Interaction with the tax authorities is an essential part of business operations in Russia. Our survey results from this year and previous years show that businesses should consider it a given that they will ultimately have tax disputes with the authorities and, therefore, they should be prepared to manage them.
Almost 72% of the survey respondents reported having disputes with the tax authorities in 2008, 62% of which were taken to court. Of those cases which went to judgment, 89% were settled in the taxpayer’s favor.
The continued high success rate clearly indicates solid support of taxpayers by the court system. However, this year the percentage of respondents with tax disputes increased to almost 72%, up from 56% last year, indicating that the tax authorities are more aggressively auditing companies’ compliance with tax law. This would also seem to reflect their efforts to maintain tax revenue in a period of falling corporate earnings.
Impact on investment
Our 2009 survey shows that respondents consider that the tax regime has either a neutral or negative impact on the investment environment in Russia. This view does not seem to have been significantly affected by the reduction in corporate profit tax rate from 24% to 20% which was introduced in the legislation starting in 2009.
Non-Russian multinational companies consider the tax regime to have a negative (52% of respondents for negative and 41% of respondents for neutral) impact on investment in Russia , while most Russiabased companies consider its impact to be neutral (52% for neutral impact and 36% for negative).
Improvements in the tax regime
One of the most important changes noted through the survey is the improvement in the VAT refund process, both in tax legislation and its practical implementation. A significant number of respondents indicated that the VAT refund period decreased significantly to three or four months, while last year it took up to twelve months to receive a VAT reimbursement.
Respondents also indicated a slight improvement in relationships with the tax authorities. This year the majority of respondents said they had either neutral or even positive relationships with the tax authorities. Additionally, respondents’ perceptions of the performance of the tax authorities continue to increase marginally in the areas of consistency, objectivity and integrity.
Further, respondents noted improvement in transfer pricing tax legislation and the application of double-tax treaties, as well as deductibility of business expenses.
The 2009 survey results showed that further improvements are required in Russian tax legislation and administration, as well as the tax authorities’ inconsistency in application of the tax law and code of ethics. Additionally, the weakest area of the Russian court system is considered to be its perceived lack of independence.
We hope that our survey will be interesting and useful for you.
Tax audits and disputes in Russia
Over the past five years, Ernst & Young in Russia has collected hundreds of survey responses from Russian and non-Russian multinational companies representing many regions and industries. Looking back, we can see how the taxation system and relations between the tax authorities and companies have been evolving. The results of the 2009 survey are outlined below in order to convey a summary of the taxation issues in Russia today.
The 2009 tax survey showed a continued trend toward a decreasing number of onsite tax audits performed once per year. According to respondents’ comments, the tax authorities tend to perform onsite tax audits once every two or three years. This represents a positive trend for Russian business, since field tax audits can be disruptive for both the company’s operations and management.
Interestingly, our respondents reported that the tax authorities sometimes invite taxpayers for a discussion of tax matters outside the formal audit process. Based on our respondents’ comments, the tax authorities most often initiate these informal discussions around matters such as profits tax issues (35% of respondents) and VAT issues (35%).
The 2009 tax survey results showed a decrease in the number of informal meetings with the tax authorities compared with the prior year’s data, reflecting a reduction in invitations for informal discussions of tax matters with the tax authorities.
We asked our survey respondents to provide their comments with respect to the areas on which the tax authorities focus during tax audits. Respondents indicated that the tax authorities focus, in particular, on the following key areas:
- Deviation of production and financial figures of the taxpayer over time
- Activities of the taxpayer’s counterparties
- Deviation of production and financial figures of the taxpayer from industryaverages
- Tax issues specific to the taxpayer’s industry or business.
This year’s tax survey results showed a notable increase in the share of companies involved in tax disputes with the tax authorities during 2008. Almost 72% of our respondents had tax disputes with the tax authorities in 2008, up from 56% the previous year.
