Azerbaijan Tax: 2010 changes to Azerbaijan Tax Code

The Azerbaijan Tax Code, one of the government's most powerful tools for achieving the country's fiscal goals and regulating the economy, has been updated on a regular basis since its adoption in 2000. This year is no exception and, on 19 June 2009, the President signed the law "On Changes and Amendments to the Tax Code" (Law), which contains, inter alia, measures relating to the taxable base, tax rates and tax administration. The following highlights some of the most important changes introduced by the law, which becomes effective on 1 January 2010.


Tax rates

In line with tax cuts taking place in other countries, the government has reduced the standard profit tax rate from 22% to 20%. This lower rate complements a previously introduced exemption from profit tax for financial institutions - a law adopted by the Parliament in October 2008 provided a partial profit tax exemption for banks, and insurance and reinsurance companies directed to increase their charter capital beginning 1 January 2009. Both measures are viewed as means to ease the financial burden on taxpayers.

The June 2009 Law also introduces a new article 101.3 in the Tax Code, which provides that income of individual entrepreneurs will be taxed at 20% (the same rate that applies to companies), so that the rates in article 101.2 will apply only to an individual's non-entrepreneurial income. Once the Law is in effect, the tax treatment of individual entrepreneurs and corporations will be equalized, eliminating the disparity in rates as a consideration when choosing whether to do business as a corporation or freelancer.

The long-awaited reduction of the personal income tax rate has been a disappointment for both local and expatriate employees. Even after the reduction of the upper level of the personal income tax rate from 35% to 30%, Azerbaijan still has the highest personal tax rate in the Commonwealth of Independent States (CIS). In addition, the mandatory social insurance contributions of 25% of the gross salary of an employee (22% of which is born by the employer) makes payroll costs for companies a serious financial burden.

Over the last three to four years, most CIS countries have radically decreased personal income tax rates with the aim of boosting tax collections, and the experiences of Russia, Ukraine and Kazakhstan boldly demonstrate that the tax cuts were  justified and have improved the attractiveness of investing in those countries. While it is difficult to understand the specific reasons for the Azerbaijan government's resistance to easing the personal tax burden, it can be explained in part by the desire to collect as much tax as possible from highly compensated expatriates employed primarily in the oil and gas sector.


Market price

Although transfer pricing is not a widely applied practice in Azerbaijan, there are rules and the tax authorities have begun to apply them. For example, under article 14.3 of the Tax Code, the tax authorities are allowed to make transfer pricing adjustments in the following cases:
- Barter (swap of goods) and import-export operations;
- Transactions between related parties; and
- Where there is a price deviation of more than 30% (either side) from the pricing level applied for the same or similar goods, works or services within 30 days from the date the transaction was entered.

The new Law expands the cases where a transfer pricing adjustment can be made to include the situation in which a taxpayer's property is insured for an amount exceeding its residual value. In connection with this change, the taxable base for purposes of the assets tax has been amended. Thus, if property is insured for an amount exceeding its residual value, the assets tax (which is levied at a rate of 1% of the average annual residual value of fixed assets) will be calculated according to existing market prices. Further, any part of the insurance expense relating to property whose residual value is less than the insured amount will be scrutinized by the tax authorities and such expenses may not be deducted in computing taxable income.


VAT

The Ministry of Finance initially proposed a reduction of the VAT rate from its current 18%, but the Ministry of Taxes opposed the measure because VAT is the second highest tax revenue raiser. Thus, the VAT rate will remain unchanged. Further exemptions from VAT have been introduced, however, and the list of tax-exempt supplies will include preschool education services. Additionally, the mandatory VAT registration requirement will be calculated on a consecutive 12-month basis rather than a three-month period, with the amount of taxable supplies triggering registration set at AZN 90,000 for individuals and AZN 150,000 for legal entities (representing a higher threshold for legal entities from the currently applicable AZN 22,500 per three-month period).

