• Horizontal Monitoring and Voluntary Compliance
    Croatian view

    By Ksenija Cipek

    01-01-2018

    INTRODUCTION

    With the Act on Amendments to the Tax Administration Act1, the Tax Administration of the Republic of Croatia obtained the legal framework for adopting the concept of horizontal monitoring, although the term itself was already applicable in the everyday work of the Tax Administration. With the latest Croatian tax reform this concept, i.e. provision, was transferred in the new General Tax Act. The said legal framework indicates the seriousness and readiness of accepting this concept as a strategic objective of the Tax Administration.

    Namely, by looking at the key aspects of the Tax Administration's external and internal communication strategy for the period 2012 to 2015, it is obvious that the Tax Administration's vision at the moment of adoption of the said legal framework was that the Tax Administration is a recognizable public institution with transparent and open external and internal communication. The general objective of external communication of Tax Administration was to strengthen the reputation of the Tax Administration as a successful institution in the public sector of the Republic of Croatia thanks to good communication with taxpayers. The specific objectives of the external communication of Tax Administration were: to continue to communicate openly with taxpayers in order to inform and educate them about their rights and obligations; improve and expand existing ones and introduce new forms of external communication that will contribute to the establishment of a more flexible approach to taxpayers; accurately communicate the introduction of modern business services in order to reduce costs, simplify tax procedures and increase public revenues. The new Tax Administration Strategy for the period 2016 to 2020 still includes the same main goals: the focus of the Tax Administration is on co-operation and partnership, the improvement of the efficiency in the use of available resources of the Tax Administration and the emphasis on the voluntary compliance: "... an essential element of the voluntary compliance is to help taxpayers understand their tax obligations and promote voluntary, timely and accurate reporting of tax liabilities with the reduction of costs for the taxpayers. "

    The aforementioned new legal framework provided the basis for adopting an implementing regulation which, while respecting the Tax Administration's vision, enabled the application of the concept of horizontal monitoring in reality.

    2. TAX PAYER`S BEHAVIOR AND APPLICATION OF RELEVANT MEASURES

    A proper and optimal selection of effective measures that affect the taxpayer’s behavior in timely compliance is required!

    However, the behavior of the highest management structures, officials and tax administration inspectors should also not be neglected in order the measures to have effect on correcting the taxpayer’s behavior in the direction of voluntary compliance. So, we must look at the behavior of taxpayers and tax authorities (two-way analysis). If the focus is exclusively on the taxpayer’s behavior without simultaneous analysis of the tax authorities' behavior towards taxpayers, the goals cannot be achieved in an effective way.

    We can conclude that we must change and adapt ourselves within the Tax Administration in all vertical and horizontal organizational structures. Lawful conduct, knowledge, competence, innovation, creativity, precision, respect must become an integral part of all officials in order to achieve a partnership relationship with taxpayers who are compliant or wish to become voluntarily compliant.

    Of course this is not an easy task because of the large number of civil servants, and requires time and continuity, but with a competent and professional selection of people primarily in the top management structures, and then the lower ones, such a task can be achieved and improved in the future with constant work and education. Or as it is represented in the "Joseph`s Principle", we must invest in our talents2. In this case, the tax authority must "invest" in the competencies, knowledge and expertise of all its employees in different organizational structures, including the highest one, in order to influence the increase in voluntary compliance. This creates mutual trust between partners and adherence to the principle of bona fide, which results in the optimum use of Tax Administration resources and savings for the taxpayers (partners).

    The tax authority should encourage taxpayers who are voluntarily compliant in a way that it makes the tax compliance easier and, if that is not enough, help them in that (unless it is a tax planning). The tax authority should pay special attention to taxpayers who are not voluntarily compliant but are inclined to do so if special attention is paid to them. For taxpayers who intentionally fail to meet their tax obligations, the tax authority should use a number of timely tax audit measures and misdemeanor and criminal measures.

    One of the incentive measures in the Croatian tax system, intended for voluntarily compliant taxpayers, is the horizontal monitoring.

    3. WHY HORIZONTAL MONITORING IN THE CROATIAN LEGAL FRAMEWORK?

    The legal framework, which since 25 June 2015 also includes the Ordinance on the Approval and Abolition of Special Status of the Taxpayer to Promote Voluntary Compliance, i.e. the new Ordinance on the Implementation of the General Tax Act, gives new impetus and momentum to the relationship between taxpayers and tax authority. These new rules incorporate principles of transparency, trust and understanding into legal norms. It is necessary to emphasize also the adoption of provision on binding tax rules and tax settlement as well as the rules on the advance pricing agreement (APA). Such a legal framework will certainly have effects on greater legal certainty for taxpayers as well as encourage tax authorities to make a new, contemporary, partner approach towards taxpayers. It is worth pointing out that the Ordinance described in this text contains the rights and obligations of, not only taxpayers, but also tax authorities, thus imposing the principle of equality and opens the way to strengthening the preventive (contrary repressive) activity of the tax authority.

