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On-site Audits

December 2011

How audit "victims" are chosen

Clearly, it's impossible to conduct an on-site tax audit for each taxpayer. No tax service has the manpower to do that. Besides, provisions in the Tax Code, which regulate the frequency of on-site audits quite tightly, prevent such audits en masse (more on that a little later).

Thus, today on-site audits are reserved for only the "chosen" taxpayers. Selection of the "chosen" is automated and based on information given to tax authorities by the organisations themselves as well as information that the tax service has obtained from other sources–contractors, power companies, state authorities, etc.

To their credit, the tax authorities have long since stopped keeping secret the criteria which underlie the selection of the "lucky ones". Anybody with the desire can acquaint himself with the document entitled "Publicly Available Criteria for Independent Evaluation of Taxpayer Risks, Used by Tax Authorities in the Selection of Subjects for On-site Audits". Legally, it is appendix No. 2 to Order No. MM-3-06/333@ of May 30, 2007 from the Federal Tax Service of the Russian Federation.

It follows from the "publicly available criteria" that the main candidates for an on-site audit are companies whose performance indicators deviate from the average. For example, if employee wages are lower than in other companies in the same sector. Or if large VAT refunds are always being claimed. Or if the amount of taxes paid is extremely disproportionate to the organisation's account turnover.

Companies that frequently relocate, carry out activities through intermediaries, and so forth, i.e. companies whose activities are not transparent, may also find themselves being audited on-site. Furthermore, for the very same reason, business non-transparency, companies that are derelict in their communication with the tax authorities may be hit with audits, for example, for failing to provide clarifications or explanations as requested by the tax inspectors.

How you learn about the audit

In most cases, the management of a taxpaying organisation learns that it is facing an on-site audit, as they say, "on an actual basis"–that is, from the very inspectors who have come to conduct the audit. When doing this, inspectors must show the organisation's management their employment certificates and the order for the on-site audit, which a manager (or other authorised person) must review and sign. We note that the inspectors are not obligated to provide a copy of the order for the audit. Therefore, it should be thoroughly studied before being signed. In particular, it doesn't hurt to copy out the following information:

• the surnames of the inspectors conducting the audit;
• the specific taxes they will audit (it may be indicated that all taxes and duties will be audited);
• the time frame in which the tax audit will be conducted.

Attention should also be given to ensure that the company details–the business name, taxpayer identification number (INN), and the tax registration reason code (KPP)–are correctly specified in the order. You should also be certain that the order is specifically issued by the tax authority that the organisation is registered with, that it has been signed by the tax authority's director or deputy director, or by somebody fulfilling their duties (if you have doubts, you can call the tax office and verify this information). Further, the order should be certified by the tax authority's official blue seal.

Finally, it doesn't hurt to verify the surnames of the inspectors mentioned in the order against the surnames of those who have come to your business. If discrepancies are discovered, you are fully within your rights to exclude the "superfluous" inspectors from the audit.

Where auditors will look

The Tax Code does not contain regulations today that directly mention a requirement to allocate a special room for auditors to work in. Further, the Code does say that if a taxpayer cannot offer a room for conducting the audit, then it is to be held at the tax office. So, in practice, the decision as to whether or not to allocate a room and the quality of the room offered fall entirely to the manager of the company being audited. If the inspectors are not satisfied with the room provided or if management decides not to provide one at all, then the inspectors will seize the documents they need and send them off to be examined in their own office.

But even if a room is allocated, the inspectors are not at all obligated to stay there. According to the rules set forth in the Tax Code, they have the right to move about the taxpayer's site and inspect its manufacturing and storage facilities, and commercial premises. Auditors may also take interest in other facilities and sites used by the organisation for commercial purposes or to store taxable items. It's important to remember that the inspection of any room may only take place in the presence of the taxpayer, "on the record", and with the participation of witnesses. Otherwise the inspectors may not use the information obtained for calculating taxes and penalties.

