Court Practice Confirms that Tax Overpayments Can Be Used to Effectively Protect Taxpayers

The judges of the Russian Supreme Arbitration Court once again confirmed that the tax authorities must account for both the understatement and overstatement of tax liabilities when they audit taxpayers.

Facts of the case

A taxpayer filed adjusted property tax returns, reducing the property tax in the process owing to increased depreciation accrued on fixed assets. The tax authority assessed additional profit tax on the reduced amount of property tax, but failed to take into account the increased expenses on the depreciation of fixed assets.

The state arbitration courts of all three instances concluded that in these circumstances the tax authority should have accounted not only for the reduced expenses on the property tax, but also for the increased expenses on depreciation. The tax inspectorate failed to perform these calculations and the courts ruled that the additional assessment of profit tax was illegal in this episode. The tax inspectorate believed that the company should have claimed its right to deduct the accrued depreciation by filing adjusting profit tax returns. The courts dismissed this argument, as the Tax Code does not release the tax authorities fr om the obligation to establish all the circumstances related to the calculation of taxes.

The panel of judges of the Russian Supreme Arbitration Court upheld the conclusions of the lower courts and ruled on 17 February 2010 not to refer the case to the Presidium of the Supreme Arbitration Court for consideration.

Thus, the panel of judges of the Russian Supreme Arbitration Court confirmed once again the obligation of the tax authority, when performing an audit, to take into consideration any instances wh ere the taxpayer paid excess tax, and also the right of the taxpayer to declare that it paid excess tax during a court hearing directly, in other words, without the preliminary filing of adjusted tax returns.

Clause 4, article 89 of the Russian Tax Code expressly states that “the subject of a field tax audit is the correct calculation and timeliness of the payment of taxes”. In practice, the tax authorities often interpret this rule as their obligation to establish the understatement of taxes. At the same time the correctness of the tax calculation should be interpreted as an objective assessment of tax liabilities, including potential additional assessments and established excess payments. Therefore, when assessing additional taxes on the basis of an audit, tax inspectors should take into account not only an increase in the tax base owing to facts that they have established, but also a decrease in tax liabilities if the taxpayer made a calculation error that led to the accrual of excess taxes.

The Russian Supreme Arbitration Court has already expressed a similar position. For example, in Resolution No. 4909/04 dated 5 October 2004, the Presidium of the Supreme Arbitration Court stated that the tax authority and the courts erroneously failed to account for the tax deductions, cited by the taxpayer when the state arbitration court was considering a statement of claim filed by the tax authority on the collection from the taxpayer of arrears on personal income tax. In a Ruling dated 9 November 2007 on refusing to refer the case to the Presidium of the Supreme Arbitration Court for consideration, the judges of the Supreme Arbitration Court confirmed that, when determining the actual tax amount, the tax authority should account for both the understatement of the tax base caused by the illegitimate deduction of expenses and overstatement of the tax base owing to the erroneous recognition of income on transactions that do not relate to the audited period.

Recommendations

If a field tax audit is being conducted at a company, the performance of a parallel tax due diligence to identify potential tax overpayments (including those made by the taxpayer earlier to be on the safe side) is one effective way of mitigating tax risks and neutralising the consequences of the audit.

After a company receives an audit report from the tax authorities, it should indicate in its objections to the audit report all instances of overpayments to cover those additional assessments, which are impossible or difficult to contest, and also clarify positions on disputed tax issues and a refund of overpaid taxes without inflicting any additional risk on the company.

Specialists from Pepeliaev Group have for a long time provided effective support for taxpayers in field tax audits, including the performance of tax due diligence. Owing to our integrated approach, Pepeliaev Group clients have won 97% of tax disputes in court or pre-trial settlements.

For further information, please contact:

in Moscow – Olga Baranova, the Head of the Tax and Accounting Consulting Practice, at: (495) 967-0007 or by e-mail: info@pgplaw.ru

in St Petersburg  - Sergey Sosnovsky, Head of Tax Practice (St. Petersburg), at (812) 333-07-17 or by e-mail: spb@pgplaw.ru