Undeclared Income Loans and Personal Income Tax Disputes (Part I)

The article examines a tax dispute that raised issues, such as granting a loan with income received from sources unknown to the tax administrator and related personal income tax calculation issues.

The tax dispute between the parties concerned the legality and validity of the tax administrator's instructions to the Applicant to pay personal income tax and personal income tax penalties to the state budget. After conducting a repeat tax audit of the correctness of the Applicant's personal income tax calculation, declaration and payment in accordance with Article 70 of the Tax Administration Act, applying the expenditure method, the tax administrator established that the Applicant covered the expenses incurred for granting the loan with income from sources unknown to the tax administrator, which he did not declare in accordance with the procedure laid down in Articles 25 and 27(1) of the Income Tax Act, and did not calculate and pay income tax on them to the budget. 

After examining the arguments of the appeal and the evidence gathered in the case, the panel of judges of the Supreme Administrative Court of Lithuania agreed with the assessment of the evidence and the application of the law by the court of first instance, endorsing the grounds for the decision of the court of first instance without repeating them, but, taking into account the arguments set out in the applicant's appeal, supplemented them.

First of all, the Supreme Administrative Court of Lithuania noted that the practice of the Supreme Administrative Court of Lithuania indicates that various civil law contracts for the receipt of relevant funds are not primary and direct evidence in the sense of the application of the Law on Personal Income Tax, irrefutably confirming the fact of receipt of the relevant funds. Such contracts only provide grounds for the assumption that a person could have received the relevant funds under these transactions, but they do not in themselves prove that the person actually received and disposed of these funds.

It is important to note that in such cases, the actual fact of receiving/not receiving the funds becomes a matter of proof, which can be proven and refuted by all permissible means (both direct and indirect evidence), with this evidence being assessed in accordance with the general rules of evidence assessment. Therefore, in such cases, determining whether a person received/did not receive the relevant funds, whether they are subject to personal income tax or not, depends on the specific circumstances of the case, the totality of the evidence gathered in it, etc.

Thus, in the court's opinion, all this determines the nature and scope of the circumstances to be proven in the case, and it is the person who must prove that he actually received funds not subject to personal income tax under civil law transactions, and the tax administrator must prove that the person did not receive these funds under the transactions they indicate, that their origin and nature are different, etc. The mere submission of separate formal evidence of income, in the absence of the actual fact of income receipt confirmed by a comprehensive analysis of the factual circumstances of income receipt by the State Tax Inspectorate, does not substantiate the receipt of income itself. This conclusion can also be drawn from the provisions of the Tax Administration Act, which establish the principle of substance over form, according to which, in tax legal relations, priority is given to the substance of the activities of the participants in these relations, rather than their formal expression.

Incidentally, the Supreme Administrative Court of Lithuania has repeatedly stated that by choosing to receive income in cash (as a result of which the fact of receiving this income is not recorded in the accounts of credit institutions) and not declaring this income when submitting income declarations for the relevant tax period (e.g. when the submission of such a return is not mandatory), the taxpayer assumes the entire risk of the burden of proof.

Therefore, in assessing the evidence in the case, written documents and explanations of the parties, the Supreme Administrative Court of Lithuania noted that the appellant is a businessman, a professional in his field, who is well aware of his obligation to pay taxes and the general requirements for the substantiation and registration of economic operations set out in Article 3 of the Financial Accounting Law of the Republic of Lithuania to substantiate all economic operations with accounting documents and to record them in accounting registers. Furthermore, in this case, the evidence is assessed as a whole and not separately, as requested in the appeal. It noted that the appellant provided inconsistent and contradictory explanations during the tax dispute and, taking into account the totality of the evidence in the case, his explanations regarding the receipt of funds from a natural person and the acquisition of shares in UAB are unconvincing. 

The court found that the case file showed that the tax administrator had analyzed the appellant's income and expenses and sought to determine the applicant's income balance using various sources of information. In the opinion of the tax administrator, the applicant received income from unidentified sources on which no taxes were paid. 

It should be noted that the appellant attempted to prove that the balance of income and cash funds at the beginning of the audit period was different, and that the funds returned in cash should be included in the balance at the beginning of the audit period. With regard to the appellant's arguments, the court noted that there was no doubt in the case that the appellant had transferred sums of money to a natural person in three international bank transfers, indicating the purpose as 'purchase of cars'. The appellant claimed that the written evidence in the case – the agreements – confirmed that the natural person had returned all the funds transferred to him and that he had not received any cars from the natural person.

After assessing the circumstances and evidence presented by the appellant that he had received this money, the Supreme Administrative Court of Lithuania ruled that the appellant's claims were unproven. It noted that the case file showed that neither during the operational inspection nor during the first tax inspection did the appellant's explanations contain any information about signed agreements with a natural person, under which the relevant amount was received in cash. Only during the tax dispute (already knowing about the fact that the missing income to cover expenses had been established ) did the evidence of income received (funds returned under agreements) submitted to the State Tax Inspectorate, with the complaint, raise doubts about the authenticity of such agreements. 

Furthermore, during the repeat inspection, neither the appellant nor the natural person was able to explain in detail the circumstances of the transfer of cash under the agreements submitted. Both the appellant and the natural person claimed that the funds were transferred in cash through third parties, but neither of the residents identified these persons, did not specify when and where the transfer of money took place, or when and how the confirmations of the transfer of money were signed.

Therefore, in the court's opinion, the case file also shows that, when examining the appellant's comments on the repeat inspection report, in order to gather additional evidence on the circumstances of the use of funds under agreements formalized in the name of a natural person, an analysis of the appellant's financial situation was carried out to determine: whether cash deposits were made into the appellant's bank account during that period; what the appellant's income and expenses were during that period; what loans the appellant took out during that period, what they were used for and what interest the appellant paid; what movable and immovable property he acquired during that period.

The above circumstances are detailed in the article in order to provide a proper understanding of the context of the dispute.

Thus, in the court's opinion, it is clear from the data collected that during the period when the natural person allegedly returned the funds to the appellant in cash, the appellant did not deposit any cash into his bank accounts, but borrowed significant amounts of money from credit institutions, paying bank interest accordingly, i.e. incurring additional costs.

In the court's opinion, borrowing from a credit institution and paying interest, even though a large amount of cash is available, is contrary to common sense and is implausible. 

The second part of the article examines other relevant facts and the court's assessment.