Subject: Deduction of expenses related to audit of the financial statements by business entities

Deduction of expenses related to initiative audit for the purposes of Corporate Income Tax (CIT).

Author: Gaukhar Narbekova, MinTax Group Partner, Certified Auditor, Member of “Auditors’ College” PAO, DipFR (ACCA), CIPA Certificate, Qualification certificate of the Tax Consultant, Member of the Auditing Committee of CTC RK. This material is subject to copyright. Reprinting and other use is prohibited by the copyright holder. This material expresses the author’s opinion and is a recommendation. This material is based on regulatory acts in force at the time of publication.

Recently, as a result of tax audits performed, it frequently happens that additional CIT amounts are assessed by cancelling deductions of taxpayers’ expenses related to their business activity, which, in the opinion of the inspectors of the state revenue authorities, are deemed to be expenses not related to activity aimed at earning income, and are to be eliminated from deductions in accordance with sub-paragraph 1) Article 115 of the Code of the Republic of Kazakhstan # 99-IV dated 10 December 2008 «On Taxes and Other Obligatory Payments to the Budget” (the Tax Code).

It should be noted that the Tax Code does not contain definitions of “expenses not related to activity aimed at earning income”, and “expenses related to activity aimed at earning income”.

However, in accordance with paragraph 1 of Article 2 of the Entrepreneurs’ Code of the Republic of Kazakhstan dated 29 October 2015 No. 375-V (“Entrepreneurs’ Code”), entrepreneurship is an independent, initiative activity of citizens, oralmans and legal entities aimed at earning net income through the use of assets, production, sale of goods, performance of works, provision of services, based on the right of private property (private entrepreneurship), or on the right of economic management or operational management of the state enterprise (state entrepreneurship). Entrepreneurial activity shall be carried out on behalf of, under the risk, and under the property liability of the entrepreneur.

According to paragraph 1 of Article 100 of the Tax code, expenditures of a taxpayer connected with the performance of activities aimed at earning of income shall be subject to deduction when determining the taxable income, except for the costs which are not subject to deduction in accordance with Tax Code. However, in cases as specified by Tax Code the amount of costs referred to deductions shall not exceed the established norms. Based on paragraph 3 of Article 100 of the Tax code, deductions shall be made by the taxpayer in the availability of documents confirming the costs connected to his activity aimed at earning of income. These costs shall be subject to deduction in that tax period in which they were actually incurred, except for the costs of future periods, to be determined in accordance with the international financial reporting standards (IFRS) and requirements of the legislation of the Republic of Kazakhstan on accounting and financial reporting. Prepaid expenses shall be taken as deductions in the tax period to which they apply.

According to sub-paragraph 3) of Article 1 of the Law of the Republic of Kazakhstan “On Auditing” (hereinafter – “Law on Auditing”), audit means verification for the purpose of expression of independent opinion on financial reporting and other information, linked with financial reporting, in accordance with the legislation of the Republic of Kazakhstan. Further, according to Article 5 of the Law on Auditing, the types of audit are compulsory and initiative. Among those subject to compulsory audit are public interest entities as well as financial, insurance, and other entities specified in paragraph 2 of Article 5 of the Law on Auditing. All other entities which are not listed in paragraph 2 of Article 5 of the Law on Auditing are entitled to conduct audit of financial statements which is defined as initiative audit.

According to Article 4 of the Law of the Republic of Kazakhstan “On Accounting and Financial Reporting” (hereinafter the “Law on Accounting”):

• Small business entities, as well as legal entities whose exclusive activity is the organization of exchange transactions with foreign currency, shall prepare financial statements in accordance with the national standard, unless otherwise provided by this article.
• Medium-sized business entities, as well as state enterprises based on the right of operational management (state-owned enterprises), shall prepare financial statements in accordance with the international standard for small and medium-sized businesses, unless otherwise provided for by this article.
• Large-scale businesses and public interest organizations are obliged to prepare financial statements in accordance with international standards.

Article 4 of the Law on Accounting states that the purpose of accounting and financial reporting is to provide all concerned parties with complete and reliable information about financial position, results of operations and changes in financial position of individual entrepreneurs and entities.

At the same time, when conducting both compulsory and initiative audit, the purpose of the audit is to verify whether or not the financial statements compiled for the entity’s entire activity for the reporting period (both aimed and not aimed at earning income) conform to the basis for their presentation specified in the Law on Accounting. Financial statements can not be separated by types of activities of the reporting entity.

According to paragraph 1 of Article 15 of the Law on Accounting, financial statements, except for the statements of government institutions, shall comprise the following:

1) balance sheet;

2) income statement;

3) statement of cash flows;

4) statement of changes in equity;

5) explanatory note.

The procedure for preparing financial statements and additional requirements to them are established in accordance with the international standards, the international standard for small and medium business and the requirements of the legislation of the Republic of Kazakhstan on accounting and financial reporting.

Thus, the costs of conducting an audit, both initiative and compulsory, are directly related to activities aimed at earning income, since the subject and purpose of such services is to verify whether or not the financial statements compiled for the entity’s entire activity for the reporting period (both aimed and not aimed at earning income) conform to the basis for their presentation, in particular – IFRS, the National Financial Reporting Standard or IFRS for small and medium business entities.

That is, due to the fact that the entity’s financial statements comprise all revenues and expenses for the reporting period, then expenses incurred to engage a licensed auditor to provide services to verify the correctness of their recognition in the financial statements can not be qualified as expenses on activities not related to earning income.

Conclusions contained in the tax audit report resulting from exclusion from deductions can be appealed to a superior state revenue body or to the court, as non-conforming to the norms of the Tax Code.