False Businesses: a Study of VAT Refund Experience

In this article, we will address the matters that subsoil users constantly face in their attempts to refund the amounts in excess of the value added tax (‘VAT’) based on the findings involving the use of the risk management system (‘RMS’).

Let us review this situation through the example of a subsoil user engaged in oil production.

Because the company exports the extracted oil and the turnover for such sale is taxed at zero rate, the company has a VAT excess amount, subject to refund pursuant to Article 272 of the Kazakhstan Code No. 99-IV ‘On Taxes and Other Statutory Payments to the Budget’ dated 10 December 2008 (‘the Tax Code’).

To confirm the consistency of the VAT amounts claimed for refund under the Tax Code, the state revenue bodies conduct a thematic tax audit using the RMS rules. The RMS rules include the execution of the analytical report ‘Supplier Pyramid’, which involves audit for VAT violations, including the VAT offsetting on mutual settlements with a false business, from direct suppliers, suppliers of direct suppliers and so on up to n-level suppliers.

As a result, the state revenue bodies frequently refuse to refund VAT for mutual settlements with a false business, detected at the n-level of suppliers, i.е. a company bears responsibility for unconnected taxpayers.

It should be considered that subsoil users purchase goods, works and services (‘GWS’) through the state procurement system. This procedure for the purchase of GWS limits the choice of suppliers for the companies, they do not have any control or influence on the direct suppliers, the suppliers of the direct supplier, all the more so on the n-level suppliers and, accordingly, cannot be held responsible for them.

Even though, in most cases, all the contracted GWS suppliers were duly checked and were operating legal entities at the time of the deal and the GWS provision, subsequently, due to the n-level supplier being recognized as a false business, the company is held liable via elimination of expenses from the VAT offset and additional taxes and penalties. Ultimately, this leads to unfounded reduction in the VAT amount to be refunded.

Surely, these and other obstacles arising in refund of excess VAT amounts lead to a deterioration of the investment climate in Kazakhstan and lack of confidence in the Kazakhstan tax system.

Because the state bodies consider the current RMS rules to be an effective instrument of tax administration for VAT refund, which helps minimize the risks of unjustified tax refund from the budget and eliminates various illegal VAT refund schemes, no measures or proposals have been put forward to revise these rules, as well as the need for a consistent approach in the application of tax norms and norms of state control over GWS procurement.

The issue remains: how does the state body suppose the subsoil user to monitor the fulfilment of tax obligations by the n-level subcontractors and suppliers? Shall we also note that the refusal to refund VAT, as a result of the detected RMS violations at the second and subsequent levels, negatively affects the activities of subsoil users?

In addition, lack of co-ordination and inconsistency are common in the practical work of the republican and local state revenue bodies when the same period is checked repeatedly, each time with a different approach to the RMS rules. First, this negatively affects the investment and financial activities of the company; second, it draws away huge human resources and generally impedes the company and third, the company may be charged additional penalties for the results of the latest check on the VAT refunded and confirmed from the previous checks. It appears that Kazakhstan financial state revenue departments discredit their own checks, for which the taxpayers are held liable.

Moreover, the taxpayers reasonably believe that the current rules for applying RMS when confirming the VAT excess amount claimed for refund do not provide a fair procedure for the refund/non-refund of the VAT excess amount and, ultimately, may situate corruption. In other words, the RMS rules should strike a balance between the identification and prevention of the activities of false businesses and non-interference in the legitimate activities of dutiful companies.

Hence, we believe that the actions of state bodies and statutory and legal acts should be aimed at the prevention, identification and elimination of false business, failure to pay taxes and submit tax returns by unconscientious subjects of private entrepreneurship, and not at punishing the counterparties who are also victims of fraud. Moreover, dutiful taxpayers should not bear the responsibility and be forced to make up for the losses in the budget caused by imperfect tax administration and actions of dubious organizations.

Further, currently, if the taxpayer has been issued an act of tax audit and a notification of additional CIT and VAT charges for transactions with counterparties whose registration was found unlawful based on a court decision and, therefore, de-registered as a VAT payer, disputing such a decision and declaring illegitimate elimination of expenses from deductions and VAT from offset is very difficult, if not impossible.

In May 2016, the Office of Prosecutor General published a letter stating as follows: ‘... we believe that the tax authority during tax audit does not have the right to eliminate taxpayers’ expenses from deductions if relevant documents are available confirming the real transaction, including that with a company whose state registration was declared invalid by court’. This opinion of the prosecutor’s office proves the need to elaborate a uniform approach and law enforcement practice on recognizing the expenses under transactions with entities declared as false businesses or whose state registration is declared invalid by the court.

Thus, comprehensively and thoroughly to review cases and make a truly just and balanced decision, we believe that courts, among other things, should take into consideration the following:

1)\tProcedural moments: the actions of tax authorities during thematic tax audits to confirm the consistency of VAT amounts claimed for refund;

2)\tDetailed examination of acts and notifications of tax authorities, and primary documents on the disputed transactions, provided by the taxpayers as grounds for their claims;

3)\tComprehensive investigation of the facts and grounds for the elimination of taxes from deductions and related additional charges;

4)\tPossible discrepancy between the rules applied when refunding the VAT excess amounts and the RMS rules, which are often used by the tax authorities as a VAT non-refund tool;

5)\tThe necessity to work out a uniform judicial practice in respect of taxpayers’ claims, for which state revenue bodies eliminated the VAT amounts to be refunded from VAT or did not confirm such amounts.

Our recommendations for this example are as follows:

1)\tDetermine the level of suppliers, up to which the analytical report ‘The Supplier Pyramid’ is executed;

2)\tOnce the agent is recognized as a false business, the tax authority should accordingly directly notify the counterparty and allow resubmission the declaration (within the statutory period), without additional liability;

3)\tDetermine at the domestic level and elaborate an instruction to identify false businesses at the level approved by the revised RMS rules;

4)\tDetermine verification measures for potential suppliers included in the state information system for the purchase of GWS and their suppliers, to minimize the risk of contracting with false businesses. If false businesses are detected in the system, the users of the state procurement system should not bear responsibility for this;

5)\tDo not bring to liability companies that have not concluded transactions directly with suppliers of suppliers recognized as false businesses, if these companies are not affiliated entities;

6)\tLegislatively prohibit aggressive approach of inspectors during tax audits;

7)\tIf the tax authority violates the deadline for requesting the elimination of violations, such notifications are deemed invalid for the RMS rules application.