The courts’ position on certain matters of separate accounting for the purchased goods (works, services)

On request by Development Corporation OJSC (former Urals Industrial – Urals Polar Corporation OJSC), the Court of Arbitration of Sverdlovsk Region passed on 09.11.2012 the judgment on the case No. А60-33664/2012 to rule invalid the decisions to refuse to bring the company to tax liability for a tax offence and to refuse to completely compensate the VAT amount. Seventeenth arbitration court of appeal by its judgment dated 30.01.2013 left the ruling by the first instance court in force.

The contested non-normative acts were passed on the basis of the conclusion by the tax administration that the company, in the 2nd quarter of 2011, was not entitled to deduct the VAT amounts paid as a part of general economic expenses in the part involving the operations of production and sale of goods (works, services) that are not acknowledged as taxable object pursuant to clause 21 of the TCRF.

According to the inspectorate, the company illegally applied the provision of paragraph 9 of clause 4 of Article 170 of the TCRF (in the edition that was in effect during the contested period). That provision stipulates the possibility of including the entire amount of “incoming” VAT on purchased goods (works, services) used for taxable and non-taxable operations during the tax period, when the share of total expenses on the production of goods (works, services), the operations of sale of which are not taxable, does not exceed 5% of the total general production expenses, among the tax deductions.

The courts did not agree with the conclusions of the tax authority. They pointed out that said provision of the TCRF stipulates the taxpayer’s right to not apply clause 4 of Article 170 of the TCRF. This includes not keeping separate accounts of the tax amounts on purchased goods (works, services) used for taxable as well as not taxable operations. Also, said provision allows including the entire amount of “incoming” VAT on such purchased goods (works, services) used for taxable and non-taxable operations during the tax period, when the share of total expenses on the production of goods (works, services), property rights, the operations of sale of which are not taxable, does not exceed 5% of the total general production expenses, among the tax deductions.

According to the tax authority, based on the value of the sold goods (works, services), the operations of sale of which are taxable (exempt from tax), the share of non-taxable operations of the company of the total value of the goods (works, services) soled during the tax period was of 87,9 %. This does not allow application of paragraph nine of clause 4 of Article 170 of the TCRF. After that, the inspectorate applied said proportion for allocation of the entire VAT amounts, including expenses directly related to the taxable activity.

The courts dismissed the inspectorate’s arguments and pointed out that the tax authority’s calculation is wrong: the inspectorate did not study the share of total expenses on the production of goods (works, services), property rights, the operations of sale of which are not taxable, in the total amount of general production expenses during the checked period. The check for compliance with the criterion fixed by paragraph 9 of clause 4 of Article 170 of the TCRF takes into account not the volume of operations that exempt from taxes but the expenses related to them. Also, the courts pointed out that only the VAT amounts on the expenses, which definitely cannot be classified as a certain kind of activity (taxable or otherwise), are to be allocated in proportion to the proceeds (if the organization does not comply with said criterion).

The study of the proof submitted to the case materials showed that the taxpayer had confirmed that his expenses on the operations not taxable by VAT had not exceeded 5% of the total production expenses. In this connection, the tax amounts payable by him were to be fully deducted according to the procedure fixed by Article 172 of the TCRF. The account policy of the organization for taxation purposes described in full detail the allocation of general economic expenses (rent, salaries of the management etc.) between taxable and non-taxable activities. This was an important point in the favor of the position defended by attorneys of the Law Firm "YUST".

Based upon the results of consideration of said case, the Federal Court of Arbitration of the Urals District passed the resolution dated 24.05.2013 on leaving the court acts ruling in favor of the taxpayer unchanged and dismissing the cassation appeal of the tax authority. The limitation period for contesting court acts on the case with the Higher Court of Arbitration of Russia has expired.

Therefore, the position of the courts of arbitration on several debatable matters of VAT taxation at once, which many taxpayers face, was fixed during the case. This is particularly important for those organizations, whose main income during a tax period was received from non-taxable operations with small expenses, while the income from the main (taxable) activity, which requires more expenses, was for some reason insignificant.