Recognition as Unlawful and Annulment of the Notice on the Results of the Tax Audit in the Part Concerning the Assessment of CIT and Penalties

This issue is relevant given that, for the implementation of large-scale engineering, oilfield services, mining, and construction projects, companies capable of carrying out design, construction, supervision of construction sites, and the transfer of know-how, new technologies, and software are invited to Kazakhstan.

Accordingly, non-residents may create a permanent establishment through the assignment of personnel to Kazakhstan and construction sites. If such a permanent establishment is deemed to have been created under the temporary test provided for in Article 5 of the Convention for the Avoidance of Double Taxation with the relevant country, the income derived through such permanent establishment shall be subject to taxation in Kazakhstan.

Thus, the key issues in this area are determining whether a permanent establishment has been created and attributing to it the profits derived both through the permanent establishment and by its head office.

Judgment No. 6001-22-00-6ап/1073 dated 19 January 2023 analyzed the following situation.

JSC “Exalo Drilling” (a non-resident) filed a claim with the court against the Department of State Revenues (“DSR”), seeking recognition as unlawful and annulment of the notice on the results of the tax audit insofar as it assessed corporate income tax (“CIT”) and penalties.

By the judgment of the Specialized Interdistrict Administrative Court dated 19 October 2021 and the ruling of the Judicial Collegium for Administrative Cases (“JCAC”) dated 11 April 2022, the claim was dismissed.

In general, the DSR alleged that the Claimant had:

• overstated deductions without supporting documents in the amount of KZT 69,323,048;
• overstated deductions for general administrative and management expenses of the head office (hereinafter, “GA&ME”) in the amount of KZT 1,134,712,456;
• unjustifiably applied the reduced corporate income tax (“CIT”) rate of 10% to net income, which resulted in an additional tax assessment of KZT 226,230,379.

In its cassation appeal, the Claimant challenged all of the above issues. The Claimant argued that, in issuing the contested judicial acts, the courts had violated and incorrectly applied substantive and procedural law. In particular:

• the courts disregarded paragraph 3 of Article 4 of the Constitution, according to which international treaties ratified by the Republic of Kazakhstan have priority over laws;
• the contested judicial acts were issued in violation of paragraph 6 of Article 10 of the Convention between the Government of the Republic of Kazakhstan and the Government of the Republic of Poland for the Elimination of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital, ratified on 21 April 1995 (hereinafter, the “Convention”);
• the courts disregarded the fact that discrepancies between corporate income tax and value-added tax returns cannot constitute grounds for the Department to exclude the branch’s deductions;
• the Company’s argument that a certificate could be submitted at a later date is supported by a Judgment of the Supreme Court of the Republic of Kazakhstan;
• the courts’ conclusions regarding the limitation periods violated the principle of the taxpayer’s good faith;
• the court’s judgment did not comply with the requirements imposed by Article 152 of the Administrative Procedural and Process-Related Code (“APPC”) as to its content.

The appellate court committed such violations in this case for the following reasons.

Pursuant to paragraph 3 of Article 4 of the Constitution, paragraph 5 of Article 2 of the Tax Code of 2008, and the Tax Code of 2017, where an international treaty ratified by the Republic of Kazakhstan establishes rules other than those contained in the Tax Code, the rules of the relevant treaty shall apply.

Paragraph 1 of Article 20 of the Law of the Republic of Kazakhstan “On International Treaties of the Republic of Kazakhstan” provides that every international treaty of the Republic of Kazakhstan that is in force shall be subject to mandatory and good-faith performance by the Republic of Kazakhstan.

