Does tax evasion generate criminal proceeds? a comparative analysis of Latvian and Estonian case law

The term ‘criminal proceeds’ is significant in both confiscation and ML regulation. The Warsaw Convention provides that, with regard to the confiscation measures, ‘[e]ach Party shall adopt such legislative and other measures as may be necessary to enable it to confiscate […] proceeds or property the value of which corresponds to such proceeds and laundered property’ (Article 3(1)). ‘Proceeds’ are defined as ‘any economic advantage, derived from or obtained, directly or indirectly, from criminal offences’ (Article 1(a)). Similar provisions on confiscation are found in Directive (EU) 2024/1260 (Article 3(6)).

The Constitutional Court of the Republic of Latvia has recognized that confiscation of criminal proceeds serves the aim of upholding the principle that crime should not yield benefits, a principle also reflected in the case law of the European Court of Human Rights, and fundamentally connected to the rule of law (case No. 2021-18-01, paras. 26.3, 32.2).

Since 2015, Directive (EU) 2015/849 has been in force in the EU, incorporating the Financial Action Task Force (FATF) 2012 Revised Recommendations, requiring the offence of ML to be applied to ‘tax crimes relating to direct taxes and indirect taxes and as defined in the national law of the Member States’ (Article 3(4)(f)). At the same time, ‘no harmonisation of the definitions of tax crimes in Member States’ national law is sought’ (Recital 11).

In Latvia, the Criminal Law defines criminal proceeds as any economic benefit that has come into a person’s ownership or possession, directly or indirectly, as a result of a criminal offence (Criminal Law of Latvia, Article 70.11(1)). This definition applies to both the object of confiscation and ML. The legislator has stated that the definition should cover all possible economic benefits derived from the circulation of criminal proceeds (Annotation to Draft Law No. 1230/Lp13). The Supreme Court of the Republic of Latvia has acknowledged the necessity of interpreting the term ‘criminal proceeds’ in the context of international legal provisions binding on the state (Decision of 27 March 2020, SKK-58/2020, para. 9.2.7).

In Estonia, the concept of criminal proceeds is defined in Article 83.1 of the Penal Code, which provides that ‘assets acquired by an offence are the assets directly acquired by an offence and anything acquired for account of these assets’ (Penal Code of Estonia). ML is regulated under Article 394 of the Penal Code, while the elements of the offence are further specified in the Money Laundering and Terrorist Financing Prevention Act. Under this Act, ML involves ‘property derived from criminal activity or property obtained instead of such property’ (Article 4). ‘Property’ is defined as ‘any object as well as a document certifying the right of ownership of such object or other rights related to the object, including an electronic document, and a benefit received from the object’ (Article 9). Thus, the Latvian and Estonian legal frameworks concerning criminal proceeds do not differ substantially. Furthermore, interpretation of the legal provisions requires national legislation to be applied in accordance with the state’s international obligations.

In criminal law theory, all crimes can be classified as either formal or material, depending on whether a harmful result is an element of the offence. Tax crimes, depending on their definition, may fall under either category, based on whether damage to fiscal interests is a necessary element or if merely filing a false tax return or omitting to file one suffices. The economic loss as a substantive element of the crime may be relevant in determining whether an unlawful benefit was obtained.

In Latvia, tax evasion is defined in Articles 218 (‘Tax evasion’) and 218.1 (‘False Declaration of Transaction in VAT Return’) of the Criminal Law. Both offences are generally considered to be material, as economic loss to the state budget is an element of the offence. An exception is Article 218.1(1) and (3), where the offence is considered completed upon the declaration of a fictitious transaction in a tax return.

According to the case law of the Supreme Court of the Republic of Latvia, tax evasion is considered completed at the moment the tax payment is due for a specific taxation period and the tax is not paid or only partially paid, thereby causing a loss to the state in the form of unreceived tax revenue (Decision of 16 January 2018, SKK-4/2018, para. 10.3). A mere act of drafting false accounting documents or entering incorrect data into a value added tax (VAT) return constitutes a preparatory offence (Decision of 5 November 2019, SKK-372/2019, para. 6.3).

