How to build a tax-safe business structure and avoid accusations of business fragmentation
Content of the article
Content of the article
Business structuring allows owners to effectively organize management, allocate risks, attract investors, and scale individual business areas. However, in recent years, the issue of so-called “business fragmentation” has come under increasing scrutiny from tax authorities.
During audits, regulatory authorities are increasingly analyzing not only the formal existence of separate legal entities or individual entrepreneurs, but also the actual substance of their activities.
If several business entities exist only formally, while in reality they operate as a single business with the purpose of minimizing taxes or avoiding certain restrictions, there is a risk of additional tax assessments, cancellation of the single tax payer status, and financial penalties.
At the same time, the mere existence of several companies or individual entrepreneurs does not in itself constitute a violation of the law. The economic rationale behind the structure is what matters.
Legal structuring vs. artificial business fragmentation
The law does not prohibit taxpayers from choosing the most advantageous business model. A business has the right to use different legal forms, tax systems, and build a corporate structure based on economic rationale.
At the same time, tax benefits cannot be the sole reason for creating separate business entities.
If the activities of several companies or individual entrepreneurs effectively constitute a single business process, and the division is used solely to retain eligibility for the simplified taxation system, avoid VAT or other taxes, the tax authority may regard such actions as artificial business fragmentation.
This is why the concept of substance over form is increasingly applied, under which not only the legal structure of the relationships is assessed, but also their actual economic substance.
The existence of several business entities is justified if each of them has its own distinct business role. For example, one company is engaged in manufacturing; another carries out wholesale trading; a third provides logistics; a separate individual entrepreneur provides independent consulting or marketing services; one company owns real estate while another conducts the operating business.
In such cases, each entity has its own business processes, personnel, assets, and management, and independently bears entrepreneurial risks.
During audits, the regulatory authority analyzes a combination of factual circumstances:
- who makes management decisions;
- who actually works with clients;
- who uses the assets;
- how profits are distributed;
- whether each entity operates independently.
Even flawlessly executed contracts do not guarantee that the structure is safe if they do not correspond to the actual nature of the business relationships.
Business risk map
Legal checklist for a safe business structure
Before launching or reviewing a business structure, answer the following questions:
- Business activity: does each business entity have its own unique KVED, functions, and economic role?
- Substance of contracts: are there actual contracts between the entities (lease agreements, royalty agreements, service agreements), and do the prices reflect market conditions?
- Autonomy of assets and decision-making: does each entity have its own bank accounts, production facilities, access rights, and authority to make decisions?
- Staffing: does each entity have its own employees or contractors, and are there no instances of unjustified “transfer” of personnel?
- Compliance with the State Tax Service criteria: do the income levels comply with the limits applicable to the respective groups of the simplified taxation system, and are there no risks of losing the single tax payer status?
What to do before launching the structure and what to review quarterly
Conduct pre-launch due diligence — before establishing the structure, it is advisable to assess the business model; tax risks; corporate structure; relationships between the companies; and potential claims from regulatory authorities.
Such an analysis makes it possible to identify weaknesses before the business starts operating.
Quarterly compliance monitoring:
- Turnover indicators: monitoring whether revenues are approaching the applicable thresholds.
- IP addresses and electronic signatures: reviewing login logs for banking systems (avoiding access to the systems of different entities from the same IP address).
- Staff transfers: reviewing the grounds for employees moving between companies.
- Counterparties: monitoring the share of intra-group transactions in the overall structure of revenues and expenses.
Internal compliance — it is recommended to periodically conduct a compliance review covering corporate documents; contracts; employment records; internal policies; and the allocation of functions between entities.
If there are doubts regarding a transaction between related parties, an internal justification supported by evidence of its economic rationale can be prepared before the transaction takes place, rather than during a tax audit.
Such a document does not eliminate the risks entirely, but it may help demonstrate that the decisions were made based on genuine business needs rather than solely for tax purposes.
Court practice: how factual circumstances are assessed
The case law of the Supreme Court indicates that primary documents alone cannot be regarded as conclusive evidence that business transactions actually took place if other established circumstances indicate the absence of actual movement of assets or performance of works (services).
The Supreme Court has emphasized that, for tax accounting purposes, only transactions that actually took place, are supported by proper, reliable, and consistent evidence, and have real economic substance and a business purpose are relevant.
Case No. 1. In case No. 420/8830/20, the following legal position was set out: In order to establish whether a business transaction actually took place and whether the formation of the tax credit was lawful, the courts should have examined the physical, technical, and technological capabilities of the relevant person to perform the actions constituting the substance of the business transaction, including the nature of the services (works) provided and what they consisted of, as well as the availability of qualified personnel and fixed assets. The courts should also have examined whether the disputed business transactions generated an economic benefit (justification and risk) and whether they had a business purpose.
Case No. 2. In case No. 380/2589/22, the Supreme Court emphasized that, when assessing the tax consequences of business transactions, an administrative court should not limit itself to establishing only the formal conditions for the taxpayer’s application of tax rules based on primary documents that comply with statutory requirements in form and substance. Taking into account the arguments of the tax authority, the court should examine the actual legal relationships between the parties to the business transactions, verify the actual movement of assets in the course of the transactions, and establish the connection between the primary documents and the actual facts of the business activity.
Key takeaways for business owners
A tax-safe business structure is built not on the number of legal entities or individual entrepreneurs, but on their genuine economic independence.
When creating or reviewing a corporate structure, it is worth following several basic principles:
- it is not the number of companies that determines safety, but the substance of their interactions;
- each entity should perform its own economic function and bear its own entrepreneurial risks;
- documents should reflect actual business processes rather than being created “after the fact” to justify an existing structure;
- regular internal audits and compliance reviews help identify potential risks in a timely manner and address them before a tax audit begins.
A properly structured business not only minimizes tax risks but also enhances the company’s investment attractiveness, simplifies corporate governance, and strengthens business resilience amid increased tax scrutiny.
Share
We use cookies to improve the performance of the site and enhance your user experience.
More information can be found in our Privacy Notice