The Judicial Collegium established that, following completion of the tax audit on 1 November 2020, the Claimant:

• on 26 November 2020, pursuant to Article 25 of the Convention, applied to the competent authority of Poland with Application No. DКР11.9149.38.2020 requesting that a mutual agreement procedure be conducted with the competent authority of the Republic of Kazakhstan. The application set out all the grounds identified by the Respondent as a result of the audit. Pursuant to paragraph 1 of Article 3 of the Convention, in Kazakhstan the “competent authority” means the Ministry of Finance of the Republic of Kazakhstan (“MF RK”) or its authorized representative;
• on 20 December 2020, submitted Complaint No. Kaz/2020/84 against the notice to the MF RK.

On 3 February 2021, the Ministry of Finance, Funds and Regional Policy of the Republic of Poland (the competent authority of Poland for the purposes of the Convention, hereinafter, the “MF RP”) sent an e-mail concerning the conduct of a mutual agreement procedure, enclosing a copy of the Claimant’s application, to A. Bagibayev and A. Nurpeisov of the State Revenue Committee of the Ministry of Finance of the Republic of Kazakhstan (“SRC MF RK”) (the contact details being provided in accordance with OECD information).

At the hearing of the cassation collegium, A. Bagibayev (Deputy Director of the Department of the MF RK) explained that he had received the request, but that, due to his dismissal from the SRC MF RK and subsequent transfer to the MF RK during that period, the request had not been considered and had remained unattended.

On 21 June 2021, without taking into account the request of the MF RP, the MF RK issued Decision No. 004-ДА/ЗТ-П-3735 upholding the notice without amendment and dismissing the Claimant’s complaint.

On 23 August 2021, the MF RP sent a repeated written request to the Republic of Kazakhstan. A. Bagibayev confirmed receipt of this request as well. However, since the Claimant had filed an administrative claim with the Specialized Interdistrict Administrative Court, this request also remained unanswered.

At the same time, pursuant to paragraph 1 of Article 25 of the Convention, where a person considers that the actions of one or both of the Contracting States result or will result for that person in taxation not in accordance with the provisions of the Convention, that person may, irrespective of the remedies provided by the domestic law of those States, present their case to the competent authority of the Contracting State of which they are a resident.

Thus, pursuant to this provision of the Convention, the Company, being a resident of Poland, applied to the MF RP for the conduct of a mutual agreement procedure for the purpose of eliminating the violations resulting in its taxation in a manner inconsistent with the Convention.

Pursuant to paragraph 2 of Article 25 of the Convention, the competent authority shall endeavor, if it considers the objection to be justified and if it is not itself able to arrive at a satisfactory solution, to resolve the case by mutual agreement with the competent authority of the other Contracting State, with a view to avoiding taxation that is not in accordance with the Convention.

Thus, the MF RP, having considered the objection justified, approached the competent authority of the Republic of Kazakhstan.

In accordance with the preamble to the Convention, the Government of the Republic of Kazakhstan and the Government of the Republic of Poland concluded the Convention, guided by the desire to strengthen and develop economic, scientific, technical, and cultural relations between the two States, in order to eliminate double taxation and prevent fiscal evasion with respect to taxes on income and capital.

Pursuant to Article 31 of the Vienna Convention on the Law of Treaties (hereinafter, the “Vienna Convention”):

A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.

  For the purposes of interpreting a treaty, the context comprises, in addition to the text, including its preamble and annexes.

Based on the foregoing, the Judicial Collegium considers that, in accordance with the good-faith performance of the provisions of the international treaty, and the Convention in particular, a mutual agreement procedure should be conducted between the Competent Authorities of the two States, aimed at achieving the objectives of the Convention and initiated by the MF RP.

At the same time, pursuant to Articles 26 and 27 of the Vienna Convention, pacta sunt servanda: every treaty in force is binding upon the parties to it and must be performed by them in good faith. A party may not invoke the provisions of its internal law as justification for its failure to perform a treaty.

Thus, in the opinion of the Judicial Collegium, the filing of a claim by the Company with the court does not terminate the obligation of the MF RK or its authorized representative, the SRC MF RK, to conduct the mutual agreement procedure.

