It’s probably impossible to find a company in Russia nowadays that hasn’t undergone a tax audit at least once. It could be a desk audit (in which case the company usually gets off easy with the tax authorities) or worse, it could be a field audit which requires a substantial amount of energy, time, resources, and often, money.
Since desk audits have already become more or less commonplace for a company’s management and accounting department, we should take a moment to examine how a field audit is performed.
When are field audits called for?
Any taxpaying organization may undergo a field audit regardless of when the company was formed. There is a false belief that a field audit can only be done on a company that has existed for at least three years. However, there is no such time period stipulated by law, so a company that has existed for only a year can be subject to such an audit by the tax authorities.
The tax authorities have developed a conceptual system for planning field audits (stipulated by Tax Service Order #MM-3-06/333@ dated 30.05.2007). This Conception lists criteria that allow the taxpayer to self-assess their risk of being subject to a field audit. There are 12 such criteria:
The taxpayer’s tax burden is below the average in their specific field /industry (type of economic activity).
Losses recorded in the accounting or tax records for the last several tax periods.
A significant amount of tax deductions for a certain period are declared.
The growth rate of expenses outpaces the growth rate of income.
The average monthly wages for employees are lower than the average for the industry.
Repeatedly approaching the limit established by Russia’s Tax Code on the size of the figures which give the taxpayer the right to special tax regimes.
Individual entrepreneurs recording expenses very close to the amount of income received for the calendar year.
The business model is based on agreements with middle men without clear economic purpose or other reasons (business goals).
The taxpayer fails to present explanations after being notified by the tax authorities of discrepancies in their performance indicators.
The taxpayer repeatedly registers and deregisters with the tax authorities due to changing locations (“migration” between tax authorities).
Significant deviation between the level of profitability of the company and the statistically normative level of profitability for this sphere of activity.
12. The business is engaged in activities with a high tax risk (Not meeting personally with CEO of business partners; not having a copy of the ID of the CEO and business partners on file; Business partners do not have a real office…).
The Conception indicates that when assessing the above-listed criteria, the tax authorities should look for unjustified tax benefits, including those indicated in Resolution #53 of the Plenum of the Supreme Arbitration Court of the Russian Federation from 12.10.2006 (which basically states that tax benefit should not be the only purpose of the business model).
In practice, a field audit can be initiated based on other reasons: frequent “corrections,” increased revenues with no change in the amount of tax paid, filing for VAT reimbursements, applying tax breaks, etc.
Preparing for a Field Audit
As you can see, a field audit is inevitable for the majority of companies.
What do you need to do to make sure that it is performed with minimal losses?
If the company performs an annual audit to intensively review the accuracy of tax calculations, the risk of significant additional amounts of tax is pretty small. This would also save time preparing for such a tax audit.
On the other hand, if such an audit hasn’t been performed, the company should carefully prepare for the field audit. Here is a list of common issues which need to be addressed when preparing for the audit:
1. Check documentation on tax breaks.
If your company claims tax breaks, you needs to check that all corresponding documents affirm the legality of the breaks and whether the documents are filled out correctly. Checking the accuracy of how tax breaks are applied is one of the tax authorities’ favorite procedures. Even if you successfully pass through the desk audit on this point, that doesn’t mean that these breaks will not be challenged in the field audit. The same can be said about the application of lower tax rates.
2. Check documentation of expenses.
It will be necessary to perform a selective audit of the documentation of the biggest expenses. You also have to check that all documentation of expenses contain all necessary details, stamps, and signatures from both sides. The company also has to have all the original documents. If the documents are in a foreign language, there should be line-by-line translations for each.
3. Check documentation of VAT invoices.
Check the accuracy of all invoices received on which VAT is deducted. Although the tax authorities currently cannot refuse deductions on these invoices if they have minor violations, it is best to correct those especially if there are large sums involved.
4. Check the accuracy of the segmented VAT accounting.
If some of the company’s operations are not subject to VAT (for example, they are tax exempt or the location where the work or services are performed is not within the Russian Federation), the accuracy of the distribution of the “input” VAT should be checked again. Not only does the accuracy of the VAT calculation depends on this, but also for profit tax and property tax, since part of “input” VAT is included in profit tax expenses or is accounted for in the initial cost of fixed assets.
5. Check the deductibility of expenses.
During a tax audit, the tax authorities frequently “disallow” expenses which reduce the profit tax base. Therefore, the taxpayer should re-check the content of such expenses and, if necessary, obtain additional confirmation that these expenses are justified and that the Tax Code covers them as being applied for tax purposes. It is also important to note that if the company reduces its profit tax base by losses from previous years, it should possess all documents confirming the existence of such a loss. These documents include not only tax returns, but also the primary documents.
