Tax and punishment

Tax and punishment

Viðskiptablaðið (Weekly business news in Iceland) published an article by Bjarnfredur Olafsson Partner at LOGOS last week. Bjarnfredur who specialises in tax law is writing about tax and punishment in Iceland.

Tax and punishment

The journey of people accused for tax evasion is in most cases a long and difficult journey. On the one hand it’s because the procedure take place on three administrative levels and after that the case can go through judicial process on two or three court levels. On the other hand, the reason is that a judge is obligated by law to sentence a certain minimum penalty almost without any evaluation on the accused “real guilt”. The minimum is generally so high that it results in people losing all their belongings and mire of debts.

Tax evasion cases procedure can take years and in some cases a decade or longer. All this time the accused waits a final judgement which in most cases ends in a high punishment by fine which for many people is insurmountable to pay.

Nowadays it’s unpopular to speak on the behalf of taxpayers. Not least after the financial collapse and the discussion around the Panama papers. Thus, the discussion has for a decade almost been completely one-sided.

In this article simplified generalizations are used but those who handle these cases know that they are in all essentials correct although there is no doubt that it’s possible to argue on various minor details.

What is the reason for this?

First of all, the outcome of tax evasion court cases is almost completely predictable in the beginning and long before a indictment has been issued. The reason is that the courts have formed the judicial practice that if the amount of the alleged tax evasion are sufficiently high the culpability conditions are automatically considered to be satisfied. Culpability conditions in this context mean that according to applicable law for tax evasion to be considered a criminal offence it must possible to trace the tax evasion to persons intention or gross negligence. According to case law it is thus the amount itself that actually settles the fine in advance. This is irrespective of the fact that there may be an actual dispute on the tax provision legal interpretation. Thus, legal interpretation which first appears before the Supreme Court can e.g. confirm that a higher amount should have been declared a decade ago. As a result, a disputed and unclear legal provision cannot only result in the person having to pay taxes plus charge and penalty interest but also the judge is obligated by law to impose upon the person heavy punishment.  

Secondly the procedure itself is repeated several times at administrative level. It’s thus heavier than other criminal proceeding against individuals which end on judicial level in Iceland. This is different from what is happening in our neighbouring countries where tax treatment only takes place on two administrative levels before it reaches the courts. The Icelandic system causes obvious delays and costs for everyone concerned, the State Treasury and the accused as well the system raises questions about human rights violations. In fact, these questions have repeatedly been answered by the European Court of Human Rights with condemning against the Icelandic state. These judgements and the Icelandic government reactions to them are however subject for another article.

Thirdly fines as minimum punishment are so harsh that there is a significant risk of people going bankrupt and finally debt prison because they can’t pay the fine and other litigation costs. A judge does not have the legal authority to impose fines below the minimum limit, which is double the tax amount. This is the way even though it’s considered proven that the accused did not intent to conduct any tax evasion and it was not actually the accused fault that the correct tax amount was not paid.

Made up examples:

Lets look at made up examples about tax parties A and B which however well reflect the reality in these cases.

Tax party A has a long history of unsuccessful business adventures which have repeatedly ended in disaster. In addition, A practises “phoenix activity” to the length that he can get away with. Although A still has a clean criminal record. A establishes a company engaging in the tourist service business. A withdraws withhold tax from employees pay but only partly returns the withhold tax and uses the rest for private use.

In total A evades from tax ISK 30 million. This is discovered and the case goes through the system relatively quickly as A does not want to peruse much defence in his case. Three years later a judgement has been reached for the District Court resulting in one year probation and to pay ISK 90 million on fine and ISK 2 million in litigation costs. When deciding the fine the judge exceeded the minimum and the fine is the tax amount threefold. A does not appeal the judgement. A does not pay the fine or litigation cost and goes to debt prison for 9 months.

Then there is B, but he is the type of person that rather wants to pay more tax than less and doing so support social funds as much as possible. With hard work and resourcefulness, he managed to succeed in the field of international film-making. B’s reputation and vision is of great importance. B therefor hires the most skilled professionals to handle all of his accounting and tax advice. B ensures that all business information is provided to the professionals. One year, the Tax office believes that according to the office interpretation of one legal provision ISK 30 million are missing for B tax amount to be correct. B’s advisors explain that they have never heard of this interpretation of the legal provision. The Tax office make a complain to the Director of Tax investigations. The case goes through the system and finally the Supreme Court finally confirms the Tax Office understanding, eight years later. B is sentenced to three months’ probation plus a fine of ISK 60 million, 18 million for litigation costs and eight months of prison if the fines and litigation cost are not paid. When the Supreme court reaches its judgement, B is not financially capable to pay all of the debt, goes bankrupt and suffers the substitute punishment, dept prison.

