Tax disputes on recognition as illegal and cancellation of notification of the results of consideration of a taxpayer's (tax agent's) complaint

"K" LLP (hereinafter referred to as the Partnership) filed a lawsuit with the State State Revenue Agency for the City of Almaty (hereinafter referred to as the Department, the tax authority) to declare illegal and cancel the notification of the results of consideration of the complaint of the taxpayer (tax agent) to the notification of the results of the audit and the decision of the higher state revenue authority issued based on the results of consideration of the complaint against Notification No. 834/1 dated July 16, 2019 (hereinafter referred to as Notification No. 834/1). By the decision of the specialized interdistrict Economic Court of Almaty dated October 18, 2019, the Partnership's application was partially satisfied. Notification No. 834/1 regarding the accrual of value–added tax on goods produced, works performed, and services rendered in the territory of the Republic of Kazakhstan (hereinafter referred to as VAT) in the amount of KZT 19,204,515 and in terms of reducing losses in the amount of KZT 577,923,540 was declared illegal and canceled. The rest of the application was refused. The state fee in the amount of 192,045 tenge was refunded to the Partnership. By the decision of the Judicial Board for Civil Cases of the Almaty City Court dated January 29, 2020, the court's decision was changed. Regarding the satisfaction of the Partnership's application, the decision was overturned with a new decision on the refusal to satisfy the application. The rest of the court's decision remains unchanged. The Judicial Board for Civil Cases of the Supreme Court changed the decision of the court of first instance and overturned the decision of the appellate instance. The court's decision regarding the refusal to satisfy the application of "K" LLP to the State Revenue Agency "Department of State Revenue for the City of Almaty" was canceled and a new decision was made in this part to satisfy the application. The notification of the results of consideration of the taxpayer's (tax agent's) complaint against the notification of the audit results and the decision of the higher state revenue authority issued based on the results of consideration of the complaint against the notification dated July 16, 2019 No. 834/1 in full on the following grounds was declared illegal and canceled. It follows from the case file that the Department, based on the order of August 8, 2018 No. 834, conducted a thematic tax audit of the Partnership on the correctness of calculation and timely payment of certain types of taxes to the budget: corporate income tax (hereinafter – CIT) and VAT for the period from January 1, 2013 to December 31, 2017.

Tax disputes on recognition as illegal and cancellation of notification of the results of consideration of a taxpayer's (tax agent's) complaint

Based on the results of the audit on April 10, 2019, an act was drawn up and notification No. 834 was sent to the Partnership. The Partnership filed a complaint against notification No. 834 with the Ministry of Finance of the Republic of Kazakhstan, whose decision, based on the results of consideration of the complaint dated July 16, 2019, cancelled notification No. 834 regarding VAT accrual. In connection with this Department, notification No. 834/1 was issued to the Partnership on July 16, 2019, which added VAT in the amount of 165,265,668 tenge and established the amount of reduced loss in the amount of 2,136,224,575 tenge. The following circumstances served as the basis for calculating the specified amount of VAT and reducing the Partnership's loss by the tax authority. Since October 2009, the Partnership has carried out capital investments in the deployment of a network based on WiMAX technology by installing base stations in order to launch a commercial network providing digital television and Internet access in the Republic of Kazakhstan. By January 1, 2013, the Partnership had acquired and installed 711 base stations in 28 cities of the Republic of Kazakhstan. When purchasing equipment for the construction and installation of base stations, as well as related services, the Partnership included the corresponding VAT amounts. It was found that out of 711 base stations, 370 stations were connected to the Internet, and 341 were not in operation due to lack of Internet connection due to lack of prospects and subscriber base. Since a number of the base stations put into operation were not used for taxable turnover purposes, and subsequently the Partnership partially dismantled and disposed of the base stations, the taxpayer adjusted the VAT and the depreciation of fixed assets was recognized in accounting. When calculating the amount of VAT and reducing losses, the tax authority proceeded from the requirements of subitems 1) and 2) of paragraph 1 of Article 256 of the Code of the Republic of Kazakhstan dated December 10, 2008 "On Taxes and Other Mandatory Payments to the Budget (Tax Code)", in force at the time of the Partnership's tax obligations, according to which, when determining the amount of tax, subject to a contribution to the budget, the recipient of goods, works, and services has the right to set off the amounts of value-added tax payable for the goods received, including fixed assets, intangible and biological assets., investments in real estate, works and services, if they are used or will be used for the purposes of taxable turnover, as well as if the following conditions are met: the recipient of the goods, works and services is a value-added tax payer in accordance with subparagraph 1) paragraph 1 of Article 228 of this Code; a supplier who is a payer of value-added tax has issued an invoice or other document provided in accordance with paragraph 2 of this Article for goods, works, and services sold in the territory of the Republic of Kazakhstan as of the date of the invoice.

