Refunds of value added tax (VAT) incurred in connection with the export of goods[1] has lately become a pressing issue. Despite the fact that tax legislation clearly sets out the procedure for refunding excess VAT, in reality taxpayers encounter a number of obstacles. This article focuses on excess VAT accumulated during exploration prior to the export of minerals.
The Rationale for Applying VAT to Exported Goods
Two opposing principles underpin indirect taxation[2] of cross-border trade: country of origin and country of destination. The vast majority of countries, including Kazakhstan, the CIS countries, and the European Union, charge VAT on the basis of country of destination. This 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 during production of these 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 where they are used.
When trade occurs between two countries, it gives rise to a potential double taxation scenario. The country of destination method is intended to avoid this. Furthermore, it places domestic producers on a level playing field with foreign producers, thus ensuring the competitiveness of exporting goods in the international market.
The Country of Destination Principle in the Tax Code[3]
The country of destination principle is formalised in Articles 242 and 272 of the Tax Code and implemented in the following way.
During production of exported goods
Materials, equipment, work and services used in producing exported goods, including construction of facilities for production of exported goods, once they are purchased by the exporter, become subject to VAT at the current rate (12%). In other word, when materials, equipment, work and services are acquired, the exporter has to pay suppliers the price together with VAT, according to tax invoices. VAT is 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 in Article 242 of the Tax Code. This gives rise to excess VAT that can be offset against the assessed VAT.
Paragraph 2 of Article 272 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 amount paid during 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 VAT refund as tax privileges or exemptions from the government to taxpayers. In fact, it is a means of enshrining the ‘country of destination’ principle for applying VAT. The tax authorities, in essence, are returning tax previously paid by the exporter.
Article 272 of the Tax Code:
The application of Article 272 is disputes between the tax authorities and taxpayers. A detailed analysis of this Article is provided below.
Paragraph 2 of Article 272 states:
“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 January1, 2009, except for excess related 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 ….”
This rule gives taxpayers the right to claim a refund of excess VAT related to turnover from export goods, including excess amounts incurred before 1 January 2009. The phrase “… will be used …” indicates that the exporter has the right to claim a VAT refund paid by the exporter during production of goods for export from Kazakhstan. For example, during mineral exploration the VAT paid by a subsoil user at the moment of purchasing materials, equipment, goods, work and services, can be refunded when the export of mineral resources begins.
Thus, according to Paragraph 2, the exporter may exercise his/her right to a refund of excess VAT if the following conditions are met:
once the sale of export goods has occurred i.e. once the process has begun, the exporter has the right to submit a declaration to the tax authorities claiming a refund of excess VAT accumulated during production of the exported goods;
if the excess VAT for refund is related to export turnovers – in other words, goods, materials, equipment, work and services used to produce exported goods and for which the exporter paid VAT (thereby giving rise to the excess VAT payment).
Paragraph 3 of Article 272 states:
“With regard to turnovers taxable at a zero rate, excess amounts of value-added tax to be offset against 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 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 claim for 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 cited above set out the extent to which excess VAT is refundable to the exporter, namely whether it may be refunded in its entirety or only in part. The amount of excess VAT for refund depends on whether export of goods is a consistent activity for the exporter. If the exporter constantly exports goods and the export turnover share exceeds 70% of the exporter’s total sales turnover, then the entire amount of the excess VAT is refundable. If, on the date when the refund claim is made, the exporter does not meet the criteria in paragraph 3 of Article 272, then only part of the excess VAT will be refunded. In this case, the amount of excess VAT is determined according to Paragraph 4 of Article 272.
Paragraph 4 of Article 272:
“The Government of Kazakhstan shall establish criteria for classifying the sale of goods, work, and services taxed at a zero rate as permanent sales as specified in sub-paragraph 1) of paragraph 3 of this Article, and the procedure for calculating excess value-added tax to be refunded in the following circumstances:
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”.
Paragraph 4 of Article 272 is a reference rule that applies when the exporter does not meet the criteria specified in Paragraph 3 on the date a VAT declaration is submitted. If the exporter does not meet at least one of the conditions, the amount (share) of the refundable excess VAT is determined according to the “Rules for Determining Refundable Excess Value Added Tax, and Criteria for Classifying the Sale of Goods, Work, and Services Subject to Zero Rate VAT as Permanent Sales’’, approved by the Government of Kazakhstan, No.373 of 20 March 2009.