The difference in these to cases for A and B is that in fact the result for B is worse than for A. The most important factor is that there is no room to evaluate when it comes to culpability and the minimum fine is so high that it’s almost impossible to pay. It’s also clear that if a person decides to try and defend oneself against the charges the litigation costs are massive. B spent eight four years in these proceedings, five years only at the administrative level. This long period and the great cost that the spent on these proceedings simply became to much for him.

Then there is material for another article to explain the situation for tax party C. In his case the Supreme Court reached the decision that the Director of Tax Investigations, the Tax Office and later the prosecutor office had no reason to interpret the Income Tax Act against the acts clear wording and therefore acquitted C ten years after the proceedings started against him. However, it must be mentioned here that such conformation of misinterpretation has limited effect on the relevant official practice and no one in fact is made responsible for the decisions taken based on the misinterpretation of the law.

What people “encounter” in tax evasion?

The status and risk of employees such as members of the parliament, judges and general employees are quite different regarding tax returns from those who earn their living through an independent business or are directors of companies. It’s almost impossible for employees to declare their income incorrectly and such parties really do not declare themselves for the reason of automation of completing a tax return. This groups risk of tax evasion is virtually nonexciting and that is completely irrelevant from their legal and moral consciousness. Those who are employees may lack understanding for the difficulties of the self-employed which have to declare their tax despite of how unclear these rule are in the law at any time and how tax authorities instructions are.

Amount as a condition for punishment

Unrelated of actual guilt there really no room for mistakes when these amounts are millions of Krones. Thus, the tax party bears criminal liability for false tax returns which can lead to imprisonment and fines, even there is really no actual guilt. Furthermore, is also likely that the party in question needs to pay penalty interest plus charges which the Director of Internal Revenue may have added to the party’s tax base on the administrative level.

As previously mentioned, the Income Tax Act makes it a condition for criminal liability that the party in question has declared tax falsely by intention or gross negligence. There is no discussion on amounts in this context. In advance and from reading these legal provisions alone you might think that the prosecution would have a difficult time to prove culpability. However, this is not the case as it can be drawn from court cases that in reality the prosecution does not need to prove anything when it comes to culpability. The liability is therefor completely objective, that is irrelevant from guilt the amount itself fulfils the evaluation on gross negligence of the accused. This must be a food for thought for everybody that is interested on human rights.  

A light in the dark

However, this has somehow changed in the recent years.

Firstly, the parliament has fixed the minimum punishment for Value Added Tax. A judge can go under the minimum in Value Added Tax cases if the party declared correct Value Added Tax reports and “[…] returned the substantial amount of the tax amount or mitigating circumstances are considerable.” For some reason similar exceptions have not been made to the minimum punishment regarding income tax or customs duty.

Secondly, the Supreme Court or other courts have side stepped from their previous precedents on objective liability of board members of companies and increasingly considers the division of duties of directors in the company management in relation to defaults of tax returns and the company’s obligation to return duties. The Supreme Court now believes that the directors that actually have no involvement to the company’s management, including accounting and tax returns, even though they are formally registered in the company’s board of directors, can not be held responsible for the company’s offenses for the reason that their conduct is not considered criminal. In such cases, it was previously assumed that it was enough that the relevant person was registered as a member of the board of directors so their conducts was considered gross negligence and there for punishable activities, completely irrelevant if intention or gross negligence has been proved regarding the board members will to commit a tax violation. This development appears to have taken place at the Supreme Court level following criticism of the courts previous outcomes regarding this area. It seems that this change was not due to law changes from the parliament. How this falls in line with the principal of constitutional law of the separation of powers is however not the subject of this article.

Final words

If a self-employed party, or a director of a business makes an error in the tax area when the relevant person can lose all its possession without actual guilt, that is without ever having the intention to violate tax law by intention or gross negligence. The person may even made a great effort to declare correctly. This same person can end up in dept prison for the same “offence”. Most people must realize that this is unacceptable in today’s society.

It’s normal that the tax payer always bears responsibility for correct tax returns, as it is defined by law. However, it’s unacceptable that heavy punishment is based on objective viewpoints. When determining punishments there must be some independent evaluation of guilt in accordance to the principals of criminal law.

Legal changes must be made to fix this as soon as possible.

 Bjarnfredur Olafsson

Bjarnfredur Olafsson