Share of companies involved in tax disputes with the authorities during 2008
Similarly to last year’s survey results, over half of respondents with tax disputes (62%) had tax disputes taken to court during 2008 (65% in 2007). This slight decrease may reflect a temporary trend in light of the overall increasing number of companies involved in tax disputes with the authorities (up from 56% in 2007 to 72% in 2008). We would expect to see a further increase in litigation next year.
In conducting our 2009 tax survey, we were provided with information on 95 court cases in 2008 by respondents. Similarly to prior years, the majority of those court cases related to VAT (48%) and profits tax matters (41%). It is interesting that notably more profits tax disputes were taken to court than in previous years (30% in 2007 and 2006).
Other less commonly disputed tax matters are payroll and social taxes, withholding taxes, and water and mineral extraction taxes; these comprise only 11% in 2008.
This year’s survey results showed that, similarly to prior years, the majority of court cases (73%) described by respondents involved disputed amounts in excess of US$1 million.
A significant number of respondents indicated that litigation took more than half a year (47%) or even longer than a year (37%) to resolve the case, while the percentage of fast-track litigation (less than six months) is significantly smaller (14%).
Perception of the tax authoritiesand court system
As in previous years, an ever-growing majority of respondents indicated neutral relationships with the tax authorities.
It is interesting that while most respondents experienced a significant number of tax litigation events during the period under discussion, they still indicated having either a neutral or even positive relationship with the tax authorities.
Perception of the tax authorities
A considerable majority of our respondents (73%) indicated no improvement in the tax authorities’ performance from the previous year. Other respondents indicated a slight deterioration in performance (15%) and only 9% of respondents noted a slight improvement.
Perception of the court system
The majority of respondents (75%) consider that performance of the Russian court system did not improve in 2008. However, many of the remaining respondents (17%) indicated a slight improvement and only 4% reported a slight deterioration in performance. This shows a more favorable disposition to taxpayers by the Russian court system compared to the tax authorities.
We asked respondents to provide specific comments with respect to various areas of the tax authorities’ and court system’s performance. The answers we received have provided interesting and surprising results.
This year’s survey results showed that competence, integrity and objectivity are perceived to be the most developed areas of the Russian tax authorities and court system. However, at the same time, respondents noted that the tax authorities still sometimes have a form-oriented approach when dealing with the taxpayers and need further independence. The court system, in contrast, is perceived to give more emphasis to the substance of transactions and to be more consistent when applying legislative norms.
The weakest area of the Russian tax authorities’ performance is considered to be the inconsistency in the application of law, while the court system is considered to have a lack of independence. In this respect, certain respondents even noted the concern that political factors sometimes dictate the tax authorities’ actions and court rulings.
Russia’s tax legislation and administration
Although the tax regime in Russia is considered to have improved significantly over the past several years, companies continue to encounter difficulties with Russian tax legislation and administration. Our survey focuses on identifying these problems and measuring any significant changes from previous years’ benchmark surveys.
This year’s survey results indicate that deductibility of expenses, economic justification of expenses and transfer pricing remain the weakest and most often discussed areas of current Russian tax legislation. Although certain improvements were made during the last year, respondents believe these issues still need further development.
Further, while the situation with VAT taxation seems to have improved this year, the VAT legislation is still rated as not higher than average.
Overall, the perception of tax administration is similar to the tax legislation’s rating – deductibility of expenses, application of transfer pricing rules and VAT taxation are the most underdeveloped areas.
In addition, the handling of taxpayers’ complaints is considered to be the weakest area of the current tax administration.
Administration of VAT
Similarly to the prior years’ survey results, in 2008 VAT administration remained one of the hottest issues in Russia’s tax administration. Respondents criticize the complicated procedures required for recovering input VAT.
Just over half of respondents (53%) have VAT refund period recoverable VAT; almost half of these (22% of all respondents) have recoverable VAT on exports. The majority of these taxpayers (75%) have recoverable VAT in excess of RUB 1 million per annum.
