Reduced tax rates;
Tax exemption for certain categories of legal entities;
Special benefits offered under state programs;
Deferred payments of taxes.
Legal ways to reduce tax26 April, 2018
By Ekaterina Kalinkina, Head of Branch Office Intercomp Ryazan
One effective way for companies to improve their cost-effectiveness is to reduce their financial burden through tax optimization. It should be noted that “gray” tax evasion schemes will always be very risky for companies opting for such solutions. We have reviewed in this article only legal and reliable ways of reducing corporate tax base.
State policy to take business out of the shadow economy
The government has actively adopted some measures to take business out of the shadow economy as well as improve tax administration and collection. The Federal Tax Service is already aware of most “gray” tax evasion schemes, while new ones are identified quickly thanks to ever-improving computer programs (VAT-2 Automated Control System, Tax-3 Automated Information System).
In addition, the Federal Tax Service together with the Ministry of Finance and the Investigative Committee published on July 13, 2017 methodological recommendations for local tax and investigative authorities to establish during tax and procedural inspections facts and circumstances evidencing intent of tax non-payment in the actions performed by the officers of taxpayers (Federal Tax Service Letter No. ЕD-4-2/13650@ dated July 13, 2017). These recommendations are detailed instructions for inspectors to identify and prove tax evasion schemes. They also describe in detail common tax evasion schemes:
- Sham transactions;
- Business split for abusive application of special tax treatments, tax deductions and reduced tax rates;
- Substitution of civil law relations in order to derive tax benefits.
When should tax optimization begin?
It is worth thinking about legally reducing a company’s tax burden even before registration of the company, by choosing then the most profitable tax system depending on the activity in which the company will engage, and whether or not it will be possible to apply special tax treatments and statutory benefits.
That being said, it is never too late to engage in tax optimization. First, it is necessary to analyze the actual legislative base to determine the tax benefits that would be suitable based on the company’s tax burden:
Measures for profit tax optimization
The difference between a company’s revenues and its expenses is subject to profit tax (Article 247 Russian Tax Code) so to reduce profit tax it is necessary either to reduce revenues or to increase costs. Deductible and non-deductible expenses for profit tax purposes are listed in Chapter 25 of the Russian Tax Code.
Legal ways to increase expenses for reduction of profit tax base
- Making provisions for bad debts (Article 266 Russian Tax Code), including outstanding obligations of other companies. Provisions for this reserve are made monthly or quarterly and cannot exceed 10% of proceeds. These provisions are included for profit tax purposes in non-operating expenses;
- Making provisions for vacation payments (Article 255 Russian Tax Code). Companies are allowed to include vacation payments in labor costs evenly throughout the year. Companies applying the accrual method may make provisions for vacation payments, and the Russian Tax Code sets out how to do so;
- Making provisions for repair of fixed assets (Articles 260 and 324 Russian Tax Code). Provisions for this reserve are calculated on the basis of the number of replacements and estimates of repair works that do not exceed the amount set for the last three years. Companies that have been operating for less than three years are not allowed to make such provisions. These provisions are included in expenses incurred for production and sale of products, work, and/or services.
2. Depreciation (Article 259 Russian Tax Code)
Depending on the depreciation group of a company’s new asset, the company may only once deduct from 10% (for depreciation groups I, II, VIII, IX, X) to 30% (for depreciation groups III-VII) of the cost of this new asset upon calculation of profit tax. Such deduction is allowed upon purchase of a new asset and in case of further construction, refitting, reconstruction and modernization of previously acquired fixed assets.
3. Investment tax deduction (Article 286.1 Russian Tax Code)
Companies purchasing or making major improvement in III-VII group fixed assets have been able to use this deduction since January 01, 2018. This deduction may be applied only if it is provided for in regional laws and regulations, and it cannot exceed 90% of the expenses incurred for purchase, modernization and reconstruction of fixed assets. It is important to note that any fixed assets used for investment deduction cannot be depreciated thereafter
Investment deduction allows including in profit calculation only once a considerable part of the expenses incurred for purchase, modernization and reconstruction of fixed assets.
Measures for VAT optimization
VAT is an indirect tax. The taxable base for VAT is the value of sold goods, work or services. Chapter 21 of the Russian Tax Code sets out the procedure for VAT accrual and payment. According to this procedure, companies are to pay to the budget the difference between the amount of tax accrued and the amount of tax paid.
Buyers essentially pay this tax as part of the price of the goods they purchase, while companies only transfer this amount to the budget. It is understandable that companies would strive to reduce the amount of VAT payable to the budget as they often have to transfer their own funds in cases where buyers do not pay for goods, work or services on time. Moreover, VAT unpaid to the budget increases income which is not subject to profit tax.
Ways to decrease amounts of payable VAT
- VAT exemption subject to the conditions provided for in Article 145 of the Russian Tax Code:
- Revenue for the 3 preceding calendar months should not exceed RUB 2,000,000 exclusive of VAT;
- The company should not sell excisable goods;
- The company must notify tax authorities that it is exercising its VAT exemption right.
It should be noted that applying this exemption will not be advantageous for companies selling goods, performing work or providing services to organizations operating under the general tax system, as in this case, companies will not be able to reclaim VAT for purchased goods, work or services.
- Expansion of list of suppliers that are VAT payers. This allows increasing the amount of input VAT thereby reducing the amount of tax payable.
- Application of option, i.e. concluding a contract under which the company acquires the right to buy a certain underlying asset in the future at the price fixed in the contract. The payment of option price is not subject to VAT (Article 149(12) Russian Tax Code).
- Use of various aspects of different types of contracts and content of business transactions to optimize VAT:
- Contract of intent;
- Provision of loan;
- Use of deposit, pledge, special conditions for ownership transfer;
When using this method, the risk of requalification of contract and content of business transaction as an unlawful scheme is quite high so it is important to justify doing so based not only on the rules of the Russian Tax Code, but also on the latest clarifications from the Ministry of Finance, Federal Tax Service of Russia and current court practice.
The right of legal entities to choose an optimal taxation method is provided in the Russian Tax Code and confirmed by the Constitutional Court of the Russian Federation. It is important to make the distinction between “tax avoidance schemes” and reasonable tax accounting. The analysis of a company’s tax burden and the development of measures to reduce its tax base may be done by the company itself or by a consultant. By engaging a consultant, companies benefit from a “fresh” professional view and can also cut down on their labor costs.