Tax Consultant's Ethical Dilemma: Client's Aggressive Tax Scheme
A tax consultant, Elena, is approached by a new client, a Belarusian trading company Delta, which wants to reduce its profit tax and VAT. Delta proposes a scheme where it will set up a company in Cyprus (a low-tax jurisdiction) to which it will sell goods at cost, and the Cyprus company will resell them to customers in the EU at a markup. Delta will then pay fees to the Cyprus company for 'marketing services' equal to the profit, effectively shifting profits to Cyprus. Delta asks Elena to provide an opinion that the scheme is legal and to prepare the necessary contracts. Elena knows that the Cyprus company will have no substance (no employees, no office) and that the marketing services will not actually be performed. Elena is also aware that Belarus has a controlled foreign corporation (CFC) law and that the Belarus-Cyprus double tax treaty may not apply if the Cyprus company is a conduit. Elena is a member of the Belarusian Chamber of Tax Consultants, which has a code of ethics requiring consultants to act with integrity and not to assist in tax evasion.
1. Discuss the ethical and legal issues Elena faces. What should she do? Refer to the code of ethics and relevant tax law.
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Elena faces a conflict between her duty to her client and her ethical and legal obligations. The proposed scheme involves creating a Cyprus company with no substance solely to shift profits, and paying for services that will not be performed. This is likely an artificial arrangement that lacks economic substance and may be considered tax evasion or abuse of law. Under Belarusian tax law, the general anti-avoidance rule (GAAR) in Article 33 of the Tax Code allows the tax authority to recharacterize transactions that lack business purpose. Additionally, the CFC rules (Article 25-1 of the Tax Code) may attribute the Cyprus company's profits to Delta if it is controlled. The Belarus-Cyprus treaty may be denied benefits if the company is a conduit. Elena's code of ethics requires her to act with integrity, objectivity, and professional competence, and not to assist in illegal activities. She should decline to provide an opinion that the scheme is legal and should not prepare contracts that facilitate the scheme. She should explain to Delta the risks, including the potential for tax evasion penalties, and advise them to restructure in a compliant manner. If Delta insists, Elena should withdraw from the engagement. She may also have a duty to report if she suspects money laundering or tax evasion, but in Belarus, the obligation to report suspicious transactions may apply under anti-money laundering laws. Elena should document her advice and the client's refusal to follow it. She should not violate client confidentiality unless required by law. Overall, Elena should refuse to assist in the aggressive scheme and provide ethical advice.
2. What are the potential consequences for Delta if it proceeds with the scheme, and how might the Belarusian tax authority challenge it?
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If Delta proceeds, the Belarusian tax authority may challenge the scheme under the GAAR, arguing that the main purpose was tax avoidance and the arrangement lacks economic substance. The tax authority could disregard the Cyprus company and attribute the profits to Delta, assessing additional profit tax and VAT, plus penalties (20% for underpayment, 10% for failure to file). Under CFC rules, Delta may be required to include the Cyprus company's profits in its taxable base if it controls the company. The treaty benefits may be denied if the Cyprus company is a conduit. Additionally, the tax authority may impose a penalty for failure to submit transfer pricing documentation if the transactions are considered controlled. Delta could also face criminal liability for tax evasion if the amount is large. The tax authority may use the concept of 'unjustified tax benefit' and recharacterize the marketing fees as non-deductible. Delta would have to prove the services were actually rendered and the fees were arm's length. Given the lack of substance, Delta is likely to lose. Therefore, Delta should not proceed.