Problems with Obtaining Refunds from the Budget of Excess VAT Accumulated During Mineral Exploration
Lately, obtaining a refund of value added tax (VAT) incurred in connection with the export of goods has been a pressing issue. Despite the fact that the tax legislation clearly regulates the procedure for refunding excess VAT from the budget, in practice there are various obstacles for taxpayers. This article focuses on the amount of excess VAT accumulated during the exploration period prior to the export of minerals.
The rationale for applying VAT to exported goods
There are two opposing principles which underpin the indirect taxation of cross border trade: the country of origin and the country of destination. The vast majority of states, including Kazakhstan, the CIS countries and the European Union charge VAT on the basis of the country of destination. Such a system has well recognised benefits in terms of customs control and customs valuation.
According to the country of destination method, exporting goods and the capital expenditure incurred by an exporter during the production of such goods are not subject to VAT in the country of origin. These goods are only subject to VAT in the country into which they are imported and consumed.
When trade occurs between two countries, it gives rise to a potential double taxation scenario. The country of destination method is intended, primarily, to avoid such a situation. Furthermore it allows domestic producers to be on equal terms with foreign producers and thus ensures the competitiveness of exporting goods in the international market.
How the country of destination principle is expressed in the provisions of the Tax Code
The principal of the country of destination is formalised in Articles 242 and 272 of the Tax Code and implemented in the following way.
During the production period of exported goods
Materials, equipment, work and services that have been used in the production of exported goods, including the construction of facilities used for the production of exported goods, once they are purchased by the exporter, become subject to VAT at the current rate (12%) to be paid into the budget. In other words when materials, equipment, works and services are acquired, the exporter has to pay suppliers the price together with VAT according to tax invoices. The paid amounts of VAT are then offset and accumulated by the exporter prior to export. These obligations are contained in Articles 229, 231, 268 and 256 of the Tax Code.
For the export of produced goods
Export sales are subject to VAT at the rate of "0"%, i.e. export goods are not subject to VAT, as stated by Article 242 of the Tax Code. This gives rise to excess VAT which can be offset against the amount of assessed VAT.
Paragraph 2 of Article 272 of the Tax Code states that the exporter has the right, at the start of the export process, to claim a VAT refund from the tax authorities of the sums which he paid to the budget during the preparation for production and the actual production of the exported goods.
Thus, it is a mistake to regard the zero rate VAT on exports and the refund of VAT from the budget as a tax privilege or exemption provided to taxpayers by the state. As shown above, it is in fact a means of enshrining the ‘country of destination’ principle for applying VAT. The budget, in essence, returns amounts of tax previously paid by the exporter.
Article 272 of the Tax Code:
The Application of Article 272 of the Tax Code is the cause of dispute between the tax authorities and taxpayers. In view of this, we provide below a detailed analysis of this Article.
Paragraph 2 of Article 272 of the Tax Code:
“Excess value-added tax specified in the first part of subparagraph 1) of paragraph 1 of this Article, relating to goods, work and services purchased prior to the 1st January 2009, except for excess which relates to the purchase of goods, work and services that are or will be used for the purposes of turnovers taxable at a zero rate, shall not be refunded from the budget….”
This rule gives the taxpayer the right to claim a refund of excess VAT that relates to turnover from export goods, including the excess amounts that were paid before 1 January 2009. In this case, the phrase "... will be used ..." indicates that the exporter has the right to claim a refund from the budget of the amount of VAT which was paid by the exporter during the production of goods that will be exported from Kazakhstan. For example, during exploration the amount of VAT paid by a subsoil user at the moment of purchase of materials, equipment, goods, work and services can be refunded to them from the budget, when the export of materials actually begins.
Thus, according to paragraph 2 of Article 272 of the Tax Code the exporter may exercise his/her right to a refund of excess VAT, if the following terms are met:
- the sales of export goods has occurred i.e. once the process has started the exporter has the right to make a declaration to the tax authorities that it wishes to claim a refund of the excess VAT accumulated during the production of the exported goods;
- that the excess VAT claimed for refund from the budget is related to export turnovers. In other words, goods, materials, equipment, work and services, which were used to produce exported goods and in connection with the acquisition of which the exporter paid VAT (thereby giving rise to excess VAT payment).
Paragraph 3 of Article 272 of the Tax Code:
“With regard to turnovers taxable at a zero rate, excess amounts of value-added tax to be offset against amounts of the assessed tax as stated in a declaration as a progressive total at the end of the reporting tax period, shall be subject to refund, provided the following conditions are simultaneously met:
1) a payer of value-added tax permanently carries out sales of goods, work, services which are taxable at a zero rate;
2) if turnover from sales taxable at a zero rate, for a tax period in which turnovers taxable at a zero rate were received and in relation to which a statement of claim of refund of excess value-added tax is made, was not less than 70 per cent of total taxable sales turnover”.
