The Tax Audit, the Offshore Payment, and the Privilege Question
The tax authority is auditing Company C, a logistics firm. It discovered a 200,000 AZN payment to an affiliated entity in a jurisdiction with no exchange of information and disallowed the expense, assessing additional profit tax plus penalties. Company C's director tells its advocate, T, that the payment was for 'consulting' but cannot produce a contract, invoice, or evidence of services. The director asks T to draft a retroactive consulting agreement and backdated invoices to support the deduction. T also receives a written request from the tax authority for documents concerning T's legal advice to Company C on the transaction.
1. How should T respond to the director's request to create retroactive documents?
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T must refuse. Drafting a retroactive agreement and backdated invoices to support a deduction that lacks substance would be creating false evidence and facilitating tax evasion, which is incompatible with the advocate's professional duties. T should explain the refusal in writing, warn the director of the consequences of false documentation, and advise on lawful responses to the audit, such as substantiating the services if they truly occurred or accepting the adjustment and negotiating penalties.
2. Must T produce the documents requested by the tax authority about her legal advice?
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T should distinguish between documents that are protected as legal advice and those that are not. Communications seeking or giving legal advice may be protected by professional privilege, but the underlying transactional documents and facts are generally not. T should not produce privileged advice without a legal basis, should assert the protection expressly and in writing, and should seek clarification of the legal basis for the request. She must not destroy or conceal documents. If the request is lawful and covers non-privileged material, she should comply to that extent.
3. What substantive defense, if any, remains for the disallowed expense?
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The defense depends on substance over form. If genuine consulting services were received, T should gather contemporaneous evidence: correspondence, meeting notes, deliverables, bank records, and witness statements. The absence of a written contract is not automatically fatal, but the burden is on the taxpayer to prove the expense was real and business-related. T should also examine whether the transfer-pricing rules and the no-exchange-of-information jurisdiction trigger a specific anti-avoidance provision, and prepare arguments on proportionality of penalties. T must not rely on fabricated documents.