According to paragraphs 1 and 3 of Article 100 of the Tax Code, a taxpayer's expenses in connection with carrying out activities aimed at generating income are deductible when determining taxable income, with the exception of expenses that are not deductible in accordance with this Code. Deductions are made by the taxpayer in the presence of documents confirming expenses related to his activities aimed at generating income. Paragraph 1 of Article 115 of the Tax Code establishes that expenses not related to income-generating activities are not deductiblerding to paragraphs 1 and 3 of Article 100 of the Tax Code, a taxpayer's expenses in connection with carrying out activities aimed at generating income are deductible when determining taxable income, with the exception of expenses that are not deductible in accordance with this Code. Deductions are made by the taxpayer in the presence of documents confirming expenses related to his activities aimed at generating income. Paragraph 1 of Article 115 of the Tax Code establishes that expenses not related to income-generating activities are not deductible. The Partnership of 711 stations did not use 341 stations in income-generating activities, and according to paragraph 1 of Article 117 of the Tax Code, fixed assets are accounted for in groups formed in accordance with the classification established by the authorized state body for technical regulation and metrology, the tax authority recognized as unjustified deduction of acquisition and installation costs. groups of these assets and a decrease in the cost of base stations accounted for in the tax accounting for the corresponding group. The Partnership, disagreeing with the grounds for calculating the amount of VAT and reducing the amount of losses, challenged the notification in court. The Court of First instance, canceling notification No. 834/1 regarding the calculation of VAT in the amount of KZT 19,204,515 and the reduction of losses by KZT 577,923,540, proceeded from the fact that out of 711 stations, 370 stations were installed and used by the Partnership to generate income. The remaining 341 stations were also acquired to carry out income-generating activities. The partnership carried out activities for the purchase and installation of stations, the concluded contracts for the lease of roofs on which the stations were installed have not been disputed, the reliability of the primary accounting documents for these expenses is beyond doubt. Consequently, the tax authority had no grounds to exclude the amount of VAT in the amount of KZT 19,204,515 from offset, as well as to reduce losses in the amount of KZT 578,923,540. Taking into accountng into account that, according to subparagraph 3) of paragraph 2 of Article 87 of the Tax Code, non-depreciable assets include unidentified equipment, the court pointed out that 341 Internet stations not connected to networks were unidentified equipment and therefore the Partnership could not subject them to depreciation. Therefore, the conclusions of the tax authority regarding the additional assessment of the amount of VAT and the reduction of losses on them are justified. The appellate judicial 

