An Overview of Tax Audits in Russia

By Nataliya Larina

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Dealing with tax audits is a particular problem for businesses in Russia. The most profitable companies often become targets of tax-control measures, which are the government’s best sources for additional taxes. In practice, foreign companies suffer from the arbitrariness of Russian tax authorities more than domestic companies do. The injustice exists in both the selection criteria and the procedure for tax audits (also called tax checks). Sometimes tax inspectors and courts base their decision on formal criteria only. The recent case of Yukos shows that any company, however respectable and stable, might be under the threat of punishment for a tax violation.

The ABCs of Audit in the Russian Federation

The main legislative act regulating the mechanics of tax audits is the Tax Code of the Russian Federation. It sets forth the two main types of tax audits.

Chamber audits (article 88 of the Tax Code) are conducted in the office of a tax authority. The essence of the audit is the examination of documents that a taxpayer has filed. If the audit reveals mistakes, the taxpayer is notified and requested to make corrections. The tax authority is entitled to request additional data and to receive explanations and documents that confirm the correctness of the actions. In practice, tax auditors often require multiple copies of groups of documents at one time, creating problems for a taxpayer.

The on-site tax audit (article 89 of the Tax Code), held on the taxpayer’s premises, is one of the most problematic business issues in present-day Russia and a headache for all entrepreneurs. During on-site audits, tax authorities often seem to forget about the law.

The ‘Deepness’ of a Tax Audit

Inspectors look for signs of tax violations in a taxpayer’s documents and account reports. According to article 87 of the Tax Code, a tax audit may cover only three years of a taxpayer’s activity preceding the year of the tax audit. This term corresponds with the three-year statute of limitation set by article 196 of the Civil Code of the Russian Federation. Russian court practice corrected this legislative provision. To address whether a tax audit may cover not only the three prior years, the Supreme Arbitration Court of the Russian Federation examined article 87 of the Tax Code and decided that “there is no prohibition for tax authorities to check the activity of the current year while holding of the tax audit.” This decision, Decree 5 of the Supreme Arbitration Court, February 28, 2001, is disputable, however. Pursuant to article 55 of the Tax Code, the tax period on the majority of taxes is one year. Therefore, the court allowed tax authorities to check unfinished periods. Moreover, if the tax auditor requests quarterly reports, that creates additional difficulties and problems for the company.

In another case, in 2003 the Supreme Arbitration Court heard a typical case regarding an on-site audit begun in 2001. While examining the company’s activity for 1998, the tax inspector found signs of tax violation and imposed penalties. The taxpayer applied to the court and claimed that the tax authority infringed the three-year limitation rule because the audit was finished in 2002; therefore the inspector could not examine the 1998 records. The Presidium of the Supreme Arbitration Court said that when the tax authorities began the audit made no difference; because the report on the on-site audit was made in 2002, it could examine only the three previous years, 2001, 2000, and 1999 (Decree number 2203/03 of the Supreme Arbitration Court of the RF, October 7, 2003).

Last year marked the reviewing of tax rules about the limitations of tax audits. In the case of Russian oil company Yukos, the courts delivered another interpretation of the Tax Code, and all previous practice was ignored. The tax authority conducted an on-site tax audit of Yukos’ activity in 2000 and 2001, and completed the audit in 2004. Tax authorities learned that during 1997–2000, 22 companies in the Russian offshore zone were created and registered, 21 of them connected with Yukos. Offshore zones—territories with favorable tax regimes—are intended to support the development of that region, but many companies register in an offshore zone for the sole purpose of obtaining tax privileges. Examining Yukos, the court decided that the Russian oil company was a dishonest taxpayer because the aggregate sum of the tax privileges that Yukos received did not correspond with the size of its economic investment in the offshore region. Yukos was required to pay almost 100 billion rubles (US$3.5 billion) (Decision A40-17669/04-109-241 of the Arbitrage Court of the Moscow region, May 26, 2004). The decision proved that the rules about the statute of limitation of tax audits are unstable.

This decision shocked the country. It implied that every company might be designated as a “dishonest” taxpayer. This term first appeared in Decision 138-O of the Constitutional Court of the RF, July 25, 2001. The court did not define dishonesty. Since then, however, Russian courts have freely interpreted this rule.

The Length of Tax Audits

Articles 88 and 89 of the Tax Code concern the length of tax audits. Although they set forth the definite terms of auditing actions, their wording effectively means that tax audits may last forever.

The duration of the chamber audit may be no more than three months; however, this provision was corrected by the Supreme Arbitration Court. In point 9 of Decree number 71, March 17, 2003, it decided that even if the chamber audit was longer than required, courts are not obligated to refuse to satisfy the tax inspector’s demands that the taxpayer pay taxes and penalties.

On-site tax audits can be even worse. Despite the general rule in Article 89 of the Tax Code that an on-site tax audit may last no more than two months, the higher tax authority can increase the length of the audit by up to three months. In addition, if a company has branch offices, the tax audit becomes one month longer for every office.

Special provisions govern production-sharing agreements. Extraction of mineral resources and other relevant activities are regulated by particular special agreements between a company (the investor) and the state. When tax authorities audit the activity of companies that participate in production-sharing agreements, an on-site tax audit may last up to six months. The one-month branch office extension also applies. Significantly, the term of the on-site tax audit includes only the time when tax auditors are physically present at the taxpayer’s premises. Therefore, an audit may last as long as tax authorities wish, because the inspectors can check documents requested from a taxpayer at their office. In practice, an on-site tax audit may last for a year and still be within the law.

The situation became worse after Decision number 14-P of the Constitutional Court (July 16, 2004). Before this decision, whether tax authorities may pause a tax audit for some period of time was disputable because the subject is not covered by the Tax Code, and article 3 of the Tax Code provides that all doubts, contradictions, and ambiguities of legislative acts about taxes and fees should be interpreted in favor of taxpayers. The Constitutional Court, however, decided that tax audits can be paused, because the rules about the duration of tax audits do not correspond to calendar terms. Only the time when tax authorities are in the taxpayer’s premises is calculated.

Frequency of Controlling Measures

Under article 87 of the Tax Code, a taxpayer can be the subject to an on-site audit of a particular tax for a specific period only once. However, if an audit covers different taxes or a particular tax within different periods, inspectors may be present at the taxpayer’s office for an indefinite period.

Moreover, the general rules on frequency of tax audits do not apply if an on-site tax audit is conducted in connection with a taxpayer’s liquidation or reorganization. All companies are obligated to inform the tax authority about their reorganization or liquidation within three days of issuing such a decision, after which point they may be subject to a tax audit.