Furthermore, the Supreme Court has stated that in cases of tax evasion, the perpetrator’s act or omission is aimed at avoiding the transfer of property to the state, thereby obtaining an economic benefit. Consequently, the aggravating circumstance under Article 48(1)(11) of the Criminal Law (the commission of a criminal offence out of greed) should not be applied, as the pursuit of an economic gain is an inherent element of the offence (Decision of 20 October 2021, SKK-505/2021, para. 5.2). This indicates that also tax savings may constitute an economic benefit from the offence.

In Estonia, tax evasion is regulated under Article 386.1 of the Penal Code (‘Concealment of tax liability and unfounded increase of claim for refund’). One of the key elements of the offence is a concealed tax liability that results in ‘major damage’ or ‘particularly great damage’ (Article 386.1(1) or (3), respectively). In addition, Article 386.1(4) provides that for the offence under subsection 2, the court may impose extended confiscation of assets or criminal proceeds.

On the issue of ML based on tax crimes, Estonia has acknowledged that a predicate offence arises when an individual files a fraudulent tax refund claim and then uses the proceeds in a subsequent ML transaction (OECD, 2024: 202). It can be concluded that in both Latvia and Estonia, tax evasion may result in economic loss to the state budget. However, only in Latvia is such loss explicitly included in the law as an element of the offence. In Estonia, the offence is defined based on the extent of the unjustified reduction of tax liability or the amount of the received tax refund.

In Latvia, tax evasion has been recognized as a predicate offence since 2000 (Amendments to the Law ‘On the Prevention of the Laundering of Proceeds from Crime’). In 2004, the ‘all crimes’ approach was adopted to define the scope of predicate offences (Annotation of Draft Law ‘Amendments to the Law “On the Prevention of the Legalization of Proceeds from Crime”’). Since then, a relatively broad body of case law has developed in cases involving charges of tax evasion and ML. Although numerous cases exist, the question of whether tax evasion can generate criminal proceeds has been addressed only relatively recently.

Latvian case law distinguishes tax evasion from tax fraud based on whether the offence involves the reduction of tax liabilities or the unlawful acquisition of tax refunds (Decision of the Senate of the Republic of Latvia of 26 March 2013, SKK-3/2013). This distinction was partly blurred by the introduction of Article 218.1 of the Criminal Law in 2021, which is a special provision concerning VAT evasion that may encompass both types of results within a single offence (Office of the Prosecutor General of the Republic of Latvia, Proposal for the Draft Law ‘Amendments to the Criminal Law’). Nevertheless, this development does not alter the general understanding of tax evasion.

The Supreme Court of the Republic of Latvia has, in several cases, examined whether ML can occur before the completion of tax evasion. In earlier case law, it was held that the predicate offence must always be completed before the ML can take place (Decision of the Senate of the Republic of Latvia of 20 December 2012, SKK-446/2012). This approach created challenges in recognising the proceeds from tax evasion as an object of ML, since laundering activities often commenced before the tax evasion was completed.

In 2021, the Supreme Court revised its position, holding that laundering of proceeds acquired through tax evasion may begin before the predicate offence is completed. The Court emphasised that what matters is not the temporal gap between the two offences, but rather the fact that both crimes concern the same object (Decision of 17 March 2021, SKK-3/2021, para. 6).

In 2023, the Supreme Court issued a decision explicitly recognising that savings resulting from the declaration of fictitious transactions constitute unlawfully obtained financial resources, which qualify as criminal proceeds. In this case, the defendant declared fictitious transactions in VAT returns, thereby increasing input VAT and unlawfully reducing tax liabilities. The person carried out monetary transfers, including the avoided taxes, which were classified as ML. The Supreme Court noted that fictitious transactions are conducted with the awareness that they will be used to reduce VAT payable to the state for business transactions. The funds equivalent to the fictitious VAT are retained by the taxpayer and not transferred to the state budget. The Court concluded that these financial resources, that is, savings resulting from the declaration of fictitious transactions, were unlawfully obtained and qualify as criminal proceeds (Decision of 1 February 2023, SKK-1/2023).

Thus, Latvian case law reflects a broad understanding of criminal proceeds, encompassing any economic benefit, including savings resulting from tax evasion.