    4. BASIC PRINCIPLES

    The basic principles are pointing to the acceptance of the concept of horizontal monitoring, namely:

    • Principle of voluntary compliance, which includes:
      • the readiness of the taxpayer to legally, correctly and timely compliance
      • the ability of the taxpayer to provide and carry out effective control of his tax liabilities and their improvement.
    • The principle of reducing the administrative burden of tax audit means that during the period of the special status of voluntary compliance and the reduction of the administrative burden of tax audit assigned to the taxpayer, no tax audit procedures are initiated.

    The special status of voluntary compliance and the reduction of the administrative burden of tax audit (hereinafter referred to as "special status") is based on the following principles:

    • transparency i.e. full disclosures of the taxpayer and the Tax Administration
    • acting in good faith between the taxpayer and the Tax Administration
    • mutual understanding between the taxpayer and the Tax Administration in tax matters
    • mutual trust between the taxpayer and the Tax Administration in terms of mutual expectations and assumption of responsibility for risks.

    5. OBJECTIVES FOR APPROVAL OF SPECIAL STATUS

    By approving a special status for taxpayers, it is possible, on the basis of partnership principles, to achieve the following goals:

    • Timely reduction of tax risks managed by taxpayers and the Tax Administration
    • Encouraging taxpayers to voluntarily compliance in accordance with tax regulations.

    6. TAX RISKS

    Tax risk is considered to be any risk that may have the effect of reducing or resulting in a reduction in the collection of tax revenues, in particular the risk of taxpayer registration, the risk of filing tax returns and prescribed reports, the risk of disclosure of data relevant to the determination of tax liabilities and the risk of paying tax liabilities.

    The tax risks governed by taxpayers are particularly considered:

    • the risk of taxpayer registration - results in a reduction in tax revenue as a consequence of the next sub-risk: taxpayers do not report or do not report timely all changes in data relevant to taxation, whereby such obligations arise from tax and other regulations
    • the risk of submitting tax returns and prescribed reports - results in a reduction of tax revenues as a result of non-filing or timely non-filing of tax returns and reports by taxpayers, whereby such obligations arise from tax and other regulations
    • the risk of disclosure of data relevant to the determination of tax liabilities - results in a reduction of tax revenues as a result of inaccurate data in tax returns and reports that taxpayers are obliged to fill, according to tax and other regulations.

    Tax risks that are managed by the Tax Administration in particular are:

    • Formal communication with taxpayers
    • Inadequate or long-term tax audit procedures
    • Inadequate or inaccurate analysis of different occurrences in identification of tax rights and obligations.

    7. GETTING A SPECIAL STATUS

    In accordance with the General Tax Act, taxpayers may obtain a special status under the following conditions:

    • Auditor’s opinion with no reservations has been issued for the last three years prior to the year in which the special status is acquired. The auditor's opinion without reserve is considered in accordance with International Standards on Auditing, a positive opinion of the authorized auditor who expresses it when he concludes that the financial statements of the taxpayer provide a true and fair view of all the relevant determinants in accordance with the applicable financial reporting framework
    • They have established an internal control system, i.e. they apply and respect the principles of corporate governance (business transparency, clear procedures for the work of supervisory boards, management and other bodies and structures that make important decisions, conflict of interest prevention, effective internal control and accountability system) and to apply proven computer programs for internal control recognized by the taxpayer and the Tax Administration
    • are committed to informing the Tax Administration of all business decisions that could result in tax risks
    • there is no criminal proceedings against members of the managing board for criminal offenses for which prosecution is ex officio
    • It is expected from the data available to the Tax Administration that the taxpayer will meet the tax liabilities of a special status.

    Taxpayers who meet the above-mentioned legal requirements acquire special status under the Agreement on voluntary compliance that, in accordance with Article 47 of the Ordinance, shall be concluded with the Tax Administration.

    8. PROCEDURE FOR APPROVAL OF SPECIAL STATUS

    The procedure for granting a special status includes the following steps:

    • an initiative to initiate the procedure for approving a special status
    • creating a taxpayer's tax profile
    • previous discussion with the taxpayer
    • conclusion of the Agreement on Voluntary Compliance
    • evaluating the results achieved and improving the process

    If in the process of approving a special status it is estimated that the granting of special status to the taxpayer is justified, appropriate and purposeful, the Taxpayer and the Tax Administration may, in accordance with Article 10 of the Ordinance, sign an Agreement on voluntary compliance (hereinafter referred to as "the Agreement").

    The Agreement establishes the rights and obligations of the taxpayer and the Tax Administration.

