Problems of Tax Legislation – the View of Foreign Investors
Petr Medvedev, Co-Chairman of the Tax Working Group of the Foreign Investors’ Council Chaired by the President of the Republic of Kazakhstan, Tax Partner of Ernst & Young.
During the course of recent sessions of the Tax Working Group of the Foreign Investors’ Council Chaired by the President of the Republic of Kazakhstan, it has become clear that the interests of foreign investors are becoming more and more similar to the interests of domestic producers with respect to the formation and application of tax legislation. The aim of this article is to familiarise readers with those amendments and additions to the Tax Code which are currently being discussed by our working group.
Tax Working Group
The main issues discussed at sessions of the tax working group may be divided into 2 main categories – 1) amendments requiring a “conceptual political resolution” and 2) issues requiring an administrative decision or “non-conceptual” amendments to the Tax Code.
The first group contains such issues as, for example:
• Improvements to legislation concerning the state control over the application of transfer pricing;
• The requirement to introduce amendments to the Code Concerning Administrative Violations in order to mitigate liability for tax violations and to reconsider the level of liability for formal violations (for example, the late submission of statements);
• The possibility to offset the total amount of VAT accrued by operators under “old” contracts for the use of the subsurface (20% against 16%);
• The reconsideration that the concept of the payment of VAT for non-residents be brought into line with the “European Model”
(the possibility of offsetting at the moment of accrual rather than after the payment of VAT to the budget);
• The elimination of the double imposition of VAT in settlements for services with the other CIS countries.
As is clear from the above list, in order to resolve these issues conceptual decisions often need to be taken in the field of tax policies while various ministries and departments need to be engaged.
At the same time in order to initialise a decision of the issues listed below from the second group, as a rule, only the approval of the Ministry of Finance and the Ministry for the Economy and Budget Planning is sufficient.
• A change to the frequency of audits of the state control over the application of transfer pricing;
• A simplification of the procedure for the administration of international treaties concerning the avoidance of double taxation;
• The taxation of the transportation expenses of employees working under rotation conditions, if the “gathering point” is located outside the borders of the Republic of Kazakhstan;
• The imposition of interest penalties in those cases when the tax bodies fail to fulfil their obligations to execute certain procedures relating to the refund of VAT (Article 252 of the Tax Code);
• A definition of the procedure for the tax authorities to conduct tax audits and to apply fines.
Below I would like to discuss two of the issues that are most often discussed and in examples indicate the importance of their solution for both foreign companies and for domestic investors.
Improvements to Legislation Concerning State Control over the Application of Transfer Pricing
Even before the Law Concerning the State Control over the Application of Transfer Pricing was adopted in January 2001, it was causing heated debate with respect to its compliance with international practices and the possible infringement of the legal interests of taxpayers.
Experience of its application has shown, some of these fears have rung true. Evidence of the shortcomings of the Law is, for example, the fact that any deviation of an actual sales price from the market price in relation to any of the transactions indicated below leads to an additional accrual of taxes, the application of fines and late payment interest (Article 3 of the Law):
• Transactions between interdependent parties;
• Barter transactions;
• Transactions using a mechanism of the cross-cancellation of debts;
• Transactions between parties registered in offshore zones;
• Transactions between parties enjoying tax concessions;
• Transactions between companies with tax losses.
As a result, if a taxpayer is unable to explain even a 0.1% deviation in an actual price from the market price for the above transactions, the tax authorities carry out an additional accrual of taxes. However, the fact that the mechanism for market price formation depends on many factors, the influence of which may not always be defined accurately, has been totally ignored. As a rule, according to international practices, only those transactions concluded between associated enterprises fall under state control, while any remaining transactions are considered as having been concluded at the market price and, accordingly, are not subject to audit.
Due to the above it should be noted that, for example, a deviation in prices, even in relation to goods traded at the commodity exchanges, may be as much as a few per cent during a usual trading day (table). Accordingly, the seller selling his goods at the commodity exchange may quite easily conclude a transaction at a price higher and also lower than the average price. Therefore, the current opinion that when trading at the commodity exchange goods honest people will always conclude transactions at the average market price is misleading.
Incorrect judgements have been raised during the discussion of the Law that its articles infringe only on the large foreign oil companies and do not affect medium- and small-sized entrepreneurs, whose development the Government of the Republic of Kazakhstan has stated is one of the priority sectors. However, the Law is applied equally to international companies as it is to a single farmer. For this reason, I have illustrated an example given by Deputy E. A. Ramazanov at a recent discussion of the adjustments to the Law. In this example, in the spring the farmer concluded a forward contract for a supply of grain to be made in the autumn. The contract was concluded at the price of US$80 per tonne1, while at the moment the supply was made, the price on the global market amounted to US$100 per tonne. As a result the tax authorities accrue additional taxes based on the price valid at the moment of supply, ignoring the facts that the parties were independent of each other, that if the farmer had not concluded the transaction in the spring and not received the necessary funds, it is not beyond the realms of reality that in the autumn he would have had nothing to harvest and, this is important – this type of price formation is commonly used in this industry.