This year’s survey showed a significant decrease in the VAT refund period, with 15% of respondents receiving a VAT refund in less than three months — most likely thanks to the introduction of corresponding amendments to the Tax Code from 2008. Those changes relate, in particular, to a reduction in the number of tax returns due to the change in the tax period for VAT from a month to a quarter for all VAT taxpayers; an end of the transition period for VAT taxpayers; and the change in the mechanism of offset of overpaid taxes. Nevertheless, the majority of respondents obtain a VAT refund in three to six months (63% in three to four months; 11% in four to six months).
The most positive trend is that the majority of respondents (67%) recover 90% or more of their input VAT. This is a slight decrease from last year’s results, where 70% of respondents reported recovering 90% or more of their input VAT.
Impact of Russia’s tax regimeon investment
Generally, Russia is considered to have significant market potential and be attractive to investors. However, the tax regime may affect the amount and frequency of investments in Russia.
The survey results indicate that Impact of tax regime on investments in Russia the respondents are still concerned with whether the current tax regime encourages investments in Russia. The number of Russian and multinational respondents expressing a neutral opinion has increased this year to 46%.
The opinion of Russian companies regarding the current tax regime’s impact on investment in Russia follows a similar trend. As in previous years, Russian respondents believe that Russia’s tax regime has a less negative impact on investments in Russia each year, but the assessment is still more neutral than positive.
Meanwhile, a significant number of their multinational counterparts are still concerned with the tax regime in Russia and mostly believe it has a more negative than neutral impact on investments in Russia.
Views on how to improve Russia’s tax regime
Below we provide respondents’ views from our 2008–2009 surveys regarding the primary measures that should be undertaken by the state authorities to improve the Russian taxation system.
The majority of respondents (89%) consider Russia’s tax laws to be ambiguous. Regrettably, multiple amendments and explanatory letters intended to clarify the rules often make them more complicated and confusing. These gray areas in the legislation are often the source of tax disputes.
Companies working in Russia today incur significant costs in relation to tax administration due to, in particular, the higher need for external consultants and expert advice on complex taxation problems, the greater number of skilled accountants and legal specialists required to maintain relevant supporting documentation and, of course, the time- and resource-consuming litigation process. Another basis for frequent tax disputes is ambiguity in transfer pricing legislation.
Similarly to previous years, a significant number of respondents consistently highlight that Russia’s tax administration needs to be improved.
One of the leading matters for discussion is simplification of documentation requirements. This year’s survey showed an increase in the number of respondents (from 65% in 2008 to 72% in 2009) concerned with simplification of documentation requirements.
Another area for tax administration improvement noted by our respondents is the critical need to significantly develop tax inspectors’ professional skills. Currently, tax inspectors are very form-over-substance oriented, often leading to multiple tax disputes and subsequent tax-related litigation.
Respondents also consider that phone and online help centers should be established to assist taxpayers and respond to requests for information.
A significant number of our respondents (65%) call for simplification of Russian tax accounting. One of the primary concerns is the cancellation of limits for certain types of expenses or even allowance of more deductible expenses. Currently, Russian tax legislation provides a rather long list of limited and/or non-deductible expenses. Such limitations are considered outdated and thus unreasonable.
This year’s survey showed that a still significant number of respondents consider VAT to be a problematic area of Russia’s tax legislation and administration. Although new legislation has introduced certain amendments related to VAT refund, further improvements in this area are needed. Specifically, respondents indicated they would like to see:
- Clearer and simpler rules on VAT calculation
- A reduction in documentation requirements (e.g., on zero-rated items and export VAT)
- Simpler procedures for recovering input VAT
- Minimal delays on tax refunds.
In addition, in order to enhance transparency and ensure consistency, respondents indicated that the authorities should officially publish a full list of conditions and reasons for which a VAT refund can be denied and should not be allowed to deny refunds on any other grounds.
