Practical Solutions for Avoiding Tax Sanctions in Reference to Contracts with Foreign Contractors

Please find below for your attention a commercial proposal from GRATA’s tax department which analyses for your interest contracts with foreign contractors and makes observations on how to minimise the tax burden of your company.

It is well known that in the course of business activity many Kazakhstan companies establish and further enter into commercial relationships with foreign partners. Meanwhile most of them do not satisfy the requirements of the current tax legislation of the Republic of Kazakhstan. As a consequence of this, Kazakhstan companies are faced with essential tax, administrative, and sometimes criminal sanctions, which have a direct and negative affect on the company’s business activity. The main reason for this is ignorance or lack of knowledge regarding current procedures of taxation, as well as frequent changes and additions to tax legislation of the Republic of Kazakhstan.

GRATA suggests and can provide analysis of your contracts including the following general steps:

1.   Analysis of business and account documentation. In this stage our specialists will research and check documents in respect of operations with foreign contractors and their compliance with the tax legislation of the Republic of Kazakhstan, as well as ensuring you have completely and timely made payments of tax duties in connection with your Company’s contracts with nonresidents.

2.   Preparation of written recommendations for minimising the tax burden of the Company in respect to contracts with nonresidents. As a result of our investigation we will prepare a written opinion with our comments and recommendations for current and future commercial transactions with nonresidents, including optimal forms of inter-payments and accounting based on the current tax legislation of the Republic of Kazakhstan, as well as provisions of International tax agreements for the avoidance of double taxation and prevention of fiscal evasion with respect to taxes on income and on capital.

Our previous experience dictates that when documents and arguments were checked and prepared in advance we were able to assist many taxpayers in evading otherwise unforeseen tax penalties and administrative fines. Taking this into account we are suggesting your company takes preventive measures ahead of the new tax inspection by means of the above stated procedure.

Analysis of court practice on tax disputes connected with breach of legislation with respect to companies’ tax duties for their operations with foreign contractors shows that the court considers the situation for all contracts in similar manner. For this reason we will consider one example of the tax consequences a on standard service transaction between a nonresidents and a Kazakh company.

Considered case:

A Kazakhstan company, the service recipient (hereinafter – ‘Company A’), concluded a contract with a Canadian company, the service performer (hereinafter – ‘Company B’), for rendering consultancy services beyond the bounds of Kazakhstan for a total cost of 1 000 000 US dollars. After the services were rendered Company A paid the total cost of the transaction to Company B. Company B earned an income from consultancy services, which in accordance with the tax legislation of Kazakhstan is subject to tax by 20% tax withheld at the source of payment, e.g. in the Republic of Kazakhstan.

At the same time the current tax legislation of the Republic of Kazakhstan makes the tax agent, who in considered case is Company A, responsible for the calculation, withholding and transferring tax withheld at the source of payment. In most cases Company A does not withhold the 20% tax due to their contractual agreement with Company B and an assumption that this is the correct procedure. Additionally Company A simultaneously pays tax it should have withheld at the source of payment (in Kazakhstan) out of their own net profit. However both of these actions are in breach of the tax law of the Republic of Kazakhstan. Such that, at the end of the transaction Company A is faced with at least two serious tax circumstances:

First, for not-withholding as a tax agent equal to an amount of taxes that should be paid in Kazakhstan.

Second, for the payment oneself of a foreign tax debt out of one’s own net profit.

According to point 1, Article 210 of the Administrative code of the Republic of Kazakhstan, not-withholding or incomplete withholding by a tax agent of the sum of taxes or other obligatory payments that are subject to being withheld and transferred to revenue directly shall be punished by an administrative fine in the amount of 30 to 50 % from the not-withheld sum of taxes and other obligatory payments.

Moreover in June 2006 it was agreed by Normative resolution of the Supreme Court of the Republic of Kazakhstan entitled ‘About court practice of tax legislation use’; according to which all tax debts must be dealt with by the associated taxpayer alone and independently. At the same time according to the above stated document, tax debts accrued in all civil transactions concerning conveyance to another person which were concluded with the intention of their being exempt from taxation should be considered as invalid as not meeting the requirements of the legislation.

In summary, it is necessary to note that in the future with such a scheme of taxation, Kazakh companies in the place of profit will actually accrue the following heavy losses:

Sum of 20% of income tax should be withheld at the source of payment and should be paid at the expense of the company’s net profit  +  administrative fine in the amount of 50% from the sum of non-withheld income tax  +  possible recognition of the concluded commercial contracts as invalid.

Transferring this result on stated above situation with payment of consultancy services we can see following:

The total sum of the contract: 1 000 000 US dollars

200 000 US dollars (20% - income tax for nonresident) + 100 000 US dollars (50% - administrative fine)

The total sum of losses: 300 000 US dollars

During the tax inspection for the corresponding tax period when Company A did not withhold income tax for the nonresident (Company B) there is heavy administrative fine in the amount of 100 000 US dollar sanctioned by tax authorities.

A sum in the amount of 200 000 US dollars under stated above contract was paid by Company A from its net profit, e.g. this sum was not included in the tax deductions and does not reduce the taxable income of the company. This payment of assumed income tax is made out of Company A’s net profit and will have the effect of reducing the size of dividends available to be distributed to founders (participants).

For the avoidance of greater losses, Company A could carry out the above stated analysis of its contracts with foreign contractors and could take recommendations on how to reduce such risks in the future.

Thus by the correct completion of contracts and the observing of certain administrative procedures on document formation you are able to escape losses in the amount of 300 000 US dollars.

Should you have any questions or require additional information, please contact us on the information below.