    The rights and obligations of the taxpayer and the Tax Administration, established by the Agreement, include:

    1. for a taxpayer:
      1. timely settlement of tax liabilities in accordance with tax regulations
      2. timely submission of tax returns and reports in accordance with tax regulations, i.e. promotion of real-time processing: filing of tax returns and reports as soon as possible upon completion of accounting periods
      3. providing internal control systems and internal and external auditing
      4. allowing the Tax Administration of a complete insight into all the relevant facts and circumstances from which tax liabilities or tax risks arise or may arise
      5. submitting to the Tax Administration in the shortest possible time of present or future considerations on tax matters and their legal consequences
      6. at the request of the Tax Administration, to provide as soon as possible all information and data in a complete and unambiguous form,
    2. for the Tax Administration:
      1. Harmonizing the manner and intensity of monitoring with the quality of internal control and internal and external auditing,
      2. providing advice and guidelines and, where appropriate, issuing opinions as soon as possible upon receipt of the current or future taxpayer's position on relevant tax issues, with more frequent consultation with the taxpayer and discussion of essential tax issues, particularly on issues in which the Tax Administration has different standpoint,
      3. promoting real-time processing or determining tax liabilities in the shortest possible time
      4. solving existing tax issues and determining further procedures on these issues
      5. cancellation of the Agreement in the event of a tax risk that requires conducting of a tax audit.

    The Agreement shall enter into force on the date of signature of both Contracting Parties and shall be made in two originals, each Contracting Party retaining one original. The Agreement is signed by the taxpayer or the responsible person of the taxpayer and the official of the Tax Administration, who is required to do so.

    9. THE PROCEDURE OF ABOLISHING OF THE SPECIAL STATUS

    Each Contracting Party may denounce the Agreement provided that notifies in writing the other Contracting Party of the reasons for the cancellation of the Agreement.

    Cancellation of the Agreement is not possible without prior oral explanation of the reasons for the cancellation of the Agreement, provided that at least one of the Parties requests such an explanation. Oral explanation of the reason for the cancellation of the Agreement may be requested by the Contracting Party in writing within 30 days of the date of delivery of the notification of termination of the Agreement.

    If one of the Contracting Parties requests an oral explanation of the reasons for the termination of the Agreement, the other Contracting Party shall provide such explanation within 15 days upon receiving the written request. If one of the Contracting Parties requests an oral explanation of the reasons for the termination of the Agreement, the termination of the Agreement shall take place after an oral explanation with immediate effect. If neither of the Contracting Parties requests an oral explanation of the reasons for the termination of the Agreement, the termination of the Agreement shall expire on the expiry of a period of 30 days from the date of delivery of the notification of termination of the Agreement.

    Exceptionally, the Tax Administration may unilaterally terminate the Agreement, without the completion of the entire previous procedure, with immediate effect in the event of the occurrence of the risk that requires the initiation of tax audit. In this case, the Tax Administration shall inform the taxpayer, his / her authorized representative and / or tax adviser in writing within 8 days of the date of termination of the Agreement in writing.

    10. CONCLUSION

    Most taxpayers show the behavior of good taxpayers and taxpayers who, due to the lack of information or misinterpretation, are not tax compliant. Choosing that taxpayers for tax audit creates a certain repression, and the result of repression (due to non-recognition of taxpayers' behavior and application of wrong measures) is the cost for all taxpayers for costly audit procedures that result in:

    • Audits with no new irregularities
    • Penalties for ignorance or lack of information without previous procedures of indirect tax audit and verification and information and education - the behavior of taxpayers is changing in the negative direction
    • Abolishing the principle of partnership with taxpayers.

    Consequently, signing the Agreement on voluntary compliance is one of the measures that prevents repression and consequently reduces the cost of tax audit and relieves the resource allocation area towards those taxpayers who are the most risky in the form of recourse to various tax fraud and tax evasion measures.

    Contrary to repression is the prevention and this is what this Tax Agreement, as well as other positive measures of the Tax Administration, pursues to achieve (positive normative regulation, IT tools, availability of information, educated officials). Repressive measures should be targeted and focus on high-risk taxpayers, and measures must be timely and effective, and optimization of the use of tax audit resources should be achieved. Positive effects of prevention are lower costs, more effective and better results, and legal security.

    The Republic of Croatia is not the only nor the first country to implement such measures of prevention, i.e. intensified cooperation with taxpayers, and such measures are also used in other EU Member States, in particular the Netherlands.


    1. Narodne novine“, no. 141/14
    2. Raimer, D.A.: The Joseph Principle, Ministry Publishing Company, USA, 1989; str. 12

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  • The information provided in this article is for general information purposes only. The information is not intended to be comprehensive or to include advice on which you may rely. You should always consult a suitably qualified professional on any specific matter.

Ksenija Cipek

Ksenija Cipek is based in Zagreb, Croatia and she is a lecturer at the local University of Law and a Member of European Law Institute. Ksenija has over 20 years experience working at the Ministry of Finance and the Tax Administration. She is a highly respected and recognised tax expert who has been heavily involved in lawmaking. Ksenija is also an author and books writer.

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