Tax rate reduction
One of the most notable changes in respondents’ opinions on improving Russia’s tax regime relates to the reduction of the VAT rate.
Over 40% of respondents said the VAT rate should be reduced. Last year only 26% of respondents considered that a decrease in the VAT rate was required. This significant change in views could be due to the expectation by many taxpayers last year that the VAT rate would be reduced; however, the initiative on VAT rate reduction was postponed indefinitely by the government.
Respondents remarked that, if a reduced VAT rate were to become uniform for all kinds of goods — even for those that are currently taxed at the 10% rate — such a reduction would improve the transparency and effectiveness of tax administration.
Interestingly, the reduction of the corporate tax rate, which was reduced from 24% to 20%, is considered to be one of the least significant factors in improving the tax regime (only 13% of this year’s respondents noted that it should be further reduced). This may reflect a view that the reduced profits tax rate is considered to be relatively reasonable.
Below are some of the other recommendationsput forward by respondents.
Since last year’s survey, a notably lower but still significant number of respondents reported an urgent need for greater oversight of tax authorities’ activities and their compliance with the law. It is considered that the law should be binding for both the tax authorities and taxpayers; otherwise, there will inevitably be an abuse of power and an adverse effect on the overall business climate.
Enhanced control over the tax authorities and increased accountability for the decisions of individual officers will, according to respondents, improve the current situation.
This year’s survey results showed that certain improvements need to be made to reduce political influence on the tax authorities’ decisions. Many respondents specifically mention that politics remains an important driver in resolving taxation disputes.
Respondents remarked that the Russian government should establish a more independent, consistent and transparent court system.
To improve the tax climate, tax authorities should attract better qualified, professional, and objective tax inspectors. In order to maintain credibility, tax offices need to train their personnel to maintain higher ethical standards and discourage tax inspectors from abusing their authority.
Additionally, some respondents noted the necessity of streamlining dispute resolution either by mutual agreements or through the introduction of independent mediators.
Tax functions of companies in Russia
Companies operating in Russia face increased attention to taxation matters not only as a result of expanding operations, but also due to the ambiguity of tax legislation and scrutiny of tax inspectors. It has become important for companies to ensure there is an adequate tax function and processing in place to handle taxation matters.
Respondents described their tax function’s organization and explained changes made over the last year. We compared these results with results from previous years and tried to understand their nature.
Organization of tax functions
According to respondents’ comments, taxation issues are usually handled by dedicated tax (55%) or financial and accounting (49%) departments.
Our respondents showed interesting changes in internal taxation handling. In contrast to prior years, respondents noted an increase in the use of dedicated tax departments (from 40% in 2008 to 55% in 2009) as well as external tax consultants (from 23% in 2008 to 36% in 2009) for handling and monitoring taxation issues.
Our survey results for 2007–2009 showed a notable increase in the number of employees in dedicated tax departments. According to this year’s survey, 31% of companies working in Russia have from five to ten employees and 27% have from eleven to twenty. Other companies (27%) mostly have fewer than five employees.
Just over half of respondents (56%) noted that their tax function (including dedicated in-house tax department and tax specialists in the financial and accounting departments) deals with matters related to up to five entities of the group, while only 17% indicated that their tax specialists are involved in tax issues of 26-50 entities and 12% in over 50 units.
Thirty-three percent of respondents provided information on their annual tax administration budget and turnover. A strong majority (83%) of them indicate they have a current tax year budget of more than RUB 1 million.
Respondents who handle tax matters using both an in-house tax department and external consultants split their tax administration budget (on average) as follows:
60% — remuneration costs relating to in-house tax personnel
40% — external tax consulting costs.
The proportion of renumeration for in-house tax personnel continues to be higher than spending on external tax consultants, maintaining a trend our respondents have noted in previous years.
