02 september 2009

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Pre-trial Settlement of Tax Disputes

Obligatory extrajudicial procedure for settlement of tax disputes: first experience.

Extrajudicial procedure for settlement of tax disputes actually consists of three stages:

Extrajudicial settlement in a tax authority with which the taxpayer is registered with (consideration of tax inspection materials).
Extrajudicial settlement in a higher-level tax authority (appeal proceedings).
Contesting of decision of a lower-level tax authority which came into legal force, in a higher-level tax authority (optional stage being beyond of the scope of this article).

I. Extrajudicial Settlement in a Tax Authority with Which the Taxpayer is Registered with (Consideration of Tax Inspection Materials)

1. Procedure for consideration of the act of inspection and materials of inspection executed by a lower-level tax authority is regulated in details and has not been recently conceptually changed (Art. 101 of the Tax Code of the RF).

2. On a global basis this procedure provides a required level of protection of a taxpayer's rights: he has right to be present at hearing, speak, produce documents (including new documents which tax authority did not request during the tax inspection).

3. In most of cases we consider we consider participation of a taxpayer's representatives (lawyer and accountant) in consideration of tax inspection materials by the executive of the tax authority to be expedient, reasonable and necessary.

It is clear that consideration of tax inspection materials by the executive of the tax authority (his deputy) is not free from affection or ill-will, the purpose of the tax authority is to accrue the amount of taxes payable and by no means rendering of a lawful and well-founded decision.

Nevertheless, even using such a biased approach to consideration of a taxpayer's objections, participation of a taxpayer's representatives in consideration of tax inspection materials allows to:

eliminate apparent errors (arithmetic or errors in facts) from the decision of a lower-level tax authority on bringing to tax liability;
change the position of tax authority being expressed in the inspection act (in fact, the position of the specific inspector executing the inspection) if the law was applied apparently incorrectly or the arbitrazh practice is undoubtedly different from this position.

II. Extrajudicial Settlement in a Higher-Level Tax Authority (Appeal Proceedings)

1. Upon January 1, 2009, contesting in court of decisions to bring a taxpayer to tax liability or refuse to bring a taxpayer to tax liability is allowed only upon preliminary recourse to a higher-level tax authority: thus, the law in this case provides for the obligatory out-of-court procedure.

Moreover, the obligatory extrajudicial settlement procedure has been introduced partly and inconsistently: it is set only for two types of decisions provided by the law, it does not provide for the obligatory extrajudicial settlement with respect neither to the other types of decisions of the tax authority, nor actions (omissions) of the tax authority.

2. The declared purposes for introduction of the obligatory extrajudicial settlement are mostly related to state interests: they are to decrease the judges' workload, to speed and make justice cheaper.

As early as in 2005 the Chairman of the Supreme Arbitrazh Court of the RF A. Ivanov pointed that "the obligatory extrajudicial settlement procedure" is one of the means to decrease the courts'' workload. Ivanov believes that "these arrangements, being widely used, will allow to speed and make justice cheaper for the state and, what is even more important, for the citizens".

Principal point: protection of the taxpayer's rights either is not mentioned as a purpose for introduction of the obligatory extrajudicial procedure for settlement of the tax disputes, or it is placed as being the secondary purpose.

A significant decrease of the courts' workload, as a purpose for introduction of the o obligatory extrajudicial procedure for settlement of the tax disputes, did not happen. According to the SAC of the RF, during the first half of 2008 arbitrazh courts tried 49 605 tax cases compared to 43 252 cases during the first half of 2009 (only 12,8% more).

3. Introduction of the appeal proceeding has not resulted in any significant decrease of the amount of tax disputes cases being tried in court because the current procedure for appeal examination of the decisions of the lower-level tax authorities decisions is ineffective and it does not allow the taxpayer to protect his rights in full due reasons:

3.1. Now the consideration of the taxpayer's complaint by the higher-level authority is conducted in a closed session being beyond the control of any authorities, including the judicial authorities.

The revised Rules for consideration on an extrajudicial basis of applications and complaints of legal entities and individuals on actions (omissions) and individual acts of the tax authorities of the Russian Federation, approved by the Order of the Federal Tax Service of the RF №SАE-4-08/44dsp@, dated March 24, 2006, marked as "Restricted".

Previously the similar Rules approved by the Order of the Federal Tax Service of the RF №BG-3-14-/290, dated August 17, 2001. Subpara. 1 of para. 8.3. of these Rules entertained a possibility for the tax authorities to call the taxpayer "where there is sufficient reason to believe that the act, action or omission being contested is not in compliance with the legislature of the RF".

However, the 2001 Rules were repealed by the Order of the Federal Tax Service of the RF №SAE-4-14/44dsp@, dated July 16, 2004.

It is illustrative that the 2001 Rules, the officially publicized normative act, was repealed by the order marked as "restricted", which was neither publicized nor registered anywhere.

