The Audit Office on Thursday called for a substantial overhaul of the way VAT inspections are carried out, recommending the introduction of annual audit planning based on documented risk criteria and a greater emphasis on on-site inspections.
The recommendations are contained in a special report on VAT audits conducted by the Tax Department, which was published on Thursday.
The Audit Office said its examination of a random sample of VAT files revealed significant weaknesses in the Tax Department's audit procedures and concerns over compliance with both indirect and direct taxation frameworks.
Among the issues identified were delays of several years in carrying out substantive investigations, an overreliance on desk-based reviews, insufficient documentation regarding the place of supply of services and doubts over the tax treatment of complex transactions, including intra-EU trade and gold trading.
According to the report, these weaknesses resulted in substantial VAT refunds being issued without adequate verification, while delays in investigations prevented the timely assessment of taxes due to statutory time limits expiring.
The report also highlighted discrepancies between VAT and income tax declarations, failures to submit financial statements and cases in which potential responsibility for inaccurate declarations was not fully investigated.
The Audit Office said the findings suggested that existing procedures for selecting cases, monitoring VAT refunds and cross-checking information do not provide sufficient safeguards to protect public revenue.
Delays and shortcomings
In the report's foreword, Auditor General Andreas Papaconstantinou said the early results of the newly established Nationwide VAT Audit Unit had been encouraging and demonstrated that the Tax Commissioner's decision to create the unit was a step in the right direction.
He said the specialist unit had created the conditions for more targeted and effective audits that could make a significant contribution to protecting state revenues.
However, Papaconstantinou stressed that the effectiveness of a tax audit system should not be measured solely by the amount of tax assessed.
He said audit resources must be allocated on the basis of documented risk assessments, covering the full spectrum of economic activity rather than focusing only on sectors already under regular scrutiny. He also highlighted the importance of identifying undeclared economic activity and individuals operating outside the tax system.
The Auditor General noted that, despite serious indications of tax risk in some cases, issues identified during Tax Department audits did not always appear to receive the level of investigation or attention required.
He also pointed to significant delays in completing investigations and shortcomings in documented procedures and guidance, which may have affected the consistent handling of similar tax matters.
Specialist unit
The report examined operations at the Limassol District Tax Office, the Large Taxpayers Unit in Limassol and the Nationwide VAT Audit Unit.
According to the findings, the specialist VAT unit carried out 175 audits in 2024, with 112 of those investigations resulting in tax assessments totalling around €10 million.
By comparison, 3,609 VAT audits were conducted nationwide during the same period, generating approximately €30 million in assessed VAT.
As a result, although the specialist unit accounted for only 5 per cent of all VAT audits by number, it was responsible for around one-third of the total VAT assessed through inspections.
The Audit Office also noted that the unit's audits covered just 0.07 per cent of the 261,077 VAT-registered entities in Cyprus, yet delivered particularly significant results.
Recommendations for reform
Despite describing the overall performance of the specialist unit as successful, the Audit Office said its 2024 audit selection process focused primarily on businesses operating in the construction and consultancy sectors without clearly documenting the reasons for their selection.
It said audits should generally be targeted and based on clearly defined risk criteria, while retaining flexibility to investigate significant issues as circumstances require.
The report also found that the unit does not operate under an annual audit programme and is periodically assigned additional responsibilities that may hinder its effectiveness.
To strengthen the system, the Audit Office recommended a comprehensive reorganisation of VAT audit procedures, including the development of annual audit plans, enhanced on-site inspections and targeted reviews of high-risk cases.
Particular attention should be given to cases involving intra-EU transactions, special tax regimes and significant discrepancies between direct and indirect taxation records, it said.
The report also called for the publication of unified guidance to ensure the consistent application of tax legislation, stronger cooperation with the Central Bank and other authorities, and improved mechanisms for cross-checking information through government databases.
In addition, it recommended the prompt investigation of cases involving inaccurate declarations or missing mandatory documentation, as well as the introduction of procedures to improve information-sharing within the Tax Department.
"The implementation of these measures is considered necessary to strengthen audit procedures and ensure the effective protection of public revenue," the report concluded.