Focus of tax function
This year’s survey results indicate that companies in Russia are spending much more time on routine and administrative tasks (such as tax accounting and reporting, audits and litigation), leaving less time for tax planning.
This is a symptom of the problems in Russia’s tax regime — ambiguity in tax legislation, complex tax accounting, excessive documentation requirements, inefficient tax administration, repeated tax audits and unwarranted tax disputes.
Performance measurement criteria
Companies operating in Russia use a wide range of criteria to measure the tax function’s performance. No significant changes since last year were noted in the most widely used criteria: correctness and timeliness of day-to-day work, as well as cooperation with the tax authorities and senior management, are the most important performance measurement criteria used by many Russian companies. This year’s results also showed a rather high importance given to internal controls and business processes in tax function effectiveness.
Success in onsite audits and tax litigation
Tax disputes consume a considerable amount of time for companies operating in Russia. It is therefore important that the company’s tax function is able to resolve any disputes directly with the authorities without having to go to court or manage and support the litigation process internally.
Confirming this, the majority of respondents (85%) indicated success in dealing with tax audits and tax litigation as one of the key criteria for their tax function’s performance evaluation.
Compliance with the legislation
Other widely used criteria for tax function performance measurement are the correctness of tax calculation and timeliness of tax reporting (85% of respondents) as well as the correctness of data in financial statements and disclosures (57% of respondents). This represents routine, day-to-day work.
The complexity of Russian tax accounting, exemplified by the multiple differences between Russian statutory accounting, international standards and/or special rules established for taxation purposes only, is perhaps the main reason that excellence in day-to-day operations continues to be a more common performance measurement criterion for tax functions in Russia than in other countries. This supports our general observation that Russian tax functions continue to be more focused on the compliance and reporting part of the tax lifecycle rather than on tax planning.
Tax risk management
Timeliness of identification of tax risks of certain transactions (79% of respondents) and reporting on tax risks to senior management or to the Board (66% of respondents) are other very important criteria for measurement of the tax function’s performance.
Companies in Russia are increasingly emphasizing tax risk management and analysis to protect themselves from potential penalties, sanctions and back tax claims.
Internal processes and controls
Interestingly, this year we noted that many companies are giving greater attention to internal controls and tax-related business processes. Sixty percent of our respondents noted that effectiveness of tax-related business processes and controls is no less important than other areas of tax function performance. This shows that companies are starting to pay more attention to building effective internal tax processes and internal controls.
Cash flow impact
In Russia, companies can face long delays in recovering input VAT. According to our respondents, tax functions are often evaluated on their ability to obtain timely refunds from the tax authorities. However, this particular issue seems not to carry the emphasis that it does for companies abroad. Perhaps this is because obtaining a refund quickly is often not within the control of tax functions of companies operating in Russia. This year’s rated importance of the cash flow impact as a performance measure (45%) did not change significantly from last year.
Among other criteria used to evaluate tax function performance, respondents also noted the effective tax rate, amount of tax reserves accrued, tax efficiency of operations, reconciliation with the tax authorities and effectiveness of cross-tax audits. However, these criteria are isolated cases and are not widely used in Russia.
Tax risk factors
We asked our survey respondents to list the internal and external factors which contribute to the tax risk of an organization.
Changes in legislation
Similarly to previous years, unclear tax legislation and changes in tax law and its interpretation by the tax authorities were noted as the major challenges for the tax functions of companies operating in Russia.
Russia’s tax legislation is still undergoing reform. Tax personnel and accountants spend a significant amount of time keeping up with amendments to tax laws.
However, this year our respondents also noted ambiguity and underdeveloped regulatory requirements of industry legislation as one of the key areas presenting a tax risk for business.
Organizational and business changes
Businesses in Russia are growing rapidly — organically, as well as via mergers and acquisitions. This leads to an increased tax risk that must be addressed by the companies’ tax functions.
