The volume of the Tax Code of Azerbaijan has doubled with regard to the number of words and pages since its effective date of Jan. 1, 2001. For comparison, other codes (such as the Code for Civil Procedure, Employment Code, and Civil Code) have been expanded and modified at most by about 20% to 30% from their original volume. Taxation, being by nature very dynamic, is not comparable with these other areas; however, such an extreme contrast in the number of changes may provide certain indications.
The tax code, which was based on the IMF draft tax code of “Taxastan,” has been repeatedly amended almost on a yearly basis in order to meet contemporary economic and business needs, and particularly international tax developments. However, the structure and the number of articles (225) has been virtually maintained, which has created further conceptual, structural, and interpretational complications. Unlike Azerbaijan, other countries using similar tax law formats, such as Kazakhstan, Georgia, and Kyrgyzstan, have adopted modernized new tax codes.
Fast-forwarding to Oct. 26, 2022, Azerbaijan officially joined the OECD/G-20 BEPS project as an associate member. Before such official undertaking, international measures such as transfer pricing rules, a general-anti avoidance rule, and country-by-country reporting mechanism were adopted. On March 12, 2021, Azerbaijan signed the Multilateral Competent Authority Agreement on the Exchange of Country-by-Country Reports—commencing the automatic exchange of information AEOI standard voluntarily and rapidly since 2017 and delivering the first exchanges in 2018.
As an initial step against offshore profit shifting, an additional 10% withholding tax deduction from payments made to low-tax jurisdictions has been applicable since 2017. Effective from 2022, as an additional measure, controlled foreign company rules were introduced into the tax code and the regulations regarding its procedure, and filing forms were adopted on April 19, 2022 by the Ministry of the Economy.
As a small emerging Eurasian economy willing to attract foreign investment and expand international tax cooperation, Azerbaijan has been successful in the international tax development area, with 55 effective double tax treaties already and several more currently being negotiated. The vast majority of DTTs are based on the Organization for Economic Co-operation and Development standard treaty forms.
We can see a rapid, and at the same time piece-meal, integration into the international tax regime and harmonization of tax law measures. One of the vital areas still pending improvement, clarity, and simplification, is the resolution of tax disputes—both conceptually and procedurally.
Conversely, in light of underdeveloped tax law concepts, such haphazard and diverse international initiatives could be seen as arming tax authorities with an additional arsenal. Against the backdrop of 85% to 90% of tax disputes being decided in favor of the tax authorities by the courts, the implementation of new developments will be under strict scrutiny.
It is therefore important to be attentive in the administration of tax affairs and not to assume the same understanding of concepts and details as could be expected in international practice. I will elaborate on this with certain examples below.
Some Issues to Consider
Implementation of Double Tax Treaties
Where no taxes are to be paid in Azerbaijan under a DTT, a prior approval mechanism is applied under the Rules of Administration of International Agreements on the Elimination of Double Taxation. If a foreign resident intends to benefit from treaty exemptions, it must apply with form DTA-03 and obtain a “permission letter” from the tax authority before the actual transaction. If no such permission letter is obtained, taxes must be deducted and paid in Azerbaijan.
Under the explanatory statement of the state tax service, in case of quarterly payments, where such DTA-03 application is lodged 20 days before the end of the same quarter, all payments in the same quarter (including those prior to the application date) would be considered as covered under the same application for exemption purposes.
However, the nonresident is authorized to demand the refund of such payments, again via another similar procedure, by obtaining the approval of the tax authority using form DTA-05 post transaction.
All these processes are accompanied by certain technical difficulties in practice—such as translation of documents, review of passport copies of employees to determine permanent establishment matters, exact matching of figures on invoices, contracts, bank payment documents, and applications for the refund.
According to the explanatory statement, the application form DTA-05 shall be rejected where the paid withholding taxes of the nonresident in question have already been considered as a tax-deductible expense of the resident taxpayer.
Anti-Avoidance
A tax avoidance scheme is defined as “any transaction or operation conducted for the purposes of obtaining tax benefit,” where “tax benefit” is “avoidance of paying taxes in the amounts and periods defined by the tax code, where no actual economic figures are altered.” This vague anti-avoidance formulation in the tax code clearly lacks conceptual foundation and is extremely wide. By definition, many genuine tax planning schemes would be covered by this clause, even if they have substantiated economic substance or business needs, and neither in the law nor in the case law (which does not exist in this regard), have additional tests or doctrines been developed.
Another similar concept unique to local practice is the notion of “high-risk taxpayer” and “high-risk transactions,” primarily intended to eliminate “no-commodity transactions,” where taxpayers simply transfer funds without exchanging any service or goods. In order to be considered as high–risk transactions, such transactions must serve to conceal another transaction and obtain profit without actual delivery of goods, services, and works. Taxpayers involved in high-risk transactions are considered as high-risk taxpayers.