6. Check the validity of income exclusions from the profit tax base.
Article 251 of the Tax Code contains a list of incomes that are not subject to profit tax (e.g. receipt of gratuitous financing from the parent company). If you have any of these types of income, you are in the zone of risk. These types of income need to be checked again for documentary confirmation and justification for their exclusion form the profit tax base.
7. Check the validity of tax payments from autonomous subdivisions.
If the company has work is geographically spread between work locations, the comapany needs to assess whether they are autonomous subdivisions. If an autonomous subdivision is created, you will need to check the accuracy and completeness of tax payments by all of the autonomous subdivisions. As a rule, we are mainly speaking of profit tax, individual personal income tax, and property tax.
8. Check the accuracy of the unified social tax calculations.
Although the UST was cancelled long ago, don’t forget that the tax authorities can still check this tax until the end of 2012. Therefore, you should refresh your memory on this tax and recheck the accuracy of your UST calculations, especially with regards to foreign employees. Specifically, check that you have all necessary documentation confirming the foreign employees’ status (non-residents, temporary residents, and permanent residents alike).
9. Check the accuracy of personal income tax calculations.
If there are a lot of employees who have been granted personal income tax deductions, then you need to devote special attention to the availability of applications for deductions as well as documents giving the right to the deductions (in particular, deductions for children and property). Additionally, check for documents confirming the status of foreign employees who have tax residency in Russia.
10. Check for confirmation of a foreign company’s permanent location.
If the company pays income to foreign companies which are taxed at reduced rates or tax exempt in accordance with agreements on avoiding double taxation, check for confirmation of the foreign company’s permanent location within the country that has a preferential tax treatment in accordance with the tax treaty.
11. Check the “good faith” of business partners.
It’s no secret that the tax authorities pay the closest attention to evaluation of the whether the company and its business partners are “good faith” tax payers. Of course a company is not able to independently check whether a partner is scrupulous and whether they pay their taxes. However, in order to reduce the risk of disputes with the tax authorities regarding business partners, there are precautions that can be taken to confirm whether the company exercised due diligence in choosing a business partner. Of course, this should be taken care of when signing an agreement with a business partner. Also before the audit, it wouldn’t hurt to make sure that you have copies of the founding documents from your biggest business partners, check their registration in the Unified State Register of Legal Entities in the database on the Federal Tax Service’s website, obtain signature cards, and – ideally – get copies of the tax and accounting reports along with the tax authorities’ confirmation that the business partner reports and pays taxes.
12. Assess the availability of “tax airbags.”
Lastly, one should pay attention to uncovering so-called “tax airbags.” In other words, you need to assess what kind of reserves the company has for lowering the amount of tax which may be collected as a result of a tax audit. It’s possible that the company doesn’t qualify for any tax breaks or some expenses are not applied to lower the profit tax base, although they may be eligible to apply them as such. You should also check for overpayments on taxes since, if one is found, then fees according to the tax can’t be collected (if the amount of additional taxation is less than or equal to the amount overpaid). In addition, if some documents are missing and can’t be presented for the audit, you need to start recovering the documents so that they may be presented and the amount of additional taxation can also be reduced.
It should go without saying that this is not a comprehensive list of procedures that should be performed before a tax audit. However, making sure you perform these checks as a bare minimum will greatly reduce the chances of additional taxation.
Alinga Consulting’s Role in Preparing for an Audit
Of course, an accounting department with an already heavy workload usually doesn’t have the ability to perform all the above-mentioned procedures, keeping in mind that an audit is usually performed for three years, and after receiving word that an audit will be performed, a deadline of 10 business days is given for submitting all documents for the audit. In such cases, the audit can be entrusted to a specialized organization which not only performs all the necessary procedures and uncovers all the tax risks at short notice, but can also support the company during the entire audit process by assessing the appropriateness of the tax authorities’ requirements and their conformity to existing legislation.
Alinga Consulting has extensive experience in working with the tax authorities. We also have extensive experience in performing tax audits, Tax Due Diligence, and tax consulting. Many of Alinga’s specialists have formerly worked for the tax authorities, therefore we can thoroughly evaluate tax risks.
And remember, a tax audit is not infinite. And in all aspects of it you are not alone – we support you at every level of cooperation with the tax authorities!
Alinga Consulting offers the following services for companies undergoing tax audits:
Preparing companies for tax audits;
Support during the tax audits;
Preparing documents required by the tax authorities during the auditing process;
Preparing written responses to tax claims;
Preparing complaints to the higher tax authority;
Appealing decisions on prosecutions for committing tax violations;
Supporting and defending companies’ interests in court.
Our specialists can help you with these issues:
Tel. +7 (494) 988-21-916 ext. 171
Mobile: +7 926-230-91-31