Additional tax versus tax deductions
Liability and fine - timing of arrears payments

The Supreme Arbitrazh Court has taken a strict approach to taxpayers that seek to reduce their additionally assessed taxes, either during or after tax audits.(1)

Additional assessment versus tax deductions

In a case in which additional value-added tax (VAT) had been assessed, the taxpayer challenged the additional amount in court and submitted documentary evidence of additional tax deductions that exceeded the additional VAT.

The court observed that the presentation of the documents which, in the taxpayer's opinion, confirmed its right to tax deductions did not obviate the need to claim the deductions by recording them in the taxpayer's accounts; nor were the documents - as thus presented - a legitimate basis for reducing the amount of tax payable. The court observed that the documents had been presented to the court, but had not been submitted during the audit or with the taxpayer's objections to the audit report.

The court justified this position with reference to the application-based nature of VAT deductions - unlike corporate profit tax expenses, they do not form part of the tax base and may be deducted only on application. Furthermore, the tax authority is not required to calculate the amount of these deductions during the tax audit. The court has previously followed the same interpretation.(2)

For taxpayers, there is a risk that the authorities will seek to apply this interpretation to profit tax and personal income tax. However, for these two taxes, the court's position is unchanged: in the course of tax audits, the authorities must calculate expenses as well as income.(3) The profit tax issue will be reconsidered by the full court on July 19 2011 in its supervisory review of Ruling VAS-1621/11.

Under the existing law on corporate profit tax, the authorities must calculate taxable profit, rather than income, regardless of whether adjusted financial statements have been filed. However, within the scope of the audit, the authorities are restricted to deducting expenses which are connected with transactions that are reviewed during the audit. Thus, from a taxpayer's perspective it is preferable to submit documents that confirm expenses which are unconnected with transactions being reviewed during the audit, or else to submit them together with objections to the audit report; otherwise, the tax authority may cite procedural arguments and refuse to deduct subsequently identified expenses.

As VAT deductions are similar to expenses for profit tax purposes, at least from an economic viewpoint, businesses might argue that provisions should be added to Chapter 21 'Value Added Tax' of the Tax Code to allow companies to include VAT in the tax base in the same way as profit tax.

Liability and fine - timing of arrears payments

In another case the court stated that if a tax violation is identified during a tax audit, a taxpayer cannot avoid a fine by filing adjusted financial statements and paying tax arrears. Pursuant to Article 81(4) of the Tax Code, a taxpayer may be released from liability only if it performs such actions before the violations are identified. Moreover, the taxpayer must also pay default interest.

The court's analysis returns the interpretation of tax law to the position set out in Clause 42 of Resolution 5/2001: excess taxes paid before the due date applicable to the period for which arrears have been identified should be taken into account and can be used to offset tax liability if the excess is greater than the arrears. However, if the taxpayer pays arrears after the violation has been identified, it may be released from liability only if it submitted the adjusted financial statements and paid the default interest before the violation was identified.

For some time the accepted approach has been that Article 81(4) of the Tax Code merely identifies one of the cases in which liability does not apply. Therefore, if a fine is imposed before the tax authority issues a decision in which the taxpayer is held liable, even if the latter has paid arrears, liability is imposed for failure to submit adjusted tax returns and to pay default interest, which is not envisaged by legislation. Such an approach is based on Resolution 15120/07 of February 26 2008.

If a taxpayer pays taxes before the authorities find it to be liable, this is treated as no more than a mitigating factor. In order to avoid a fine by 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.

For further information on this topic please contact Ivan Khamenushko or Pyotr Popov at Pepeliaev Group by telephone (+7 495 967 0007), fax (+7 495 967 0008) or email ([email protected] or [email protected]).


(1) Resolutions 23/11 and 11185/10 dated April 26 2011. Neither of the resolutions contains a provision that it is generally binding and must be applied to cases with similar facts. However, the tax authorities may cite these legal positions in their decisions.

(2) See Resolutions 8686/07 (October 30 2007), 6961/10 (November 9 2010) and 14473/10 (March 9 2011).

(3) Resolutions 668/04 (May 25 2004) and 14473/10 (March 9 2011).