Thus, if we apply Article 272 to a situation when a subsoil user has begun production and export of mineral resources from Kazakhstan, this Article allows the subsoil user to claim a refund of excess VAT accumulated during exploration, that is, before mineral export sales. Goods, materials, work, and services, as capital costs incurred during exploration, are used for field development in preparation for production and export.
Once the subsoil user starts exporting minerals, he is entitled to claim a refund of VAT incurred during exploration (in preparation for producing exports). Hence, in confirming the refundable excess VAT, it does not matter whether the excess VAT was amassed before or after the mineral exports began. An important condition, as noted above, is that the excess VAT claimed for refund relates to export turnovers. In other words, goods, materials, equipment, work, and services in connection with which VAT was paid by the subsoil user (leading to excess VAT) should be used for field development and extraction of raw minerals for export.
The Tax Authorities’ Perspective
The tax authorities believe that only excess VAT accumulated once goods have been exported is subject to refund. In other words, the tax authorities deny the exporter’s right to a refund of VAT paid during the production of goods (during exploration) that were subsequently exported. Thus the tax authorities, referring to Paragraph 3 of Article 272, mistakenly believe that only this rule establishes the exporter’s right to a refund of excess VAT, not taking into account the other paragraphs in Article 272 that classify VAT paid during production as refundable,
We believe this view is misguided since it fails to take into account Article 272.
It should be noted that this reflects recent practice. Under the previous Tax Code, VAT refunds were made for VAT accumulated during exploration. Thus Article 251 of the previous Tax Code[4] and Article 272 of the current Tax Code, which both contain the exporter’s right to VAT refunds, do not significantly differ in their content.
We therefore believe VAT refund problems relate more to enforcement practices than to the legislation itself.
Opinion of the Advisory Council
The Advisory Council on Taxation works under the Government of Kazakhstan and its primary goal is to resolve ambiguities and inaccuracies in Kazakhstan tax law. During 2013 the Advisory Council issued two decisions regarding the interpretation of Article 272 of the Tax Code, which, in our opinion, are contradictory.
According to the decision of 31 January 2013, the Advisory Council confirmed the taxpayer’s right to refund excess VAT accumulated prior to zero turnovers. This decision was addressed to companies engaged in international shipping.
Let us recall that under the Tax Code, international shipping, as well as the export of goods, is subject to zero rate VAT. The procedure for refunding the excess VAT for shipping companies and exporters is single, i.e. the shipping companies refund the excess VAT from the budget also under a procedure prescribed in Article 272 of the Tax code.
Later on 17 October 2013 the Advisory Council issued another decision on the refund of excess VAT, where they explained that the procedure for refunding excess VAT accumulated in connection with field development prior to the export of goods, that is, prior to the zero turnovers, is not regulated in the tax law.
The Advisory Council confirmed that companies engaged in international shipping have the right to a refund of the excess VAT accumulated prior to the zero rate turnovers; however, they did not confirm this right in respect of subsoil users exporting minerals. The conditions and procedure for exercising the right to the refund of the excess VAT are regulated by Article 272 of the Tax Code, which stipulates the same conditions for all taxpayers, regardless of the nature of business.
Thus it seems the provisions of Article 272 of the Tax Code are unequally applied to entities, which contradicts principles enshrined in the Kazakhstan tax law and the Constitution.
The Courts’ Stance
The Supreme Court of Kazakhstan supports the tax authorities’ position. Reasons on which the judgements are based do not differ per se from the explanations of the tax authorities, i.e. the courts believe that only excess VAT accumulated once goods have been exported is subject to refund.
To summarize, the practice of the state bodies is not only illegal, but also results in double taxation of Kazakh domestic goods. Double taxation, in 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 Kazakhstan’s investment image. We firmly believe that one of the most important conditions to create an attractive economic climate in Kazakhstan is predictability and certainty in the field of taxation.
[1] Refund of excess VAT to be offset against the amount of assessed VAT resulting from the acquisition of goods, works and services used for export turnovers will hereafter be referred to as “excess VAT”;
[2] VAT is an indirect tax;
[3] The Code of the Republic of Kazakhstan “On taxes and other obligatory payments to the budget” of 10 December 2008;
[4] Code of the Republic of Kazakhstan “On taxes and other obligatory payments to the budget” of 12 June 2001.