The provisions of Article 272 of the Tax Code quoted above, regulate the extent to which excess VAT is refundable to the exporter, namely whether it may be refunded in its entire amount or only in part. The amount of the excess VAT to be refunded from the budget depends on whether export of goods for the exporter is a consistent activity or not. If the exporter constantly exports goods and the export turnover share is over 70% of the total sale turnover of the exporter, then the whole amount of the excess VAT is refundable. If at the date when the refund claim is made, the exporter does not meet the criteria specified in paragraph 3 of Article 272 of the Tax Code, then only part of the amount of excess VAT is to be refunded. In this case, the amount of excess VAT is determined in accordance with paragraph 4 of Article 272 of the Tax Code.
Paragraph 4 of Article 272 of the Tax Code:
“The Government of the Republic of Kazakhstan shall establish criteria for classifying the sale of goods, work, services which are taxed at a zero rate, as permanent sales as specified in subparagraph 1) of paragraph 3 of this Article, and the procedure for calculating the amounts of excess value-added tax to be refunded in the following cases:
1) in relation to turnovers taxable at a zero rate, in the case of non-observance of provisions established by paragraph 3 of this Article;
2) in relation to VAT specified in the second part of subparagraph 1) of paragraph 1 of this Article”.
As can be seen, paragraph 4 of Article 272 of the Tax Code is a reference rule and applies when the exporter does not meet the criteria specified in paragraph 3 of Article 272 of the Tax Code on the date a VAT declaration is submitted. If the exporter does not meet at least one of the conditions indicated, the amount (share) of the excess VAT to be refunded from the budget should be determined in accordance with provisions of the ‘’Rules for Determining the Amount of Excess Value Added Tax to be Refunded, and the Criteria for Classifying the Sale of Goods, Works and Services Subject to Zero Rate VAT as Permanent Sales’’, approved by the Government of the Republic of Kazakhstan No.373 of 20 March 2009.
Thus, if we apply the provisions of Article 272 of the Tax Code to a situation when a subsoil user started production and exports mineral resources obtained from Kazakhstan, the provisions of this Article allow the subsoil user to claim a refund of excess VAT from the budget accumulated during exploration, that is to say, before the export sales of minerals start. Goods, materials, works and services, as capital costs incurred during exploration are used by the subsoil user for field development and prepare it for the production period and export. Once the subsoil user started to export the obtained minerals, he is entitled to claim a refund of VAT which he incurred during exploration (preparation for production of the exported goods). Hence, for confirming the amount of excess VAT to be refunded from the budget it does not matter whether the excess VAT was amassed before or after the export of minerals began. An important condition, as noted before, is that the excess VAT claimed for refund from the budget relates to export turnovers. In other words, goods, materials, equipment, work and services goods in connection with acquisition of which VAT was paid by the subsoil user (and therefore gave rise to excess VAT) should be used for field development and extraction of mineral raw materials, which were exported.
The perspective of the tax authorities
The tax authorities believe that only excess VAT accumulated once goods have been exported can be refunded from the budget. In other words, the tax authorities deny the exporter’s right to a refund of VAT which the exporter paid during the production of goods (during the exploration period) that were subsequently exported. Thus the tax authorities, referring to the provisions of paragraph 3 of Article 272 of the Tax Code, mistakenly believe that only this rule establishes the exporter’s right to a refund of excess VAT from the budget and therefore do not take into account the provisions of other paragraphs of Article 272 of the Tax Code, which classify VAT paid during production as refundable,
We are of the opinion that this position is misguided, since it directly fails to take into account the provisions of Article 272 of the Tax Code.
It should be noted that this is the recent practice of the tax authorities. Previously, under the past Tax Code, the tax authorities refunded to the exporters VAT, which was paid during the period of exploration. Thus it is clear that the provisions of Article 251 of the previous Tax Code and Article 272 of the current Tax Code, which both contain the right of the exporter to refunds of VAT from the budget, do not significantly differ from each other in terms of content.
In this regard, we believe problems of VAT refund relate more to enforcement of law rather than the legislation itself.
The Courts’ stance
To date the Supreme Court of Kazakhstan has not yet considered and ruled on VAT refund cases or on the correct application of the provisions of Article 272 of the Tax Code. The regional courts have, however, and their decisions tend to support the position of the tax authorities, as outlined above
In summary, it should be noted that the practice of the tax authorities is not only illegal, but also results in the double taxation of Kazakh domestic goods. Double taxation, in its turn, leads to goods becoming uncompetitive on the world market. The obstacles to VAT refunds created by the tax authorities have an ultimately negative impact on the investment image of the country. In our view, one of the most important conditions for an attractive economic climate in the country is predictability and certainty in the field of taxation.
 Refund of excess VAT to be offset against the amount of assessed VAT accumulated in connection with the acquisition of goods, works and services used for export turnovers will hereafter be referred to as "excess VAT";
 VAT is an indirect tax;
 The Code of the Republic of Kazakhstan "On taxes and other obligatory payments to the budget" of 10 December 2008;
 Code of the Republic of Kazakhstan "On taxes and other obligatory payments to the budget" of 12 June 2001.