Respondents’ main concerns in this area include changes in business operations without the necessary assessment of their tax consequences (22%), failure to consult tax specialists on key decisions, and inconsistency in implementation of tax policies and decisions (10%).
Major challenges in the future
For the last several years, the tax system and tax regime in Russia have been undergoing development and change.We asked our respondents what challenges they expect to face in the future.
This year’s survey showed a dramatic increase in the number of respondents concerned about improving the taxlegislation. In contrast to previous years, in 2009 respondents said that the major challenge for the future is the changes in tax legislation and its interpretation by the tax authorities.
Due to extensive documentation requirements, the taxpayer must constantly submit enormous amounts of documentation support to the tax authorities. Going forward, respondents consider the ever-growing documentation requirements to be another major challenge for tax functions of businesses operating in Russia.
Changes in business
Changes in business and their tax implications constitute a major concern for the present as well as the future. This may be due in part to the global downturn, which has pushed back plans for rapid expansion and growth of businesses in Russia at least several years into the future.
Disclosure and transparency requirements
In contrast to previous years, a significant share of respondents this year (35%) highlighted requirements for transparency and disclosure to tax authorities and other regulatory authorities as one of the future challenges. In previous years this number did not exceed even the 10% threshold. This may be related to the amendments to the transfer pricing law, as well as other legislative amendments now under discussion which would require disclosure of information on certain types of transactions.
Finding skilled personnel
In last year’s survey, over half of respondents (53%) expected that, in the future, staffing the tax department would be one of the main challenges for companies operating in Russia. However, this year the number of respondents expressing concern on this issue has fallen significantly, and only 24% of respondents expect difficulty hiring or retaining personnel with the necessary skills and knowledge to handle taxation issues. This decrease in concern might be due to companies slowing the expansion of their business and/or investment activities in Russia — endeavors requiring significant involvement of tax specialists.
Management of tax functions in foreign markets
There was a notable reduction this year in the number of respondents (11% vs. 40% tax function outside Russia would be one of the challenges for the future. Again, this may be due to the global financial crisis, which has sharply curtailed activities related to business expansion.
It is interesting to note that respondents do not rate the tax function’s influence on executive business decisions and opinion of the media, institutional investors, and analysts among top challenges for the future.
Profile of survey respondents
In June 2009, Ernst & Young invited some of the largest companies operating in Russia to participate in our 2009 tax survey. We received 55 completed questionnaires from companies operating in a variety of industries.
The charts below illustrate the profile of our 2009 tax survey respondents by country of origin, industry, annual turnover for 2008 and type of international accounting standards applied.
A significant portion of our respondents represent public companies, i.e., the shares and/or bonds issued by the responding company are quoted publicly.
Most of our survey respondents had annual turnovers in 2008 exceeding RUB 1 billion; 25% had turnovers over RUB 10 billion and 9% topped RUB 100 billion.
Because many of our respondents are international public companies, they must prepare financial reporting to international standards. In our survey, we noted that a major portion of respondents prepare financial statements in accordance with IFRS (65%) and US GAAP (29%).
Ernst & Young —our tax and legal expertise
Ernst & Young’s Tax Policy and Controversy group provides support to businesses in tax disputes with the authorities. This group has represented clients before Russian arbitration courts of all levels, including the Supreme Arbitration Court of the Russian Federation and the International Commercial Arbitration Court of the Chamber of Commerce and Industry of the Russian Federation.
Our tax and legal professionals have gained extensive experience representing our clients in disputes with tax, customs, and antimonopoly authorities on a wide range of issues. In the tax sphere, the most frequently encountered issues include off set of input VAT related to export and domestic sales, VAT and other tax refunds, deductibility of various business expenses, and unified social tax on various types of employee compensation.
Ernst & Young is a world leader in providing tax and legal advice. Our global team of professionals has extensive experience in a wide range of projects, from multijurisdiction tax restructuring to domestic corporate and individual tax consulting and compliance.