Thus, the costs of renting premises (roofs) and placing base stations in accordance with paragraph 1 of Article 115 of the Tax Code are not reasonably attributed by the Department to expenses related to income-generating activities. The arguments of the tax authority about the unjustified attribution by the Partnership in the declarations to fixed assets of the amount of depreciation charges for base stations that were not used in operations aimed at extracting income were recognized by the court of appeal as corresponding to the norms of substantive law. Thus, according to subparagraph 1) of paragraph 1 of Article 116 of the Tax Code, fixed assets include fixed assets, investments in real estate, intangible and biological assets recorded upon receipt in the taxpayer's accounting records in accordance with international financial reporting standards (hereinafter – IFRS) and the requirements of the legislation of the Republic of Kazakhstan on accounting and financial reporting and intended for for use in income-generating activities. The base stations commissioned in 2012 cost 2,559,048.5 thousand. tenge for the period under review from January 1, 2013 to December 31, 2017 were not used in income-generating activities, therefore, their cost should be excluded from the declarations of the CPN with a reduction in the amount of deductions for accrued depreciation at a rate of 25% in the amount of 1,069,251.9 thousand tenge. The costs of renting roofs where unused stations were located were not subject to attribution by the Partnership to expenses used for taxable turnover, therefore, the tax authority reasonably adjusted the amount of VAT in accordance with paragraph 1 of Article 258 of the Tax Code. The judicial board recognizes the above-mentioned conclusions of the court of first instance regarding the refusal to satisfy the Partnership's application, as well as the conclusions of the court of appeal, as inconsistent with the norms of substantive law and the established circumstances of the case. The nature of the dispute between the Partnership and the tax authority required the courts to establish whether the Partnership had grounds and circumstances that would allow it to deduct VAT and increase losses as a result of the use and subsequent disposal of base stations. The materials of the case established and are not disputed by the parties that the Partnership has installed and commissioned 711 base stations, which is confirmed by the relevant acts of commissioning. Therefore, the board recognizes the conclusions of the court of first instance with reference to subparagraph 3) of paragraph 2 of Article 87 of the Tax Code on the attribution of 341 stations not connected to the Internet to unidentified equipment and the impossibility of their depreciation as contrary to the factual circumstances of the case and the norms of tax legislation.

The appellate judicial Board, recognizing the notification of the tax authority as justified, referred to the norms of subparagraph 1) of paragraph 1) of Article 116 of the Tax Code. Meanwhile, according to paragraph 6 of IAS 16, fixed assets are tangible assets that: (a) are intended for use in the production or supply of goods and services, for leasing or for administrative purposes; (b) are intended to be used for more than one period. The purpose of the stations acquired and installed by the Partnership indicates the purpose of their use to generate income by providing services for a period of more than one year, therefore, they are fixed assets and, by virtue of subparagraph 1) of paragraph 1 of Article 116 of the Tax Code, are classified as fixed assets. The judicial board recognizes the arguments of the tax authority that the base stations do not belong to fixed assets as untenable. Indeed, according to subparagraph 1-1) of paragraph 2 of Article 116 of the Tax Code, fixed assets do not include assets for which depreciation charges are not calculated in accordance with international financial reporting standards and the requirements of the legislation of the Republic of Kazakhstan on accounting and financial reporting. In accordance with paragraph 55 of IAS 16, depreciation of an asset begins when it becomes available for use, that is, when its location and condition allow it to be operated in a manner consistent with management's intentions. Depreciation of an asset ceases on the date when the asset is classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with IFRS 5 or on the date when the asset is derecognized, whichever is earlier. Consequently, depreciation does not cease in the event of an asset's downtime or decommissioning, except in cases when the asset is fully amortized.

However, when using depreciation methods based on output, the amount of depreciation may be zero during the time when there is no production. The implementation by the Partnership of a set of measures allowing the use of all 711 base stations in income-generating activities (purchase of equipment, determination of its location, conclusion of lease agreements for installation, installation and commissioning) indicates that the Partnership reasonably classifies it as fixed assets, the legality of depreciation and, accordingly, the reasonableness of attributing these amounts to deductions and formation of losses. It follows from paragraph 1 of Article 117 that fixed assets in the form of machinery and equipment, with the exception of machinery and equipment for oil and gas production, as well as computers and information processing equipment, are accounted for in group II. According to subparagraph 2) of paragraph 4 of Article 117 of the Tax Code, fixed assets are accounted for in groups II, III and IV in the context of the cost balances of the groups. Assigning a fixed asset to group II means that there is no need for object-by-object accounting for each station after inclusion in the group's cost balance for the purpose of calculating depreciation charges. Therefore, all stations acquired by the Partnership are accounted for in one group and amortised as one group. In this regard, the judicial board finds the conclusions of the appellate judicial board that 341 stations were not used by the Partnership in activities aimed at generating income to be unjustified. In these circumstances, the judicial board recognizes the contested notification dated July 16, 2019 No. 834/1 as subject to cancellation in full, as issued in violation of the requirements of tax legislation.

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