Furthermore, pursuant to subparagraph 4) of part four of Article 427 of the Civil Procedure Code (“CPC”), a judgment of the court of first instance shall be annulled in any event if the court has decided on the rights and obligations of persons who were not involved in the proceedings.

The MF RK and the SRC MF RK should have been involved in the present case as interested parties, given the mutual agreement procedure initiated by the Polish side.

In view of the foregoing, the Judicial Collegium considers that, in order to ensure a complete, comprehensive, and objective examination of the case, the administrative case should be remitted to the court of first instance for a new hearing, and a decision should be rendered taking into account the outcome of the mutual agreement procedure.

Conclusions:

In general, in all complaints raising issues concerning the application of international treaties and the performance by the Government of the Republic of Kazakhstan of its international obligations, the JCAC of the Supreme Court strictly follows the spirit and objectives of the relevant agreements. Failure to perform such obligations may adversely affect the country’s reputation and have consequences for attracting foreign investors to Kazakhstan and increasing the cost of projects for the Republic.

Accordingly, since the taxpayer directly affected by instances of double taxation applied for protection to the competent authority of Poland and the procedure provided for by the Convention was initiated, the MF RK should be involved as an interested party in order to ensure a comprehensive and fair resolution of the case.

In general, every administrative body must timely perform the functions assigned to it. This principle also applies to Ministries. All matters that may be resolved through pre-trial procedures, if actually resolved before litigation, should enable the Government to address such matters comprehensively.

Pursuant to subparagraph 4) of paragraph 2 of Article 19 of the Tax Code, tax authorities, within the scope of their competence, are obliged to provide explanations and comments regarding the emergence, performance, and termination of tax obligations. Such explanations and comments, as well as methodological recommendations, including those issued by the authorized body, do not constitute regulatory legal acts. They are subject to assessment by the court with regard to their compliance with the provisions of tax legislation….

Tax policy (a set of measures concerning the introduction of new taxes and budget payments and the abolition of existing ones, changes in tax rates, taxable items and items related to taxation, and the tax base for taxes and budget payments) is implemented by the authorized body in the field of tax policy….

If an international treaty ratified by the Republic of Kazakhstan establishes rules other than those contained in the Tax Code, the rules of the relevant treaty shall apply (paragraph 5 of Article 2 of the Tax Code). Pursuant to paragraph 3 of Article 4 of the Constitution, the procedure and conditions for the operation within the territory of the Republic of Kazakhstan of international treaties to which Kazakhstan is a party are determined by the legislation of the Republic….

Where an international treaty ratified by the Republic grants the Government of the Republic of Kazakhstan the right to impose taxation, but such right has not been implemented in national legislation (a tax exemption is provided), national legislation shall apply….

When interpreting conventions for the avoidance of double taxation, the general rules of interpretation established by international treaties and the legislation of the Republic of Kazakhstan shall apply, provided that such rules of interpretation comply with the provisions of the Vienna Convention on the Law of Treaties, to which the Republic of Kazakhstan acceded pursuant to a Resolution of the Supreme Council….

The resolution of the issue of conducting tax control in the event that a claim for the liquidation of a legal entity (or recognition of its registration (re-registration) as invalid) is satisfied falls within the competence of the tax authority. Only upon the adoption of measures provided for by tax legislation may the rights and legitimate interests of counterparties be affected; such counterparties are entitled to protect their rights and legitimate interests by challenging decisions, actions, or omissions of the tax authorities….

The courts are to be clarified that, pursuant to subparagraph 3) of paragraph 2 of Article 49 of the Civil Code, courts may order the liquidation of a legal entity where the legal entity is absent at its location or actual address, as well as where its founders (participants) and officials, without whom the legal entity cannot function, have been absent for one year.

The absence, in aggregate, of the above-mentioned circumstances constitutes grounds for dismissing the claimant’s request, since tax authorities have other means of responding….

