Fictitious Counterparty: How to Prove a Transaction Was Real

When the Ukrainian tax authority (the State Tax Service, or DPS) strips out a VAT credit and deductible expenses, it increasingly avoids calling a supplier “fictitious.” After Article 205 of the Criminal Code was repealed, the dispute shifted into the territory of the unreality of a transaction. But defects or a “break” in your supplier’s records do not cancel your right to a credit automatically: the law requires that your transaction and its documentary support be examined on their own merits. As a forensic economic expert, I explain below which documents prove that a supply genuinely took place, and where expert analysis does the decisive work.

From Article 205 to “unreality”: why the logic of these disputes changed

For years, accusations were built around Article 205 of the Criminal Code — “fictitious entrepreneurship.” A conviction of a “conduit” company’s director, or even an open criminal proceeding, was enough for the tax authority to disallow expenses and the VAT credit along the entire supply chain. In 2019 this article was removed from the Criminal Code, and the very category of a “fictitious counterparty” formally disappeared from criminal law.

The criminal dimension did not vanish entirely. Tax evasion, in particular, remains an offence, and such proceedings are now handled by the Bureau of Economic Security (BEB). But for most disputes the centre of gravity moved into the tax (administrative) sphere. Today the controlling authority does not allege that your partner is “fictitious”; it alleges the unreality (absence of an actual supply) of a business transaction — that the paperwork was drawn up, yet no real movement of goods or services ever occurred.

The practical consequence is simple. The dispute shifted from proving fault to proving a fact — did the transaction happen or not. What becomes decisive is no longer the counterparty’s “reputation,” but primary documents, accounting records, and a traceable movement of assets.

Individual liability: a “chain break” is not a verdict

The cornerstone of any defence is the individual nature of legal liability. Article 61 of the Constitution of Ukraine expressly establishes that a person’s liability is individual. In the tax context this means: if your supplier failed to declare VAT, lacks “sufficient resources,” filed no reporting, or appears in a “break” in the chain — that is its violation, not automatically yours.

An additional safeguard is built into the Tax Code itself — the presumption of the lawfulness of the taxpayer’s decisions (subclause 4.1.4 of Article 4 of the Tax Code, or PKU): where a rule allows more than one interpretation, the decision is taken in the taxpayer’s favour. In litigation, the burden of proving the lawfulness of its own decision rests on the controlling authority.

The settled practice of the Supreme Court (the Cassation Administrative Court), available in the Unified State Register of Court Decisions (YeDRSR), consistently proceeds on the basis that:

• a taxpayer is not answerable for the tax discipline of its counterparties and is not obliged to monitor their reporting;
• a “break” in the VAT chain, or tax information about a partner, is not on its own conclusive proof of unreality;
• even a conviction of a counterparty’s officer, entered without examining your specific transactions (for instance, under a plea agreement), does not by itself have pre-established evidentiary force;
• a finding of unreality must be grounded in an examination of your transaction, not in the supplier’s status.

This is not an indulgence, however. If the controlling authority proves that the transaction objectively did not occur — the goods never moved anywhere, the supplier physically could not have delivered them, and the funds circled back — the right to the credit and to the expenses is indeed lost. The essence of the defence is therefore not criticism of the DPS position, but affirmative proof of a real movement of assets.

Which documents prove that a transaction was real

Reality is not a single piece of paper but a body of evidence of the movement of assets. The task is to show the whole life cycle: the goods or service were received, paid for, used in your own activity, and (where relevant) resold. A break anywhere in this chain is the first thing an audit seizes on.

Transportation and movement of goods

• The consignment note (TTN), waybills, and data on the carrier, vehicle, and driver. An important nuance that often saves a position: the absence or a defect of a TTN does not by itself make a transaction unreal — the TTN exists primarily to account for road-transport work and is not the sole proof that title passed. Even so, a correctly completed TTN combined with other documents materially strengthens the case.
• Carriage contracts, powers of attorney to receive inventory, and data on the route and place of unloading.
• Warehouse documents: goods-receipt orders, warehouse stock cards, and balances as of the transaction date.

Use in your own business activity

This is what businesses most often “underbuild.” Showing that the goods arrived is not enough — you must demonstrate their business purpose and their onward fate:

• use of raw materials or supplies in production (cost calculations, write-off acts, consumption norms);
• reflection of services in the results of your activity (reports, acceptance acts, finished goods).

