Several individual entrepreneurs: tax optimization or risks?

Issues of doing business through several individual entrepreneurs (IEs) in Ukraine has become relevant for small and medium-sized businesses, especially after changes in tax legislation. Many entrepreneurs are trying to reduce their tax burden in this way, avoid registering an LLC or staying on the simplified taxation system. But is it legal and what are the consequences of such a model?

In this article, we will consider:

• when the use of several sole proprietorships is considered legal,

• what tax and legal risks this scheme carries,

• what threatens the business in case of an audit,

• and how to act safely in terms of the law.

What are several sole proprietorships used for?

The model with several sole proprietorships is most often used for the following reasons:

• Tax optimizationTo stay on the simplified taxation system with a low rate, the amount of income is "split" among several entrepreneurs.

• Avoidance of restrictions of the 3rd group of the EPIn particular, a turnover limit or a ban on employees.

• Reducing the burden on the payrollWhen, instead of hiring employees, a company "concludes contracts" with individual entrepreneurs.

• Reducing the VAT burden: division of turnover allows you to not exceed the maximum amount for registration as a VAT payer.

When is the use of several sole proprietorships not a violation?

The law does not prohibit one person from being a founder of several entrepreneurs, unless it is for the purpose of tax avoidance or imitation of business activities.

It is also legal when:

• several individuals are sole proprietors and conduct independent activities;

• relatives or partners pool resources, but each has its own niche and clients;

• there is no fictitiousness or dependence between individual entrepreneurs.

What are the risks of using a scheme with several sole proprietors?

For several years now, the Tax Service has been increasing its attention to business splitting schemes. Main risks:

1. Recognition of a "business split" for tax avoidance purposes

In the event of an audit, the tax authorities may recognize that several sole proprietors actually operate as one entity. In this case:

• additional income tax is charged;

• a fine is applied;

• the right to the simplified taxation system is lost;

• proceedings are initiated for tax evasion.

2. Dependence between individual entrepreneurs

Signals for the tax authorities:

• one registration address;

• joint management or accounting;

• the same contracts, clients, or accounts;

• Lack of independent activity.

3. Re-qualification of the sole proprietorship - company relationship into an employment relationship

The State Tax Service may recognize that the company and the sole proprietor have an employment relationship rather than a business relationship. In this case:

• additional unified social tax, personal income tax, and military duty are charged;

• fines of up to UAH 201 thousand per employee are applied;

• criminal proceedings are initiated under Article 212 of the Criminal Code of Ukraine (tax evasion).

Audit practice: what does the STS pay attention to?

During the audit, the tax authorities establish actual circumstances:

• relationships between individual entrepreneurs;

• management structure;

• who exercises control;

• sources of funding;

• having a common office, property, and employees.

They can also request contracts, acts, correspondence, and data from banks.

What does the court practice say?

Courts support the tax authorities if it is proven that several individual entrepreneurs operate as one business. For example:

• splitting the volume of income;

• fictitious conclusion of contracts;

• the use of "technical" sole proprietorships without any real business activity.

In such cases, the court will recognize the transactions as unrealistic and the tax surcharges as legitimate.

Can I use several sole proprietors without violating the law?

Yes, if you follow the following rules:

• Each individual entrepreneur must real economic activity;

• there is no joint management or subordination;

• Individual entrepreneurs do not serve one client simultaneously or exclusively;

• there is a justification for conducting the activities separately;

• documents, accounts, and communication are kept separate.

Alternative: which model is safer?

If the business is growing, it's better:

• register LTD. - more flexible and secure shape;

• utilize official employment employees;

• structure the company through contractual relationship with real contractors;

• apply for legal audit business schemes.

Conclusions.

Mass use of several individual entrepreneurs as a way to optimize taxes risky instrumentwhich is increasingly coming under the control of the tax authorities. If the scheme is improperly executed or fictitious, it may have serious financial and criminal consequences.

To avoid problems, it is important:

• objectively evaluate the business model;

• check the document flow;

• ensure the independence of each entity;

• if necessary, contact a lawyer.

Advice from Axel Legal

Team. Axel Legal will help you evaluate your business structure, check the risks of using several sole proprietorships, and provide recommendations or support when switching to another model. We protect business interests competently, reasonably, responsibly.

Contact us to ensure that your business operates stably and without risks.