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    Are you prepared for Tax Inspection?

    Who is the main target for tax inspection?

    Considering the status of the state finance, it can be noticed that the tax audits and the tax inspections became more popular. They are especially present in those companies which are in profit position and are still liquid enough to be able to pay possible additionally assessed tax liability during the tax inspection. Tax inspections are also equally present in those companies which do not have employees employed, which have incurred huge losses, that often file corrections of the tax returns, or are late with payments of their tax liabilities or tax returns filing, etc.

    Preparation for tax inspection

    Whatever criteria for the selection of the taxpayers for a tax inspection are, in order to avoid possible calculation of additional tax liabilities on time, it is important for the taxpayers to prepare themselves for potential tax inspection in advance. This primarily involves review of all significant (taxable) transactions that are recorded in the accounting records of the taxpayer in the period that is still open for tax inspection, which is at least the last three years. Such review primarily should include review of the tax treatment of each transaction, review of the existing accounting documentation (i.e. posting documents) based on which the transactions are recorded, as well as their formal accuracy.

    What is inspected during the tax inspection?

    The tax inspectors are not only in charge for review of accuracy in calculation and payment of the tax liabilities, but also to determine whether the business transactions are recorded in the accounting records accurately in accordance with the applicable accounting standards and based on reliable accounting documents. In practice, it is a common case that specific transactions are challenged just because they were not recorded properly or because of formally invalid and incomplete supporting accounting documentation. Usually that happens in case of VAT refund, where the VAT refund is often challenged due to formally invalid invoices (e.g. the invoices do not contain all compulsory elements), or when incoming expenses are challenged and the corporate profit tax base is adjusted due to lack of supporting documentation and evidences that the deliveries were actually performed, specifically in case of received services.

    Based on such taxpayers’ negligence and their extempore for the tax inspection, the tax collectors collect most of the funds in the state budget. The tax inspectors also expensively charge mistakes in taxation of specific business transactions, which the taxpayers accidently make from ignorance or from wrong interpretation of inexplicit tax legalisation. For example, in case of application of the VAT rules in complex transactions between the taxpayers from different EU member states and third countries, or in case of income paid to foreign individuals (e.g. taxation of seconded employees, in case of, for example of foreign managers seconded to work in Croatia), application of market prices in transactions between related parties, etc. Depending on industry in which the taxpayer operates and business specifics, as well on types of transactions which emerge during the business conduct, some taxes are more interesting to the tax collectors than the others. Thus the most common are VAT inspections, since the income from the VAT participate the most in the state budget, and since VAT is present almost with all taxpayers and all transactions. Personal income tax inspections will be more present with the taxpayers who besides the employment contracts also sign the other types of employment engagements, such as authorship and work on contract engagements (e.g. newspaper publishers). More and more present are also corporate profit tax inspections with focuses on justification of expenses and correct treatment of the tax recognised and unrecognised expenses, as well as inspections of all taxes at once for the one specific period.

    Duly preparation for a tax inspection is essential!

    Review of all transactions and related documentation from the current and previous years is very important in order to determine whether the tax rules and the tax authorities’ requirements are fulfilled in all segments of business operations, and where possible, to eliminate any identified shortfalls. Furthermore, it is very important to know how to communicate with the tax inspectors during the course of the tax inspection, in order to prevent any misunderstandings even then. Exactly due to all above mentioned reasons, and taking in consideration that the taxpayers are faced with very frequent amendments of the tax legislation, which are very unclear, and therefore, very difficult to interpret and apply, it is recommendable to consult the tax experts to assist in tax reviews and tax inspections. In conclusion, tax inspections cannot be predicted, but certainly can be expected. Therefore, it is important for the taxpayers to undertake every measure to identify potential tax risks in order to avoid assessment of additional tax liability during the tax inspection, as well as high penalty interest and fines, which are in such cases inevitable.

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