Tax risks in corporate operations

By Elena Rybnikova, Head of Internal Audit, Expertise and Methodology Department

Елена Рыбникова
Elena Rybnikova
Head of Internal Audit, Expertise and Methodology Department
There are many aspects of tax risks, in particular:
  • Internal risk. This risk arises from a low level of control over the overall running of business, incorrect business valuation, risk of lack of regulation of business processes.
  • Risk of tax non-payment/overpayment. This risk arises from incorrect record keeping, incorrect tax calculations, risk of tax audit.
  • Information and legislative risk. This risk arises from arguable points of Russian legislation, the lack of clarifications of how such points of issue should be regulated, when there are two or more opinions from executive bodies of the Russian Federation on one issue, as well as risk of “radical” change in tax legislation.
  • Political and economic risks. These risks arise from decisions adopted by state authorities to increase the tax burden to resolve social issues.
All the above tax risks are interrelated so it is possible to minimize them only by means of a comprehensive strategy. The risk of incorrect record keeping and the risk of incorrect tax calculations are both internal and information risks.

Internal risk

Internal risks arise from human factor, insufficient qualification of the employees who keep records and calculate taxes, from the lack of employee and management awareness of legislation changes and/or clarifications. And mere carelessness also often gives rise to errors resulting in tax risk.

Internal risks may be decreased by increasing internal control, training the employees who are responsible for keeping records, preparing reports and calculating taxes. To reduce internal tax risks, it is also necessary to exercise due diligence when conducting business. In particular, before concluding a transaction, it is necessary to check how reliable the counterparties are, assess business activities, and select the optimal tax system for each business activity.

To reduce the tax burden, it is necessary to divide the types of activities depending on whether they are subject to the single tax on imputed income, the patent system of taxation, the simplified taxation system, or the general taxation system. Although the implementation of such division will create more work for accountants, it will also help optimizing taxation and reduce the risk of tax overpayment.

Risk of tax non-payment or overpayment

The risk of tax non-payment is due partly to incorrect calculation of taxes and partly to management of accounts payable.

When company executives do business, they set priorities for accounts payable, and when assets to pay off all liabilities are not sufficient, they set a payment deferment as long as is possible so that it does not give rise to any adverse consequences.

For example, up to January 01, 2017 many companies, which fell short of funds, used a “free” loan by not paying insurance contributions (for example, contributions to the Pension Fund). Since the Pension Fund had no great leverage on the companies failing to pay their contributions (non-payment only resulted in the imposition of a penalty which included neither fines nor bank account blocking), such companies ended benefiting from a de facto “free” loan.

However, the tax risk for companies that have failed to pay their insurance contributions in due time has increased since January 01, 2017 because insurance contributions then became tax payments subject to the provisions of the Russian Tax Code. This failure is now subject to a fine for non-payment of insurance contributions, and the Federal Tax Service may also block the bank accounts of the companies that have failed to pay their contributions. Moreover, these new penalties may also be applied retroactively as the Russian Tax Code provides that tax authorities may, as a general rule, audit the 3-year period preceding any event giving rise to such audit and impose penalties.

The risk of tax non-payment can stem both from incorrect calculation of taxes and from lack of employee and management awareness of legislation. And since one of the canons of law is that “ignorance of the law excuses not”, this tenet could be continued by stating that knowledge of the law very often empowers and sets free. Management should therefore pay attention to the qualifications and knowledge of the people keeping records, calculating taxes and preparing reports.

Information and legislative risk

The great number of arguable points in the interpretation of Russian tax laws constitute a significant information and legislative risk together with the lack of clarifications of such legislation, or the existence of two or several official opinions on the same issue, which also gives rise to tax risks for companies. To decrease this information and legislative risk, companies need to obtain clarifications from the Ministry of Finance, Federal Tax Service, Ministry of Labor and other state authorities. This way companies can find out how to correctly calculate taxes and reduce the risk of tax claims.

Political and economic risks

Political and economic risks are associated mainly with taxpayers’ attempts to optimize (minimize) the tax burden and with government attempts to do the same.

The great number of tax regulations which can be interpreted ambiguously result in tax risk for both taxpayers and the tax collector. In this situation, this is, as the phrase goes, a zero-sum game.

When tax regulations can be interpreted ambiguously, some taxpayers minimize their tax risk by paying more taxes (on the basis that it is better to pay rather than later explain underpayments to the Federal Tax Service), while others defend their position in court thereby creating precedents on the basis of which one and/or the other party benefits from the court interpretation of the law.

Tax risk reduction

Tax risks will be reduced for companies provided they (i) hire qualified employees, (ii) obtain clarifications of the law in due time and keep abreast of any legislation changes, (iii) put in place sufficient control over business processes, (iv) obtain explanations of taxation, and (v) are willing to defend their position in court.