its activities.

As a general rule, the audited period is 1,095 days. However, taking into account the periods during which this limitation period was suspended by law, the actual scope of the audit may extend beyond three years.

Options and Procedure for Appealing a Tax Notice-Decision

If, following an audit of a company, the tax authority issues a tax notice-decision, the business may appeal it and seek the full or partial cancellation of the additionally assessed taxes. Below is a brief overview of the available methods of appealing a tax notice-decision.

Type of appeal	Substance	Time limit
Objections to the audit report	The objections are submitted to the regulatory authority that conducted the audit. Agreements, primary documents, calculations, explanations, and other evidence may be attached to the objections. This provides an opportunity to refute the audit findings or reduce the amount of future additional assessments before the tax notice-decision is issued.	Ten business days from the day following the date on which the audit report was received. The materials and objections are generally reviewed by a commission of the State Tax Service within ten business days after their receipt.
Administrative appeal against a tax notice-decision	A complaint is submitted to the higher-level regulatory authority, usually the State Tax Service of Ukraine. The complaint may request the full or partial cancellation of the tax notice-decision. A complaint submitted within the prescribed period suspends the enforcement of the disputed monetary liability, and the relevant amount is considered unagreed until the procedure is completed.	Ten business days from the day following the date on which the tax notice-decision was received. The complaint is reviewed within 20 calendar days. This period may be extended, but not beyond 60 calendar days, and the taxpayer must be notified of the extension in advance.
Court of first instance	A claim seeking recognition of the tax notice-decision as unlawful and its full or partial cancellation is filed with the relevant circuit administrative court. A prior administrative appeal is not mandatory. During judicial proceedings, the relevant monetary liability remains unagreed until the court judgment becomes legally effective.	If no administrative complaint was filed, six months from the date on which the tax notice-decision was received. If an administrative appeal was pursued first, one month from the day following the date on which that procedure was completed.
Appeal proceedings	The administrative court of appeal reviews the legality and validity of the judgment of the court of first instance within the scope of the arguments raised in the appeal. As a result, the judgment may be upheld, amended, or overturned.	An appeal against a judgment must be filed within 30 days, while an appeal against a procedural ruling must be filed within 15 days from the date of its pronouncement. If only the introductory and operative parts were pronounced, the period is calculated from the date on which the full judgment was prepared.
Cassation proceedings	A cassation appeal is considered by the Supreme Court. At this stage, the court primarily reviews whether substantive and procedural law has been applied correctly. Cassation review is possible where the grounds provided by the Code of Administrative Procedure of Ukraine exist and does not automatically involve a new examination of all evidence.	Thirty days from the date on which the judgment of the court of appeal was pronounced. If the full text was prepared later or the case was considered without summoning the parties, the period is calculated from the date on which the full judgment was prepared.

As we can see, appealing a tax notice-decision is a complex legal process that requires in-depth expertise and may require the involvement of significant resources. Those interested in resolving a non-compete agreement dispute may read our relevant article.

When interacting with the tax authority and subsequently appealing its decision, an IT company should take the following considerations into account:

1. To reduce the risk of penalties or additional assessments by the State Tax Service, attention should be paid to the accounting, tax, and HR records of the IT business from the very beginning of the company’s operations and at every stage of its activities. For this purpose, we recommend organising the company’s activities with due regard to the existing practices of the State Tax Service and the courts, as well as the recommendations of legal advisers, and periodically conducting audits — not only financial audits, but also contract audits.

2. Since the legislation establishes clear grounds for initiating an unscheduled documentary audit by the State Tax Service, it is advisable to take this risk into account, particularly where the deadline for submitting tax reports has been missed. In this context, it is also important to avoid hasty decisions concerning the liquidation or reorganisation of a company or the declaration of bankruptcy without first conducting a proper audit.

3. The success of a future appeal begins to take shape during the audit itself, including at the following stages:

• Admission of the regulatory authority to the audit. At this stage, it is important to verify the authority of the inspectors, ensure that the audit is accompanied by a lawyer or attorney, and, where necessary, instruct the company’s personnel regarding their rights.
• Providing documents and responses to requests from the State Tax Service. This process is extremely important, since both the position of the State Tax Service and the subsequent grounds for appeal will depend on the content of the responses and the documents provided. At this stage, the involvement of an experienced lawyer or attorney is crucial to the development of the future legal position.
• Monitoring compliance with deadlines and procedures by the regulatory authority. Procedural violations committed by inspectors may also serve as grounds for the future cancellation of their decisions. It is important to properly record such violations and raise objections to specific actions of the State Tax Service, depending on the chosen strategy.

4. Once a tax notice-decision has been received, the appeal periods begin to run. At the same time, excessive haste or poorly considered actions may also be harmful. At this stage, an entire set of circumstances and risks should be considered, ranging from the choice of procedure — an administrative appeal or an immediate application to the court — to the legal position, the preparation of materials, and whether appealing the tax notice-decision is appropriate at all, taking into account the associated costs and prospects.

5. A tax decision that is not appealed results in the company incurring a debt to the state. If it appears that the status of a limited liability company eliminates the risk of liability being imposed on its founders or members, this is not the case. Legislative mechanisms exist that, under certain conditions, allow the state to recover the debt from the company’s director and founders. The company’s inability to pay the debt may also provide grounds for imposing administrative or even criminal liability on its officers or business owners.

Conclusions

Thus, a tax audit and the possible issuance of a tax notice-decision are risks that IT companies should take into account throughout their entire period of operation — from formalising relationships with employees and contractors to preparing primary documents, submitting tax reports, and liquidating the business.

At the same time, the mere receipt of a tax notice-decision does not mean that the conclusions of the State Tax Service are indisputable. The taxpayer has the right to submit objections to the audit report, use the administrative appeal procedure, or apply to the court.

The effective protection of a company begins even before an audit and involves properly maintaining accounting, tax, and HR records, documenting business transactions in detail, reviewing agreements, and monitoring compliance by the State Tax Service with the applicable procedures. Timely legal assistance helps not only to reduce the risk of additional assessments but also to develop a well-founded position for a subsequent appeal.

Should you require professional assistance during a tax audit, in appealing a tax notice-decision, or in conducting a preliminary audit of an IT company’s activities, please contact Legal IT Group. The lawyers of Legal IT Group will help assess tax risks, prepare the necessary documents, and protect your business interests in dealings with regulatory authorities.