Here again, we see wide criteria. The following cases could be perfectly ordinary business circumstances but, at the same time, the taxpayers may be regarded as high-risk taxpayers:
- Individuals who are the head of the executive body of more than five legal entities, and the legal entities in which they are the head of the executive body;
- Where the volume of goods imported or purchased for sale purposes for the last six months is at least three times higher than its turnover for the relevant period (except for cases where the goods are ordered in advance and are to be delivered by the taxpayer within the period specified in the contract, as well as depending on the seasonal nature of the goods)
- Other legal entities which are incorporated or managed by high-risk taxpayers.
These could be considered as special avoidance rules, on their face serving to comply with international avoidance rules and practices. However, unlike well-known avoidance concepts, such rules lack conceptual merit; it is not clear under which test and criteria such cases could be characterized as high-risk transactions or high-risk taxpayers.
Permanent Establishment
Among the most debated international tax issues are those related to the criteria for “permanent establishment.” Usually, representative offices of multinational enterprises conduct market research, advertising, and related representative functions. However, the boundary between such operations and actual business operations is not always determined in practice. It has been the longstanding position of the tax authority that collection of information for sales purposes or market research is part of business operations, and therefore could be characterized as a permanent establishment when duration requirements are met.
Effective from 2022, the tax code has been amended to include “collection of client information and organization of work with the clients on behalf of the enterprise in Azerbaijan” to amount to performing business functions of the company, that is, giving rise to a permanent establishment in Azerbaijan.
In practice, market research and analysis, or certain aspects of representative functions, could be deemed to fall under “collection of client information” (database) and “organization of work with the clients,” respectively. However, the OECD Commentary does not define “auxiliary and preparatory” works to include these activities, and further, it mentions supplying of information, gathering market data, without restricting client information, as examples of cases where no permanent establishment is deemed to be created.
Since the boundary has now been clarified, in the absence of a DTT in place it would be risky to be involved in such operations. We need to see how this clause will be interpreted in the future.
From the above examples, and numerous practical situations, particularly where specific details have become of the utmost importance, we can observe the unique local application of international tax measures.
Points to Consider for Foreign Enterprises
- Many newly introduced mechanisms (transfer pricing, country-by-country reporting, controlled foreign company rules, etc.) still require proper tax administration and may cause misunderstandings between a foreign enterprise and tax officials (capacity building at the tax authority is still being carried out);
- The Ministry of the Economy, which oversees the state tax service, is modernizing the tax system and administration, and also hears tax appeals from the state tax service. Where a case fails at state tax service level, the ministry is usually preferred over the courts in tax disputes;
- Multinational enterprises should check the DTT and its contents, since DTT texts differ. In the absence of a DTT, be extremely cautious about the functions of the representative office in Azerbaijan (functions in reality and functions/job positions of employees, nature of local agreements);
- Where a DTT is in place, plan utilizing treaty benefits months in advance, since the procedure and organization of an application for obtaining a permission letter from the tax authority could be delayed;
- Where a DTT is in place, consider the treaty benefits and utilization form in the relevant contracts with the resident entities, focusing on obtaining documentary and information support from them, as well as discussing and deciding the situation where DTA-03 fails and the resident entity intends to specify withholding tax payments as its tax deductible expense;
- Taxpayers should be ready to comply with the new requirements, tax filing and reporting obligations (forms, procedure, and deadlines), stemming from international tax developments recently introduced in the tax code, particularly considering deadlines, since these would need to be aligned with the head office and its filing deadlines;
- Taxpayers should not take for granted that an internationally well-known concept will be identically applied locally—they should always seek and learn local practice via official clarification letters from the tax authority;
- Note that official clarification letters will not always be very specific and may not tend to provide clear answers or interpretation, since only courts are authorized to officially interpret the laws. Where official position or calculation of taxes in advance is required, the advance tax ruling (which is a legally enforceable decision) mechanism could be utilized.
- Where longstanding local practice would hint at a particular position or result—for example, that the majority of tax refund applications are rejected or delayed, certain situations are considered as not falling under the value-added tax 0% regime—even where these are supported by evidence from tax consultants (usually accountants), taxpayers should not take for granted the same result or base their legal position on this. The tax administration is continuously improving and intending to hear legal arguments.
Azerbaijan is interested and successful in international tax cooperation. The expectation is that the speed of fundamental tax developments in Azerbaijan—concepts, principles, due process, tax administration— should match that of international tax developments.
In particular, a modern tax code, and doctrinal case law in the area of taxation, would be very much welcome.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
Farid Nabili is managing partner at Caspian Legal Center, a law and tax advisory company in Baku, Azerbaijan. Nothing in this article is intended to be legal advice or relied upon as legal recommendation, opinion or statement. All opinions are those of the author and are not associated with Caspian Legal Center.
The author may be contacted at: f.nabili@caspianlegalcenter.az