Estonian courts have addressed the issue of criminal proceeds from tax evasion in a relatively few cases. The research identifies two significant rulings of the Estonian Supreme Court concerning whether funds saved through tax evasion may qualify as criminal proceeds.

In an order of 15 June 2015, the Estonian Supreme Court considered the justification for seizing real estate owned or co-owned by O.G., who was suspected of assisting in tax evasion (Order of the Supreme Court of the Republic of Estonia of 15 June 2015). According to the application for the seizure, O.G. was suspected under Articles 389.1(1) and (3) and 22(3) of the Estonian Penal Code for aiding V.P., together with A.L., in submitting false data in VAT returns of OÜ Well Tehnoloogia, causing EUR 79 651,17 in tax losses. To reduce the company’s tax liability, fictitious invoices were issued by various entities for non-existent transactions. O.G. participated in the preparation and handling of the false documents, instructed the company’s accountant to carry out bank transfers based on the fictitious invoices and handled cash received from A.L. The scheme did not result in unlawful refunds but only reduced the company’s tax liability.

O.G. was also suspected under Article 255(1) of the Penal Code of participation in a criminal organisation led by A.L., which aimed to gain illegal financial benefit through tax evasion. The organisation controlled various companies that issued fictitious invoices and made corresponding bank transfers. The funds were withdrawn in cash and partially used to pay for services, with the rest retained by the organisation.

In the application, it was claimed that O.G.’s property could not be justified by lawful income and likely originated from criminal conduct.

The Viru County Court granted the request to seize the properties. The decision was upheld by the Tartu Circuit Court, which noted that ‘[i]f during the proceedings it is established that the damage outlined in the suspicion—specifically the loss to the Estonian state due to unpaid VAT—occurred, then substitution of extended confiscation is possible under Section 84 of the Penal Code’.

However, the Supreme Court ruled that seizure requires a reasonable suspicion that confiscation or substitute confiscation may apply (para. 24). The facts presented in the application were insufficient to conclude that O.G. had obtained property through the alleged tax offence (para. 30). With O.G.’s assistance, OÜ Well Tehnoloogia increased its input VAT to reduce its tax liability, without claiming a refund. The amount was referred to as ‘criminal proceeds related to O. G.’ The Court found that the state did not transfer property to OÜ Well Tehnoloogia or any other party as a result of the false VAT returns. There was no evidence that the state’s VAT claim, hidden with O. G.’s assistance, had expired or that the tax authority was otherwise prevented from enforcing it (para. 32). The Court emphasised that under Section 4(2) of the Taxation Act, based on the principle of legality, the tax authority generally cannot waive a tax claim or its enforcement. Therefore, simply failing to declare a tax liability does not increase a person’s assets, at least not while the state can still enforce and collect the full tax amount. The application and lower court judgements did not rely on other facts that would allow to conclude that property was obtained within the meaning of Section 83.1 of the Penal Code through the false VAT returns (para. 31). No specific way was indicated in which OÜ Well Tehnoloogia, by filing false data in VAT returns, could have directly increased O.G.’s assets. Therefore, the Court concluded there was no basis for seizure of the property (para. 32).

In this case, the Supreme Court referred to its previous judgement of 28 January 2008, where it reached a similar conclusion (Judgment of the Supreme Court of the Republic of Estonia of 28 January 2008). The Court found that the lower courts’ decisions did not indicate the substantive legal norms requiring M.P. and M.R. to compensate the tax liability of OÜ X. The applicable Taxation Act, effective from 1 July 2002, did not allow retroactive application (para. 39).

In this case, the Tartu County Court found M.P. and M.R. guilty of deliberately submitting false data in the VAT returns of OÜ X as management board members. They unjustifiably increased the company’s input VAT by using fictitious invoices issued in the name of various companies, resulting in a total VAT loss of 1 427 047 kroons. The invoices referred to non-existent transactions and were submitted to support the false VAT returns. The Tartu Circuit Court upheld the conviction, excluding just the interest.

The Supreme Court held that the company’s tax liability arising from a management board member’s failure to declare taxes does not in itself constitute damage to the state, as the state retains the right to claim tax from the company. A breach of the declaration obligation does not affect the existence or amount of the tax claim. If the state subsequently discovers and collects the unpaid tax, no damage has occurred. However, if the claim becomes uncollectible due to insolvency or liquidation of the company, or expiration, a causal link may be established between the breach and damage to the state (para. 46).