However, inspecting rooms is usually an exception. In most instances, inspectors are limited to examining documents. The Code authorises them to check any documents related to the taxes specified on the order for the on-site tax audit. Moreover, the taxpayer is specifically obligated to show the originals of such documents to the inspectors. At the same time, the inspectors simply do not have the right to take the original documents beyond the confines of the organisation. To that end, the Code requires them to prepare a record of seizure with the exact names and quantity of the documents seized.

It must be remembered when meeting the inspectors' requests for documents that they can only examine those documents which relate to the audit period specified in the order shown at the beginning of the audit. But the audit period can never exceed 3 calendar years, not counting the current tax period. Simply put, in 2011 inspectors can audit the current year and the period from 2008-2010.

How long the audit will last

The general rule is that inspectors must complete an on-site audit within 2 months from the date the audit order is delivered. The conclusion of the audit is formalised by a special certificate. After it has been drawn up inspectors can no longer engage in compliance measures or be on the organisation's site.

At the same time, the Tax Code prescribes ways to extend or suspend the audit period. For example, if inspectors have ordered a peer review and cross-audit, or if they have requested documents from beyond the Russian Federation, then the director of the tax authority may decide to suspend the audit. During the suspension, inspectors do not have the right to enter the organisation's site, request documents, etc.

Decisions concerning extending the audit period are made by the parent tax authority based on a motion by the inspectors, with reasons given. Thus the administration for the Federal Tax Service can initially extend the audit period up to 4 months, and then (on the basis of a second motion) up to 6 months. Subsequent extensions of the period are not allowed. All evidence obtained outside the bounds of the audit period is invalid.

When an appeal is worth it

As has already been mentioned, at the conclusion of the audit a special certificate is delivered to the taxpayer. Based on this certificate, the tax authority composes a statement indicating all the discovered violations along with proposals to rectify them. The statement is delivered to the taxpayer. The organisation's management and legal department can learn from this document what violations were found and what penalties the organisation is facing. Accordingly, this information can be used to determine the prospects of an appeal.

It's worth mentioning that the tax service has recently been very actively engaged in improving the quality of the audits. Additionally, inspectors are trying to avoid the occurrence of legal appeals of the audit findings, if the legal outlook is clearly not favourable to the tax office. We're talking about obvious and flagrant procedural violations (obtaining evidence outside the scope of the audit, falsifying reports, auditing beyond what was specified in the order, etc.) or incorrect interpretation of legislation.

If such violations are discovered, it makes sense to immediately appeal to the parent tax authority. As a rule, the judgement will either be overruled or amended based on the findings of an audit conducted by the higher authority. Court statistics confirm this. In the first quarter of 2011, of the total amount for claims examined in the courts (67.5 billion roubles), the amount found in favour of the tax authorities was 36.8 billion roubles, or 55%. This measure has grown by more than 10% in comparison with the first quarter of 2010. The credit for this, in large measure, goes to the work of the pre-trial audit offices, which examine taxpayer complaints. Indeed, in one year 2,500 complaints were resolved before going to court.

In fact, when determining the expediency of a legal appeal of the audit findings, you can be guided by the following practical experience. For example, in cases of preparing invoices, where the rules to fill them out do not give a clear and unambiguous interpretation, the courts have sided with the taxpayer most of the time. Such is the case with invoices that are partially filled out on a computer and partially filled out by hand; the last time the courts supported inspectors in this matter was back in 2009.

There are also "invoice cases" in which the courts rule exclusively in favour of the taxpayer, for example, disputes over not showing or incorrectly showing the tax registration reason code (KPP), clerical errors in addresses, contact details, titles, and so forth.

But there is a fly in the ointment. There are situations when there is no need to argue with the tax authority, because the courts are highly likely to side with the state agencies. The "classic example" is a VAT refund when exporting goods from the Russian Federation using CRM shipping documents that lack entries by customs authorities.

More detailed information is given below as to the "validity landscape" of the most common types of court cases:

VAT [rulings by the Federal Antimonopoly Service (FAS) and the Presidium of the Supreme Arbitration Court (VAS) 2010-2011]

Corporate income tax

Prepared by analysts of
ICLC Consulting Department
Exclusively for Russian Survey