Upon 2004 the respective rules for consideration of the taxpayers' complaints are introduced and repealed by the orders of the Federal Tax Service of the RF marked as "restricted", they are unknown to the taxpayers.

Moreover, the Federal Tax Service of the RF itself admits ineffectiveness of the existing legal regulation of consideration of the taxpayers' complaints. In the Letter of the Federal Tax Service of the RF №MM-9-3-/63, dated June 2, 2008, the tax authority admits that: "...the named Rules do not set any normative rules obligatory for the participants of the respective legal relationships, it is an entirely internal document of the tax authorities, and in some cases the controversy and successive lawsuits incurred as a result of its use. Thus, the issue of lack in specific rules s the procedural order for consideration on an extrajudicial basis of applications and complaints of individuals and legal entities on actions (omissions) of the officials of the tax authorities, including individual acts of the tax authorities of the Russian Federation, is still an issue of urgency. It includes specifically the absence of the Tax Code of the RF explicit and exhaustive provisions on the proceedings for extrajudicial consideration of the taxpayers' complaints by the tax authorities".

In view that the procedure for extrajudicial contesting of the decisions of the tax authority is obligatory, the Rules for consideration of the decisions of the tax authority on an extrajudicial basis shall be a document in a public domain (public document): it shall be registered with the Ministry of Justice of the RF and publicized in accordance with the established procedure.

3.2. The principal defect of the procedure for consideration of the taxpayers' complaints by the higher-level tax authority is that the taxpayer is not present during this proceedings.

The Tax Code of the RG does not explicitly provide for the tax authority's duty to notify the taxpayer on date and place for the consideration of his complaint and make arrangements for his presence during the consideration of the complaint.

Accordingly, as a practical matter he taxpayer is deprived of possibility to participate in the consideration of his own complaint, produce documents, make parol explanations, file motions (for example, a motion to conduct examinations, for examination of witnesses) and exercise his other procedural rights similar to those provided him in case of the consideration of the inspection act and tax authority's tax inspection materials (Art. 101 of the TC of the RF).

In legal literature an interesting and reasonable proposal has been maid that it is expedient for the taxpayer when filing the complaint to request the higher-level tax authority in written to ensure his presence. The Tax Code of the RF does not forbid such motion and at the very least supposes this taxpayer's motion to be considered.

Furthermore, the Ruling of the Federal Arbitrazh Court of Povolzhsky Okrug in the case №А12-10757/2008, dated February 2, 2009 invalidated the decision of the higher-level tax authority on the appeal of the taxpayer solely on the grounds that the taxpayer who requested the appeal consideration to be conducted in his presence, however was not notified by the tax authority on place and date of the consideration of the complaint. In the Decree of the SAC of the RF in the case №SAC-6140/09, dated June 24, 2009, the court refused to refer the case review by way of judicial supervision in view that three of the SAC of the RF judges upheld the position of the lower-level courts, pointing that the arbitrazh courts were guided by Art. 45 of the Constitution of the RF (Everyone shall have the right to defend his or her rights and liberties by any means not prohibited by the law), subpara. 7, para. 1, Art. 21 of the Tax Code of the RF (providing for the general right of the taxpayer to provide explanations to the tax authorities and their officials on the calculation and payment of taxes and fees), and proceeding from the statement that all unremovable doubts, contradictions and ambiguities of legislative acts relevant to taxes and/or fees, including those related to the taxpayer's rights in appeal proceedings) shall be interpreted in favor of taxpayer (para. 7, Art. 3 of the TC of the RF).

3.3. The laws do not provide for explicit and exhaustive procedure for extrajudicial consideration of the taxpayers' complaints by the tax authorities.

Even the tax authority already mentioned in the Letter of the Federal Tax Service of the RF №MM-9-3-/63, dated June 2, 2008, admits that "apart from the indication that the complaint is considered by the higher-level tax authority, provisions for the type of the final decision and the terms for the consideration, the law does not provide for the procedural rules of proceedings on the extrajudicial consideration of the complaints".

The rules of Нормы Chapter 19 and 20 of the Tax Code of the RF do not provide the answers on several practical questions arising during consideration of the complaints by the tax authorities, including:

procedural formalization of the beginning (closing) of the procedure for consideration of the complaint;
the procedural rights and responsibilities of the applicant during the extrajudicial consideration of the complaint;
the procedural rights and responsibilities of the tax authorities (officers of the tax authorities) during preparation of and the extrajudicial consideration of the complaint;
the grounds for discontinuance of the consideration of the complaint in the presence of circumstances barring proceedings;
what requirements, in form and substance should satisfy the complaints;
what evidence and in which procedure proves the authority of the applicant как и чем or his legal or authorized representative;
the consequences of the complaint being dismissed;
procedure for calculation of deadline for consideration of the complaint (suspension of the time limit with connection to the request of information from the third parties);
new methods of calculation of the time periods for the cases when the applicant produces new documents and arguments;
the competence of the tax authorities in consideration of the complaints;
reconsideration of the decision of the tax authorities upon discovery of new circumstances, etc.

