14 May 2007
8 October 2013
28 March 2014
Update on legislative developments in Russia: governmental de-offshoring initiatives and proposed new CFC and tax residency rules
25 April 2014
19 May 2014
11 February 2014
The Russian Ministry of Finance has recently declared that the tax reform launched in 1998 is almost complete. The Tax Code of the Russian Federation, based on the Organisation for Economic Co-operation and Development (OECD) principles, sets out clear rules for taxation and defines the legal framework of the Russian tax system, including the rights and responsibilities of taxpayers, the powers and obligations of tax authorities, tax registration and filing procedures and tax audit and appeals procedures.
Reducing the tax burden on individuals and corporations has been the cornerstone of the first phase of the reform and this task has been accomplished successfully. An exhaustive list of taxes has been established by the tax code, reducing the total number of taxes from more than 60 to 15.
Regional and local authorities have been prohibited from introducing taxes not listed in the tax code or in violation of the general principles set out in the code. Most onerous taxes, such as turnover taxes, have been abolished and tax rates have been lowered substantially.
Today the tax rates in Russia are among the lowest in Europe. For instance, the majority of Russians encounter a flat tax rate of 13 per cent. The lowest rate of social charges, which are assessed at a regressive scale, is only 2 per cent. Inheritance taxes have been completely abolished. Property tax rates are negligible compared with other countries'.
These legislative efforts have been backed up by the courts. In particular the Constitutional Court of the Russian Federation has issued several rulings declaring various pieces of tax legislation, such as excessive tax penalties, to be in conflict with the tax code.
Notwithstanding this amazing progress achieved within a relatively short period of time, most investors do, however, continue to cite taxes as a major constraining factor to their operations in Russia. Tax law is no longer the problem - the issue is tax administration.
A fundamental distortion between the role of the tax authorities and the mentality of the tax inspectors lies at the heart of this existing problem. In practice the main goal of the tax authorities remains the replenishment of the state treasury. As such, the more money collected by taxmen, the higher their performance is marked.
Each year the government approves tax collection plans. Local tax authorities are instructed to procure the receipt of respective tax amounts, rather than to treat the taxpayers individually and lawfully. Any tax audit pursues the major objective of securing a maximum payment through the assessment of taxes, penalties and interest.
VAT attracts the most acute form of abuse by taxmen. Tax authorities make a point of refusing a tax refund or offset on any artificial grounds. Although the targeted group was initially limited to exporters and other taxpayers in a refund position, the tax authorities have broadened the attack. In the view of taxmen, the input VAT amount should not exceed 70 per cent of the output VAT amount.
Tax inspectorates have been accused of extending invitations to managers of businesses declaring excessive - as seen by taxmen - input VAT. During such meetings, they are said to push for a reduction in input VAT amounts under the threat of audits, freezing of accounts and other chastisements. It has also become virtually impossible to obtain a VAT refund without going to court. Even lengthy court proceedings do not guarantee the reimbursement of VAT, as tax authorities drag their feet over complying with court orders, using any bureaucratic loopholes available.
Administration of VAT has become such a headache for taxpayers that the government has seriously considered substituting sales tax for VAT. Indeed, all shortcomings arising out of the difficulty to collect sales tax are considered to be a lesser evil than the administration of VAT.
Taxpayers' vulnerability is aggravated further by the irresponsibility of tax officials. Despite the fact that the legislation in force provides for administrative and even criminal responsibility to be placed on tax officials that fail to perform their duties, only a single instance is known where taxmen were held responsible for infringement of taxpayers' rights and knowingly issuing unlawful orders.
Although procedural legislation enables taxpayers to pass on their legal costs in successful cases, this rule does not work out in practice. In most cases courts award only nominal amounts to taxpayers. Companies are forced to allocate a budget for non-reimbursable tax consultancy fees and legal costs.
Even where consistent case law exists, a tax authority is required by the government to exhaust all procedural steps to challenge a court order in favour of a taxpayer. Many headlines were captured by criminal proceedings initiated against two tax inspectorate lawyers who failed to file appeals in cases that were certain to fail. This approach has led to an excessive number of cases before the courts. For instance, in 2006 Russia's courts reviewed 654,920 administrative (mostly tax) cases.
Although tax experts and businessmen have been calling for tax reform for years, little progress was made until President Putin identified improvement of tax administration as one of the priorities of the state policy in the President's Address 2005. This has urged tax practitioners and governmental officials to combine their efforts in developing the reform strategy.
Time allocated for the conduct of audits has been substantially limited. The tax code also limited documents that the tax authorities may request from taxpayers in connection with a chamber audit. Tax authorities have become bound by the position of the Ministry of Finance.
At the same time the Russian Ministry of Finance has adopted an internal document aimed at determining priorities of the tax service. The efficiency of a local tax inspectorate will now be determined pursuant to eight weighted criteria. Even though tax collection is among them, this should be balanced by other criteria, such as percentage of cases won by the tax inspectorate (based upon both number of cases and their total value), the percentage of cases settled out of court and percentage of taxpayers filing tax returns in electronic form. Thus the Ministry of Finance suggests that the performance of the tax authorities should not be assessed solely or predominantly on the basis of tax collections.
Russian courts have also handed down several rulings aimed at improving tax administration. An information letter issued by the Presidium of the Russian Supreme Commercial (Arbitrazh) Court on 13 March 2007 related to the payment of the state duty. Contrary to the previous practice, when challenging court orders in cases won by taxpayers, tax authorities have now become liable for payment of the state duty.
Such expenses must be reimbursed by the respective tax inspectorate and not by the treasury. In the view of the highest judicial authority, such a measure is expected to result in less pressure on the courts, since the tax authorities would think twice before filing the appeal.
In order to attract investment, Russia needs, among other things, to create a tax system that is transparent, fair and easily administered. With the enactment of the tax code, Russia has made a significant step forward, but in order to achieve this goal it needs to continue to modernise and reform its tax administration system.
Oleg Konnov is a partner in Moscow at Herbert Smith