1 The prices in this example are nominal
However, if a large company is able to afford to engage consultants, conduct an expensive analysis and, as a result, prove that the price applied by it is the market price, then a farmer is probably not able to defend his interests, especially taking into account that price formation on the global grain market is, at times, even more complicated than that of the oil and gas market.
Based on the above, at the last session of the tax working group, the Kazakhstan and foreign parties agreed to consider the question of the introduction of amendments and additions to the Law in order to clarify certain provisions and to reflect the market realities of price formation.
Issue of the Necessity to Introduce Amendments to the Code Concerning Administrative Violations
At the most recent session of the working group, the question of the requirement to mitigate liability for tax violations and to reconsider the level of liability for formal violations (for example, the late submission of statements) was raised. This is due to an increase in the level of legal education in the Republic of Kazakhstan and the requirement to bring certain provisions of Chapter 16 (Administrative Violations in the Field of Taxation) into compliance with the general rules for the imposition of administrative fines, whereby, in particular, a fine should comply with the nature of the violation.
In our opinion, many of the provisions of Chapter 16 contradict this basic principle. For example, points 1 and 2 of Article 206 of the Code stipulate administrative liability where a taxpayer fails to submit tax reports to the tax authorities within the deadline established by legislation of the Republic of Kazakhstan. The sanction imposed on a legal entity is calculated as 10% or 50% of the amount of tax “subject to payment, but not paid”. In this respect, an interesting paradox arises: a taxpayer that is late by a week in submitting reporting, but at the moment an audit is carried has no tax debt, will be punished the same as a taxpayer that is late in submitting declarations by two months and that also has a tax debt payable in accordance with the delayed declaration.
An even more interesting situation arises when point 2 of Article 209 is applied, which establishes administrative liability for the overstatement of a loss in a corporate or individual income tax declaration in the form of a fine of 50% of the amount of corporate income tax or individual income tax calculated from the loss overstated in a declaration. We consider that this level of liability is not lawful as it contradicts the general rules for the imposition of a fine for an administrative violation.
In practice there are many cases where Kazakhstan and foreign companies open subsidiaries in the Republic of Kazakhstan to participate in various tenders, intending to win projects and accordingly to start engaging in entrepreneurial activities in the Republic of Kazakhstan. In this respect, the subsidiaries in question conduct various types of preparation activities, including hire personnel, purchase and import equipment, conduct marketing and other types of research. In accordance with the provisions of tax legislation, these types of costs may be deducted and carried forward to the following year as losses due to the absence of any income. If the subsidiary does not win the tender, or for whatever reason a legal entity finds it impossible to continue engaging in activities, it may decide to close its subsidiary. In view of the absence of aggregate annual income, the tax authorities consider the deducted costs as illegal and impose on the subsidiary the administrative fine stipulated by point 2 of Article 209.
It is clear that in this case the application of liability contradicts not only the provisions of Article 60, but also of Article 68. In as far as the unlawfulness and public wrong of a violation in the field of taxation are determined according to the amount of tax not being paid in full, then the above level of liability may only be possible in a year when a company is in a position to incur an obligation to pay tax, if it had not overstated its losses. Only in this case “an overstatement of losses” affects an underpayment of tax.
At the same time it should be noted that the tax authorities are continuing to work to train their employees in the regional tax committees with respect to the application of the Code. In particular, at the most recent discussion of this question with the Deputy Chairman of the Tax Committee, Mrs. A. B. Bazarbaeva, it was decided that the Tax Committee of the Ministry of Finance of the Republic of Kazakhstan will consider issuing a departmental instruction concerning the application of the Code in relation to the tax authorities reviewing administrative cases and will provide investors with the possibility of commenting on the draft version of that instruction prior to its approval.
It is clear that the introduction of amendments to Chapter 16 of the Code, and also the explanation of issues regarding the application of the provisions of the Code will assist, first of all, in strengthening tax discipline, and secondly, in improving the image of the Republic of Kazakhstan both for domestic and also for foreign investors.
The above examples clearly illustrate the direction of the activities of the Tax Working Group of the Foreign Investors’ Council Chaired by the President of the Republic of Kazakhstan, the aim of which is to further improve the investment climate for both foreign and domestic investors.
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