New powers of the National Labour Inspectorate – don’t forget about VAT

Recently, there has been a lot of discussion about the Act amending the Act on the State Labour Inspection and certain other acts, which was signed by the President of the Republic of Poland. Understandably, in cases where a B2B contract is reclassified as an employment contract, the focus is primarily on the risks related to PIT (personal income tax) and social security contributions (ZUS). In this article, however, I would like to focus on the VAT aspects, which are sometimes overlooked. Quite wrongly so.

If you are not yet familiar with the scope of the amendment to the State Labour Inspection Act, I would refer you to the Tax Alert on this topic prepared by our PIT team: Amendments to the State Labour Inspectorate Act have been passed – it is worth preparing for new challenges.

Business activity under VAT regulations

When considering the tax risks associated with the reclassification of a B2B contract into an employment contract, one should take into account the wording of Article 15(3)(1) of the Polish VAT Act and Article 10 of the EU VAT Directive. It is on the basis of these provisions that tax authorities may assess whether given activities were carried out in the course of an economic activity (for VAT purposes).

According to the interpretation of the above provisions by Polish administrative courts, an activity cannot be regarded as independent economic activity where, among other things:

• it is performed using the infrastructure and internal organisation of the entity for which it is carried out;
• it does not involve any economic risk on the part of the service provider;
• it does not give rise to the service provider’s liability towards third parties for damages caused in connection with the activities carried out.

Moreover, activities carried out under an employment contract or any other legal relationship of a similar nature are not regarded as independently conducted economic activity.

It is, among others, the above criteria that will be examined by tax authorities when assessing whether a given relationship for VAT purposes constitutes a genuine (and not merely formal) B2B relationship.

The essence of a B2B relationship

A B2B relationship operates as a relationship between two entities conducting business activity within the meaning of the VAT Act. Where a B2B contract is concluded with a given entity, it is therefore assumed that it acts in the capacity of an entrepreneur.

In simplified terms, from a VAT settlement perspective, such a relationship is documented and accounted for as follows:

• Entrepreneur (Mr. X) enters into a B2B agreement with the service recipient (Company A)..
• X provides services to Company A – e.g. IT or advisory services.
• X issues an invoice to Company A showing VAT (assumed at 23%), documenting the services provided.
• Company A deducts the input VAT arising from that invoice.
• X accounts for the output VAT with the tax office. He may also deduct VAT from invoices documenting expenses incurred in connection with the services provided to Company A.

The correctness of the above actions and settlements is based on the assumption that Mr. X performs activities for Company A as an entity carrying out economic activity within the meaning of Article 15(2) of the VAT Act. Accordingly, he acts as a taxable person in relation to these activities, and the activities themselves constitute taxable supplies.

This is where the State Labour Inspection comes into play. Equipped with its new powers, it reclassifies the relationship between Mr. X and Company A. Suddenly, it turns out that the parties are bound by an employment contract rather than a B2B relationship, and Mr. X is an employee of Company A rather than an independent entrepreneur providing services to it. And this is where a serious problem arises.

The VAT consequences of reclassifying a B2B contract into an employment contract

A finding by the State Labour Inspection that Mr. X in fact performs activities for Company A under an employment contract (rather than a B2B agreement) may, in practice, lead to a challenge of the assumption that Mr. X carries out activities for the Company as a taxable person engaged in economic activity within the meaning of the VAT provisions. This is, of course, not within the remit of the State Labour Inspection; however, tax authorities, once aware of the reclassification of the relationship between the parties, will take steps to analyse their VAT settlements.

As a result, the entire VAT settlement process for these activities on both sides may be deemed incorrect, which may lead to:

• A challenge to Mr. X’s right to deduct input VAT from invoices documenting expenses incurred in connection with performing activities for Company A (e.g. expenses for equipment, a company car, etc.), which would result in a VAT arrears arising on Mr. X’s side;
• A challenge to Company A’s right to deduct input VAT arising from invoices issued by Mr. X, which would result in a VAT liability (arrears) on the Company’s side;
• Despite the denial of the right to deduct VAT from invoices issued by Mr. X, Mr. X may still be required to pay the VAT shown on those invoices pursuant to Article 108(1) of the VAT Act;
• In addition, the head of the competent tax office may impose an additional VAT liability on both the Company and Mr. X of up to 30% of the amount of the understated tax liability, pursuant to Article 112b of the VAT Act.

It should also be noted that there are unfortunately no grounds for tax authorities to limit their scrutiny of the relationship between the parties solely to current settlements. There is nothing preventing such an analysis from also covering historical settlements, with the only limitation being the statute of limitations for tax liabilities.

It should also be emphasised that the reclassification of a B2B contract into an employment contract means that, for VAT purposes, it is no longer possible to treat the relationship between the parties as one between independent taxable persons. However, the VAT Act defines independence in a somewhat broader manner. Accordingly, even relationships that do not constitute an employment contract, but exhibit certain characteristics similar to an employment relationship, may give rise to a situation where, even if the State Labour Inspection does not reclassify a B2B contract as an employment contract, such an arrangement should still be subject to further review for VAT purposes, precisely in light of Article 15 of the VAT Act.   

Communication between authorities

VAT risks may therefore prove to be highly significant. However, it should be remembered that, formally, there is no “automatic” pathway whereby an inspector’s decision issued by the State Labour Inspection reclassifying a B2B contract into an employment contract would immediately result in the tax authorities challenging the VAT settlements of both the contractor and the service recipient. In practice, however, the exchange of information between the National Revenue Administration (KAS) and the State Labour Inspection may prove to be highly effective (in particular due to the new provisions), and a challenge to a given relationship by the State Labour Inspection may quickly lead tax authorities to initiate proceedings aimed at verifying the nature of that relationship also for VAT purposes.

Our support

Given the above considerations, when conducting audits of employment structures involving B2B contracts, it is safest to engage teams specialising both in PIT and social security (ZUS) advisory and in VAT matters. This allows for a comprehensive mitigation of risks in both areas – and this is precisely the scope in which we offer our support.