THE COURTS WIL APPLY A STRICTER APPROACH TO TAXPAYERS WHO TRY TO REDUCE TAXES ADDITIONALLY ASSESSED WITHIN THE SCOPE OF TAX AUDITS

The law firm Pepeliaev Group advises that the Presidium of the Russian Supreme Arbitration Court has taken a stricter approach to interpreting legislation with regard to some actions of the taxpayers that they take in the course of or after tax audits to reduce additionally assessed taxes (Resolutions Nos. 23/11 and 11185/10 dated 26 April 2011).

In a case where additional value added tax was assessed, the taxpayer challenged the additionally assessed VAT in court and submitted the documents confirming additional tax deductions that exceeded the additionally assessed VAT.

The Presidium of the Supreme Arbitration Court (“SAC”) pointed out that the documents confirming, in the taxpayer’s opinion, its right to apply tax deductions could not per se replace the need to record (claim) these deductions in the tax accounting records and did not serve as the grounds for reducing the tax payable. Moreover, the Presidium of the SAC pointed out that those documents had only been submitted in court, rather than during the tax audit or with objections to the tax audit report.

The Presidium of the SAC justifies this legal position by citing the application-based nature of VAT deductions, which, in contrast to corporate profit tax expenses, do not form the tax base and, consequently, may only be deducted for tax purposes based on an application. Moreover, the tax authority is not obliged to calculate the amount of these deductions during the tax audit. The Presidium of the SAC previously advanced a similar opinion in its Resolutions No. 8686/07 dated 30 October 2007, No. 6961/10 dated 9 November 2010 and No. 14473/10 dated 9 March 2011.

Pepeliaev Group comment

There is a risk that the tax authorities will also apply this legal position, which is unfavourable for taxpayers, to other taxes, including profit tax and personal income tax.

As for profit tax and personal income tax, the legal positions of the Presidium of the SAC remain in effect: during tax audits, the tax authorities must calculate expenses, as well as income (resolutions No. 668/04 dated 25 May 2004 and No. 14473/10 dated 9 March 2011). The profit tax-related issue will be considered one more time at the session of the Presidium on 19 July 2011 within the scope of supervisory review of Ruling No. VAS-1621/11.

Under the effective law on corporate profit tax, the tax authority must calculate taxable profit rather than income, regardless of the filing of adjusted financial statements.

However, within the scope of the audit, the tax authority may only deduct expenses connected with transactions reviewed during the audit.

In this regard, it is better to submit, in the course of the audit, the documents that confirm expenses not connected with transactions reviewed during the audit or to submit them together with objections to the tax audit report; otherwise, the tax authority may cite procedural arguments as grounds for its refusal to deduct the newly identified expenses.

As fr om the view point of economics VAT deduction is similar to expenses for profit tax purposes, the business community may suggest that provisions be added to article 21 Value Added Tax that allow companies to include VAT into the tax base similarly to the profit tax (for example, when considering draft law No. 482215-5).

In another case, the Presidium of the SAC pointed out that if any violation of tax legislation has been identified during the tax audit, it is not enough for the taxpayer just to file the adjusted financial statements and to pay tax arrears to avoid the fine, as pursuant to article 81(4) of the Tax Code, to be released from liability the taxpayer should perform such actions before the violations are identified, rather than after the tax authority issues a decision to hold the taxpayer liable. Moreover, the taxpayer should also pay default interest.

Pepeliaev Group comment

Such legal position brings the interpretation of tax legislation back to that specified in clause 42 of Resolution No. 5 of the Plenum of the SAC dated 28 February 2001: taxes paid in excess before the due date for paying taxes for the period with regard to which tax arrears have been identified should be taken into account and can be used to offset tax liability if the excess paid is greater than the arrears. However, if the taxpayer pays tax arrears after the violation is identified, the taxpayer may only be released from liability if it has submitted the adjusted financial statements and paid default interest before such violation is identified.

For some time an approach has been applied according to which article 81(4) of the Tax Code only describes one of the cases wh ere liability is not applied. Thus, if a fine is imposed before the tax authority issues the decision on holding the taxpayer liable even if the latter paid tax arrears, this would mean liability being imposed for the failure to submit the adjusted tax returns and the failure to pay default interest, which is not envisaged by legislation. Such an approach is based on Resolution No. 15120/07 of the Presidium of the SAC dated 26 February 2008.

The payment of taxes before the tax authority issues a decision to hold the taxpayer liable may only be treated as a factor mitigating liability. Moreover, to avoid the fine using lawful means, the taxpayer may perform internal audits using its own staff or external specialists to determine whether adjusted financial statements should be filed or additional taxes or default interest should be paid before the state auditors identify the violations.

Neither of the resolutions of the Presidium of the SAC contains any provision stating that these resolutions are generally binding and must be applied to cases with similar facts. However, the tax authorities may cite these legal positions in their decisions.

For further information, please contact:

in Moscow – Ivan Khamenushko, Senior Partner, at: (495) 967-0007 or by e-mail; Peter Popov, Senior Associate, at: (495) 967-0007 or by e-mail

in St Petersburg - Sergey Sosnovsky, Head of Tax Practice (St. Petersburg), at (812) 333-0717 or by e-mail