State re-registration of a legal entity constitutes an administrative act of the registration authority; therefore, a claim seeking recognition of such re-registration as invalid shall be considered in administrative proceedings….

The courts should take into account that, as of 1 January 2020, participants in tax legal relations, when taking actions during the current tax period in respect of previous tax periods, may not apply the repealed provision of the Tax Code establishing a five-year limitation period, since under the current provision of the Tax Code such period is three years, unless otherwise provided by the Tax Code.

Tax authorities are not entitled to bring claims against a taxpayer and/or tax agent after the expiry of the limitation period. At the same time, the Tax Code does not limit the calculation of penalties by the limitation period….

The general limitation period, taking into account its suspension during a tax audit concerning transfer pricing, may not exceed seven years.

When suspending an audit on the above-mentioned matters, the tax authority must comply with the requirements of Article 8 of the Law of the Republic of Kazakhstan No. 67-IV dated 5 July 2008 “On Transfer Pricing”.

The running of the limitation period may be suspended upon the submission of a request, which must meet the following requirements:

• be addressed to the competent authority (organization) of the state;
• be individualized and drawn up in respect of the taxpayer being audited;
• be submitted in relation to matters falling within the scope of the audit.

The courts should take into account that, where a request does not comply with the above requirements, such request shall not be deemed to have been duly submitted….

With respect to tax claims for the payment of taxes and other payments to the budget calculated and assessed by the state revenue authorities and presented to taxpayers for payment within the applicable limitation periods, the expiry of the limitation period does not terminate the tax obligation that has arisen and does not release the taxpayer from its performance….

A distinction must be made between the right of a tax authority to assess or revise the calculated or assessed amount of taxes and other mandatory payments to the budget and the right of a taxpayer to demand the offset and/or refund of taxes and budget payments, as well as penalties. Thus, when exercising a taxpayer’s right to a refund of taxes from the budget, the tax authority does not assess or revise the calculated amount of taxes; rather, it confirms or refuses to confirm the refund of taxes from the budget.

In this regard, with respect to the taxpayers’ right to demand the offset and/or refund of taxes and budget payments and penalties, when calculating the limitation period, the date of receipt (registration) by the tax authority of the tax application provided for by subparagraph 1) of paragraph 4 of Article 101 of the Tax Code, or the claim for the refund of the excess VAT amount provided for by subparagraph 2) of paragraph 1 of Article 431 of the Tax Code, rather than the date of issuance of the decision based on the results of the tax audit, including the notice on the results of the tax audit, should be taken into account….

If the claimant has paid the state duty using an incorrect budget classification code or has paid it in an insufficient amount, pursuant to part four of Article 138 of the Administrative Procedural and Process-Related Code of the Republic of Kazakhstan (hereinafter, the “APPC”), the judge shall point out these deficiencies to the claimant and establish a time limit for their rectification….

Where a taxpayer submits, within the period established by the Tax Code, an explanation regarding identified violations that are not specified in paragraph 3 of Article 96 of the Tax Code and that meets the requirements of subparagraph 2) of paragraph 2 of Article 96 of the Tax Code, such submission shall be deemed compliance with the notice to remedy violations identified by the tax authorities as a result of desk audit and shall not require an examination of the merits of the justification for such violations.

Pursuant to part two of Article 135 of the APPC (claim for recognition), the claimant may also request recognition as unlawful of a burdensome administrative act that no longer has legal force. Accordingly, claims challenging a notice based on the results of a desk audit that has already been complied with are subject to judicial review.

A claim challenging a notice based on the results of a desk audit shall be considered in administrative proceedings.

When considering claims challenging notices to remedy violations provided for by subparagraphs 2) and 3) of paragraph 3 of Article 96 of the Tax Code and identified by tax authorities as a result of a desk audit, the court must assess and examine the evidence submitted by the taxpayer confirming the actual receipt of goods, works, or services specifically from the legal entity and/or individual entrepreneur whose registration (re-registration) has been declared invalid by a court judgment that has entered into legal force, in accordance with paragraph 5 of Article 96 of the Tax Code.