The Azerbaijan tax authorities have made considerable progress in transitioning to electronic tax administration - annual tax liability declarations have been made via the Internet for two years already. The new Law extends electronic administration to VAT, so that beginning 1 January 2010, electronic VAT invoices rather than paper invoices must be issued. However, the Cabinet of Ministers has not yet set out applicable procedures or requirements for electronic invoicing.

Measures to minimize VAT fraud and abuse and prevent the leakage of funds from the state budget were introduced as from 1 January 2008; according to these rules, to be recoverable, input VAT must be paid through a VAT deposit account administered by the government. This measure has created a flow of VAT through accounts transparent to the tax authorities and thus far has proved to be an efficient measure in combating VAT fraud. It is almost certain that the electronic administration of tax invoices will further strengthen the VAT administration and considerably enhance the authorities' ability to control VAT flows in the country.


Assets tax

According to the revised version of article 222.0.3 of the Tax Code, if an enterprise is liquidated or becomes a simplified taxpayer during the reporting period, the taxable base for purposes of the assets tax will be calculated by (1) adding together the residual value of fixed assets at the beginning of the year and at either the date of liquidation or the date the taxpayer became a simplified taxpayer; (2) dividing the result by 24; and (3) multiplying the second result by the number of months from the beginning of the year until the month the enterprise was liquidated or became a simplified taxpayer.


Simplified tax

The current tax regime allows legal entities and individuals engaged in entrepreneurial activities with taxable supplies up to AZN 22,500 in a three-month period and which are not registered as VAT payers to pay a simplified tax. The simplified tax is 4% and 2% of gross revenue for Baku, the capital, and the surrounding regions, respectively. Individual entrepreneurs that pay the simplified tax are exempt from profit tax, VAT, assets tax and personal income tax.

Corresponding to the change in the VAT registration threshold, the maximum amount of taxable supplies to qualify for the simplified tax has been amended to provide that legal entities and individual entrepreneurs with taxable supplies up to AZN 150,000 and AZN 90,000, respectively, and those that are not VAT payers for a consecutive 12-month period, are eligible to become simplified taxpayers. These changes further enhance the attractiveness of the simplified tax regime and hopefully will encourage the small entrepreneurship that is so vitally important to the well being of the economy.


Tax declaration

Legal entities and entrepreneurs that are registered for VAT purposes and simplified taxpayers paying employment income to individuals must submit appropriate tax declarations to the tax authorities before 31 January of the year following the reporting year. Currently, this reporting is done on a quarterly basis.


Penalties

The Law makes several amendments to the penalty provisions in the Tax Code. Article 58.6 has been revised to clarify that VAT must be paid on the same day payment is made for goods (works and services). A penalty equal to 50% of the overdue amount will apply for failure to comply.

The requirement for banks to make payments in accordance with the order of priority established by legislation has been strengthened: the 20% penalty calculated against the amount of any transactions carried out in violation of the priority order is increased to 50%. A change favorable to the taxpayer, however, provides that calculation of late payment interest applied to overdue tax payments will be limited to one year for all tax payments.


Conclusion

The Law is notable in other respects in that the 2010 changes to the Tax Code were adopted earlier than usual, giving sufficient time to prepare for their implementation on 1 January 2010. Moreover, the Law changes the deadline for the administration to submit its future tax proposals to Parliament from the current date of 15 May to 1 May. This perhaps indicates the administration's willingness to make any tax policy changes by mid-year, which naturally will require having those changes drafted and discussed in the first months of the year.

The Law complements the government's efforts in the tax policy area over the last year, which resulted in the law granting a partial profit tax exemption to banks and insurance and reinsurance companies, as well as a law addressing the application of the special economic regime to export-oriented oil and gas activities. Like these laws, the 2010 changes to the Tax Code will undoubtedly benefit taxpayers. However, the most important area in which taxpayers in Azerbaijan will look for assistance is tax administration, with tax audits being the priority issue.

TAX NEWS - SEPTEMber 2009

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