Payment, settlements and onward sale

• Bank statements and payment instructions as proof of the actual transfer of funds.
• The absence of signs of “looping,” where money returns to the initiator through a chain of persons (a pattern the Financial Monitoring Service, Derzhfinmonitoring, also reacts to).
• The subsequent sale of the purchased goods: dispatch notes, contracts with buyers, and sales data.

Group of evidence	What it confirms
Contract, specifications, dispatch notes	Legal formalisation of the transaction
TTN, waybills, warehouse orders	Physical movement and receipt of the goods
Cost calculations, write-off acts, resale	Use of the asset, business purpose
Bank statements, payment orders	Reality of settlements, no “looping”
Accounting registers, returns	Correct reflection of the transaction in the books

Due diligence: showing that you vetted your partner

Court practice has developed the concept of a taxpayer’s due diligence (nalezhna obachnist): a bona fide buyer must, at the time of the deal, take reasonable steps to satisfy itself of the counterparty’s legal capacity. This is not a duty to “investigate” a partner, but a sound business standard. In practice it makes sense to keep:

• an extract from the Unified State Register (EDR) and data on VAT registration as of the transaction date;
• copies of constituent documents, orders appointing signatories, and licences (where required);
• business correspondence, commercial offers, and contacts — anything showing genuine interaction.

Diligence gathered before the deal frequently decides the dispute in the business’s favour: it defeats the argument that you “should have known” about the partner’s problematic status.

The legal framework: Tax Code Art. 44, Art. 198 and the primary-document requirements

The legal skeleton of the dispute rests on a few provisions:

• Article 44 of the Tax Code — a taxpayer forms reporting figures on the basis of primary documents, accounting registers, and other documentation. No document, no figure.
• Article 198 of the PKU — the right to a VAT credit. Clause 198.6 forbids including in the credit any amounts not confirmed by properly executed and registered tax invoices.
• Article 9 of the Law “On Accounting and Financial Reporting in Ukraine” — the mandatory requisites of a primary document.

The key point I always stress: a primary document records a business transaction — an action that genuinely changes assets or liabilities. If no transaction occurred, a document does not acquire the force of a primary document merely because its requisites are formally correct. Conversely, a minor formatting defect does not cancel a real transaction where its movement is confirmed by the body of evidence.

The role of forensic economic expert analysis

This is precisely where expert analysis comes in. A forensic economic expert does not resolve a “legal” question or establish fault — that is the court’s province. The expert establishes facts of an economic character:

• whether the submitted documents confirm a movement of goods, funds, and services;
• whether the transaction is reflected in accounting and tax records, and whether primary documents, registers, and reporting are consistent;
• whether a link can be traced between the acquisition and its subsequent use or resale.

In effect, expert analysis turns a scattered “pile of documents” into a methodically constructed picture of the movement of assets that a court finds hard to dismiss. This is especially valuable where the DPS operates with general wording while the business offers concrete figures and documents. The key is a correctly framed question for the expert: not “was the transaction fictitious” (a legal classification), but “are the business transactions between Company A and counterparty B over a given period documentarily confirmed.”

Pre-trial vs court-appointed expert analysis

The specialised Law on Forensic Expert Examination and the Ministry of Justice Instruction No. 53/5 provide for two formats.

• Expert examination on commission (pre-trial). Useful as early as the administrative-appeal stage or when preparing a claim: it helps you soberly assess your own position, find gaps in the documents before trial, and reinforce your evidence base. Such an opinion is submitted by the party as evidence and is assessed under the general rules.
• Court-appointed expert analysis. It is appointed by court ruling within the proceedings (tax disputes are heard under the rules of administrative justice — the Code of Administrative Procedure, or KAS). Such an opinion is traditionally perceived as more “neutral,” and the expert is warned of criminal liability for a knowingly false opinion.

In practice, a sensible strategy is to begin with a pre-trial examination — to understand your real chances and complete the documentation — and then, if needed, move for a court-appointed examination at trial.

Typical business mistakes

• Defending only by “criticising” the DPS position instead of affirmatively proving the movement of assets.
• Breaking the evidentiary chain: showing the arrival of goods but not their subsequent use or resale.
• Ignoring due diligence: keeping no confirmation that the counterparty was vetted at the time of the deal.
• Confusing a document defect with unreality — and, conversely, relying on formally flawless paper with no real movement of assets.
• Turning to expert analysis too late, when some documents are already lost and the appeal deadlines are running out.

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If the DPS is questioning the reality of your transactions, the key is to gather — promptly and systematically — the evidence of the movement of assets and of its correct reflection in the books. I would be glad to help with a consultation or a forensic economic examination, so that your position rests not on general arguments but on methodically confirmed facts.