In all other cases, it is sufficient for the court to establish whether the tax authority had the statutory grounds for issuing the notice, without examining the merits of the requirements contained therein. Otherwise, the results of future tax audits, including an unscheduled thematic audit concerning failure to comply with a notice based on the results of a desk audit, would be predetermined.

The tax authority is entitled to issue a decision recognizing a notice as not complied with, including in cases where:

• the taxpayer is not required to submit an explanation (paragraph 3 of Article 96 of the Tax Code) and the violations have not been remedied;
• the deadline established by the Tax Code for submitting an explanation or filing a complaint against a notice based on the results of a desk audit has expired and the violations have not been remedied;
• by a court judgment that has entered into legal force, the taxpayer’s claim for recognition as unlawful of a notice issued pursuant to paragraph 3 of Article 96 of the Tax Code has been dismissed, and the violations have not been remedied.

A complaint (claim) against a decision recognizing a notice as not complied with may be filed by the taxpayer within ten business days from the date of its delivery (receipt) with a higher tax authority and/or the authorized body or with the court.

The right to choose the authority to which the complaint (claim) may be submitted belongs to the taxpayer….

At the same time, it should be borne in mind that, pursuant to paragraph 3 of Article 117 of the Tax Code, penalties are not accrued on tax arrears in respect of property tax, land tax, and vehicle tax payable by individuals, where such arrears arose as a result of the tax authorities’ revision of the calculated tax amounts after the tax payment deadline for the relevant tax period had expired….

At all stages of challenging actions and acts of tax authorities by claimants, the court should consider the possibility of reconciliation between the parties and the possibility of resolving the dispute independently by the tax authority (for example, making amendments to information systems in the event of technical errors, changing the status of desk-audit notices to “complied with,” and so forth) where the tax authority has administrative discretion….

Pursuant to part six of Article 98 of the APPC, a complaint may not be decided to the detriment of the applicant. Since a thematic audit under Article 186 of the Tax Code is ordered in the course of consideration of a complaint filed by a taxpayer (tax agent), the authorized body may not, based on the results of such audit, issue a decision assessing additional amounts of taxes, other mandatory payments to the budget, or penalties that were not assessed in the contested notice.

A decision of a higher authority (authorized body) adopted following consideration of a complaint against a notice on the results of a tax audit may not be challenged in court as such decision does not entail legal consequences. Where the notice on the results of the tax audit is upheld without amendment through the administrative procedure, the said notice may be challenged in court; where the notice is annulled in part, the notice concerning the outcome of the consideration of the complaint against the notice on the results of the audit may be challenged.

Pursuant to Article 148 of the Tax Code, a prescription constitutes the basis for conducting a tax audit.

As an act ordering a tax audit, a prescription may be subject to judicial challenge, since it is issued in the exercise of the tax authority’s public powers and entails legal consequences for the taxpayer (tax agent)….

Unscheduled audits may not be ordered or conducted in the absence of the grounds listed in paragraph 3 of Article 145 of the Tax Code and paragraph 3 of Article 144 of the Entrepreneurial Code. Such audits are subject to being declared invalid, and the acts ordering them are subject to being recognized as unlawful and annulled pursuant to paragraph 1 and subparagraph 1) of paragraph 2 of Article 156 of the Entrepreneurial Code, as having been issued in the absence of grounds for conducting the audit.

Based on the provisions of Article 159 of the Tax Code, under which the decision based on the results of a tax audit is the notice issued by the tax authority on the results of the tax audit, where a taxpayer (tax agent) disagrees with the amounts of taxes and other mandatory payments to the budget assessed, obligations concerning the calculation, withholding, and remittance of mandatory pension contributions, mandatory occupational pension contributions, the calculation and payment of social contributions and/or contributions to compulsory social health insurance, and penalties, the reduction of losses, the non-confirmation for refund of excess VAT amounts and/or corporate (individual) income tax withheld at the source of payment from the income of non-residents, only the notice is subject to judicial challenge. The court examines the legality of the assessment of the contested amounts, taking into account the findings set out in the tax audit report.