The following legal gaps should be added to those indicated by the tax authority: first, no regulation of the possibility for the higher-level tax authority to revive the time period for appeal when the applicant let the time limit elapse on the basis of valid excuses; second, absence in the legislature of the provision on the possibility (either right or duty) of the tax authority to receive any other (new) evidence on case, for example, request various authorities to present documents, conduct the examination of witnesses, appoint examination, etc.

3.4. The consideration of the appeal complaint apparently can not ensure objective and impartial reconsideration of the decision because the principal purpose of the higher-level tax authority, as well as the lower-level authority, is a "budgetary recharge".

So far there is no statistic figures on the amount of the taxpayers' appeal complaints filed and satisfied. However, on December 26, 2008 V. Lizunov, the Head of the Department of Tax Audit of the Department of the Federal Tax Service in Sverdlovsk region cited the following statistics of consideration of regular taxpayers' complaints: in 2008 the Department of the Federal Tax Service in Sverdlovsk region proceeded 1119 complaints, 47% out of them were satisfied, in other words, the decisions on 528 complaints having been considered by the lower-level tax inspections were repealed (revised) or declared to be in non-compliance with law.

I believe that the figure of 47% of repealed (revised) decisions of the tax authorities is unrealistic being not in conformity with reality.

3.5. The Tax Code of the RF does not prohibit the appeal contesting by the tax authority that would worsen the taxpayer's position.

At first sight, the meaning of the administrative contesting is to cure the violation of the taxpayer's rights, nevertheless, as it has been already indicated, protection of taxpayer's right is not declared to be the purpose of introduction of the obligatory extrajudicial procedure for settlement of tax disputes.

Accordingly, as the case study shows, apart from curing the violation of the taxpayer's rights, it is within the realm of possibility that "the higher-level tax authority undertakes to correct the mistakes" of the lower-level authority, including strengthening the arguments, elimination of the arithmetic errors of the lower-level inspection, correction of errors in qualification of offenses, etc.

Case study proves that such situations are common, for example:

following consideration of the complaint, the Deputy Head of the Department of the Federal Tax Service of Russia decided to increase the amount of the tax sanction provided under Art. 123 of the Tax Code of the RF, and reaffirmed the decision of the tax inspection in all other points (Ruling of the FAC of the Volgo-Vyazhsky Okrug in case №А79-1893/2006, dared September 4, 2006);
in the other case the decision of the inspection of the Department of the Federal Tax Service of Russia changed the qualification of tax offense, from para. 2, Art. 119 to para. 1, Art. 119 of the Tax Code of the RF №А42-1808/2007, dated January 11, 2007;
in on more case the decision of the higher-level tax authority overturned the resolutive part of the decision being contested, to the extent of the amount of penalty due for late payment of corporate profit tax (Ruling of the FAC of the Vostochno-Sibirsky Okrug in case №А78-7292/06-С3-12/392-04АП-4763/07-Ф02-1176/08, dated April 7, 2008).

There are cases when following consideration of the complaints, the amount of penalties and fines due were increased compared to the amounts of the decisions being contested by the taxpayer. Thus, Ruling of the FAC of the Volgo-Vyazhsky Okrug in case №А29-4792/2006А, dated March 1, 2007, asserts: "Pursuant to subpara. 4 of para. 2, Art. 140 of the Tax Code of the RF, following the results of consideration of the complaint against the act of the tax authority, the higher-level tax authority has a right to overturn the decision or make a new decision. It does not appears from the text of this rule that the decision of the tax authority can be changed only to mitigate the tax liability of the taxpayer".

In practice, the listed factors minimize the attractiveness of appeal of decisions for the taxpayers: the only positive of the appeal procedure for the taxpayer is that the decision enters into legal force only upon its consideration by the higher-level tax authority. Moreover, for the taxpayer it is sufficient to file a formal appeal complaint neither being substantially grounded nor reasoned, in order to delay entering into force of the decision. Thereafter the taxpayer can relax and prepare for arbitrazh trial.

Overall conclusion: introduction of the obligatory extrajudicial procedure for contesting of the decision of the tax authority failed to ensure the balance of rights and legal interests of the taxpayer and tax authority; it failed to become an effective means for protection of the taxpayer's rights; it is nothing but the ground for delay in referral of the dispute' to arbitrazh court.

Unfortunately, even now we can not agree with A.Bryzgalin, who back in 2000 in the Commentary to the Tax Code of the RF asserted that: "judicial procedure for contesting together with the simultaneous filing of motion for provisional remedies may be more effective for protection, as far as the possibility for the court as an independent party, to rule in favor of the taxpayer is however higher".

Tax Disputes, Tax Inspections, Tax Law