To determine the amount of damage, one must subtract from the potential collectible amount the part that the state can still recover. If the company was already unable to pay the tax when the obligation arose, no damage occurred, as fulfilling the declaration obligation would not have increased state revenue. This requires assessment of the company’s financial situation at the relevant time (para. 54).

For these reasons, the Supreme Court annulled the lower court rulings insofar as M.P. and M.R. were found guilty and acquitted them of the charges.

Estonian Supreme Court case law indicates that tax evasion by a company’s board member does not in itself cause damage to the state. Damage may arise if the tax liability is concealed and becomes uncollectible due to the company’s insolvency, liquidation or claim expiry. Also, the company’s ability to pay taxes at the time the obligation arose must be assessed. To establish damage, it must be shown: (1) the existence and amount of the tax liability; (2) that the tax became uncollectible due to concealment; and (3) that the company was solvent at the time the liability arose.

The 2022 Moneyval report criticised the Estonian Supreme Court’s overly narrow interpretation of the ML offence. Moneyval noted that ‘there are thresholds set by jurisprudence that go over and above the legislative provisions, which may have hindered, and may continue to hinder, identification and investigation of ML offence.’ That is inter alia because ‘[t]he Supreme Court does not consider it to be proceeds of crime when the perpetrator has retained a proportion of tax by a falsified tax return; it can only be proceeds of crime where the money has been defrauded through a tax refund’ (Moneyval, 2022: 88–89).

Although Estonia’s legal regulation on criminal proceeds is similar to Latvia’s, its judicial interpretation of tax offences as proceeds-generating crimes is more restrictive. This may impair Estonia’s ability to meet its obligations in detecting and prosecuting ML, where tax crimes involve concealment of liabilities rather than obtaining tax refunds.

In both Latvia and Estonia, courts have addressed the issue of whether tax evasion can generate criminal proceeds. This issue has been considered under the regulation of confiscation of criminal proceeds (including extended confiscation) and ML, which is largely similar in both countries.

Both legal systems generally agree that tax crimes can be predicate offences for ML, following EU law and FATF recommendations. Moreover, it is accepted that economic benefit may also be obtained from tax evasion. Both Latvia and Estonia have emphasised the need to avoid double recovery when confiscating criminal proceeds and recovering unpaid taxes.

However, despite similar legal frameworks, Latvian and Estonian courts differ in how they treat tax savings as criminal proceeds. In Estonia, tax offences do not include damages to the state budget as a constituent element of the offence. By contrast, Latvian law explicitly includes economic loss as an element of tax evasion. This has supported the development of case law regarding the moment when tax evasion is considered complete, and the distinction between reducing tax liabilities and increasing tax refunds.

Furthermore, Latvian judicial practice closely adheres to international and EU legal instruments, as well as the recommendations of international organisations in the field of anti-ML. Based on the definitions in international legal acts and various interpretative documents, Latvian case law has adopted a broad understanding of criminal proceeds, including not only acquired assets but also the reduction of liabilities.

Estonian courts apply a narrower interpretation of criminal proceeds. It must be proven not only that the person concealed tax liabilities, but also that the state was unable to recover the unpaid tax due to the taxpayer’s insolvency, liquidation, or other similar circumstances. Only then may the tax advantage be seen as an unlawful increase in the perpetrator’s assets. One reason for broadening the scope of predicate offences to tax crimes was to enable more effective confiscation of proceeds, which, in the case of tax evasion, represent revenue withheld from the state budget. However, if the existence of criminal proceeds is recognised only after the state fails to recover the tax, this objective may be undermined, as the assets could already have disappeared. This approach also shifts the focus from the perpetrator’s actions to the state’s recovery efforts.

Tax evasion is not a declaration offence, like document falsification, but rather an offence against the fiscal interests of the state. Once the offence is completed, the perpetrator typically gains an economic benefit. Recognising tax savings as criminal proceeds better reflects the principle that crime should not pay and is more consistent with international anti-ML standards.