A tax audit report may be challenged if the taxpayer disagrees with its findings that did not result in the consequences described above but nevertheless affect the taxpayer’s rights and obligations, including in future tax periods. The audit report shall be challenged in accordance with the procedure established by the legislation of the Republic of Kazakhstan for challenging actions of officials of tax authorities.

Compliance with a notice on the results of a tax audit does not deprive the taxpayer of the right to challenge the notice that has already been complied with, in accordance with the procedure and within the time limits provided for by the Tax Code.

The content of a tax audit report must comply with the requirements of paragraph 1 of Article 158 of the Tax Code. The conclusions of the tax authority regarding violations of the tax and other legislation of the Republic of Kazakhstan committed by the taxpayer (tax agent) must be set out with reference to the relevant provisions of the legislation, together with substantiation of the arguments and disclosure of the circumstances evidencing such violations.

Pursuant to part three of Article 129 of the APPC, when considering a claim challenging the results of a tax audit, the tax authority may rely only on the findings and reasoning evidencing a violation by the taxpayer of tax and other legislation that is reflected in the tax audit report….

Pursuant to the principle of certainty of taxation established by Article 6 of the Tax Code, taxes and payments to the budget of the Republic of Kazakhstan must be certain.

Certainty of taxation means establishing in the tax legislation of the Republic of Kazakhstan all grounds and procedures for the emergence, performance, and termination of a taxpayer’s tax obligation, as well as the tax agent’s obligation to calculate, withhold, and remit taxes….

The burden of proving the circumstances that served as the basis for the tax authority’s adoption of the contested act rests with the tax authority….

Taking into account the provisions of Article 128 of the APPC, the tax authority bears the burden of submitting to the court evidence demonstrating the unlawfulness of the taxpayer’s obtaining a tax benefit.

Where a taxpayer challenges a notice on the results of a tax audit or a tax audit report on the grounds that the tax authority violated the procedure and time limits for conducting tax audits established by Paragraph 2 of Chapter 18 of the Tax Code, the court should assess the nature of the violations committed and their effect on the legality and validity of the audit results. In particular, the results of an audit conducted without a prescription, which pursuant to Article 148 of the Tax Code constitutes the basis for conducting a tax audit, or on the basis of a prescription subsequently declared unlawful, shall be recognized as unlawful.

The same consequences arise where, in violation of paragraph 1 of Article 146 of the Entrepreneurial Code, a prescription to conduct a tax audit, except for a cross-check, was not registered with the authorized body in the field of legal statistics and special records.

Abbreviations

APPC – Administrative Procedural and Process-Related Code

CPC – Civil Procedure Code

Tax Code – Code of the Republic of Kazakhstan “On Taxes and Other Mandatory Payments to the Budget”

DSR, Department – Department of State Revenues

USR, Directorate – Directorate of State Revenues

CC – Criminal Code

CPCr – Criminal Procedure Code

CIT – Corporate Income Tax

VAT – Value Added Tax

Attention!   

       Law and Law Law Law draws your attention to the fact that this document is basic and does not always meet the requirements of a particular situation. Our lawyers are ready to assist you in legal advice, drawing up any legal document suitable for your situation.  

 For more information,  please contact a Lawyer / Attorney by phone: +7 (708) 971-78-58; +7 (700) 978 5755, +7 (700) 978 5085. 

Attorney at Law Almaty Lawyer Legal Services Legal Advice Civil Criminal Administrative Cases Disputes Protection Arbitration Law Firm Kazakhstan Law Office  Court Cases