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published on 19 May 2020 | reading time approx. 8 minutes
The following describes the practice of the local tax authorities which risks the foreign investors, including the German companies operating in the Republic of Kazakhstan, and provides our legal opinion with the further recommendations.
According to the Tax Code of the Republic of Kazakhstan (hereinafter referred to as the “TC”), income of the foreign non-resident legal entities (including the foreign investors), including their income in the form of royalty and remuneration, and those for the services provision and works performance are subject to the corporate tax at a source of payment (hereinafter referred to as the “WT (withholding tax”)1. At that, the Kazakhstani users (receivers) of such works and services provided by the non-residents are the tax agents in relation to the foreign suppliers2. These tax agents are liable for assessing, withholding and transferring the withholding tax to the national budget. In this case, a procedure for exempting or applying the reduced tax rate according to the Conventions “On Avoidance of Double Taxation” is prescribed by the Tax Code. Provisions of these international agreements stipulate the terms and restrictions in terms of taxation of income of residents of other countries in Kazakhstan; such provisions prevail over the local tax legislation.3
Majority of the Conventions, including the Convention between the Federal Republic of Germany and the Republic of Kazakhstan stipulate the possibility for taxation of income of the foreign legal entities in Kazakhstan, if they have formed the permanent establishment within the Republic of Kazakhstan (hereinafter referred to as the “PE”). Moreover this must be noted that the foreign entities may form several permanent establishments within the Republic of Kazakhstan due to their business activities4.
Formation of the permanent establishment requires the non-residents to accomplish a number of conditions, including the maintenance (management) of the branch in the Republic of Kazakhstan, and rendering services within the Republic of Kazakhstan for a period longer than an established one. It is relevant to consider that in many cases the German companies opened their branches in the Republic Kazakhstan for implementing certain projects as well because of the benefits of local foreign exchange regulation and migration laws. These benefits are no longer appropriate.
It is prescribed in the Kazakh Tax Legislation that if the non-resident gains income from the services or works provided under one or related projects, then the tax agent (i.e. local services/works user) must determine whether actions of the non-resident resulted in formation of a permanent establishment within the Republic of Kazakhstan subject to the Article 666.2 of the Tax Code. If a non-resident (foreign) entity has formed a permanent establishment, then the tax agent may not exempt it from taxes or apply a reduced tax rate as prescribed by the international agreement when paying income to the non-resident.5 In a non-resident (foreign) business operator has not formed a permanent establishment, then the tax agent has the right to apply the exemption or reduced tax rate as prescribed by the international agreements when paying income to such business operator.
Most often the provision of the Article 666 of the Tax Code is interpreted by the tax authorities of the Republic of Kazakhstan as a blanket prohibition for the tax agent for applying the withholding tax exemption, if a foreign entity already has a permanent establishment (including the branch) within the Republic of Kazakhstan, in this case referring to the Part 2, Article 666.2 of the Tax Code of the Republic of Kazakhstan which literally states as follows:
Thus, the Kazakh tax authorities often consider that provisions of the Convention must not be applicable even in cases where the foreign investor has the registered permanent establishment in the Republic of Kazakhstan (for example, branch) which was not involved under the related or the same project of an investor anyhow, despite the fact if business activities of a foreign investor lead to formation of a new permanent establishment.
The tax authorities also often do not consider the existing facts in each individual case, they do not consider the circumstances which specify if such permanent establishment was involved in the services provision and works performance by the non-resident or not. Moreover, the tax authorities uphold the position that if the foreign investors have a permanent establishment, this is impossible to apply the reduced rates of the withholding tax in relation to the payment of remuneration and royalties as considered in the international agreements. In this case, the tax authorities refer to the literal text of the Article 666.2 of the Tax Code, without considering the context of the whole Article 66, as well as the Chapter 75 of the Tax Code, which describes the “Special provisions on international treaties governing the avoidance of double taxation and the prevention of tax evasion”.
Approach of the tax authorities relates both to the non-residents’ income from the business activities, and their income in the form of remuneration from loans issued which were guaranteed by the state insurance tools. In this regard, it should be noted that just recently a fundamental agreement has been reached between the Federal Republic of Germany and the Republic of Kazakhstan in relation to the German loans insurance tools (Hermes), what is welcomed by authors.
In the existing situation, the court practice shows that the majority of the court proceedings are largely resolved for the benefit of the tax authorities. This also raises fears with regard to the double taxation risks, and therefore causes the slowed foreign investments by the investors to the Republic of Kazakhstan.
According to the Convention, income of an enterprise of the Contracting State (Germany, in the case under consideration) is taxable in that State only, unless an enterprise carries out their business activities in the other Contracting State through the permanent establishment located there6. However, if an enterprise carries out the business activities through the permanent establishment, then income of an enterprise may be taxed in another State (which is the Republic of Kazakhstan), but only to the extent that relates to such permanent establishment. In this case, income of such permanent establishment is determined not based on the total amount received by an enterprise, but based on a remuneration relating the actual activities of a permanent establishment in relation to the business activities.7
As said above, it follows that generally withholding of tax at a source of payment is possible only in cases where income may be attributed to the permanent establishment, or a part of income which relates to the business activities of an permanent establishment itself cannot be separated from the total amount of aggregate income of the permanent establishment and foreign legal entity.
This is relevant to note that the Tax Code provides a separate procedure for withholding tax at a source for a number of situations, if:
and
Therefore, the Tax Code stipulates the provisions on income taxation in cases where the foreign legal entities gain income from sources in the Republic of Kazakhstan, both with and without formation of a permanent establishment8. Thus, pursuant to the Kazakh tax legislation, such investors’ income is taxed with the withholding tax, and their taxation procedure is specified in the relevant articles of the Code.
For example, as it follows from the provisions of the Article 653.1 of the Tax Code which govern and guide the taxation of the foreign legal entities those operating in the Republic of Kazakhstan through their permanent establishment, a local tax agent (services/works user (receiver) from the non-resident) shall withhold the withholding tax from income of the foreign enterprises subject to the simultaneous existence of the conditions, as follows:
Thus, the tax legislation of the Republic of Kazakhstan indicates that existence of a permanent establishment as it is cannot constitute the reason for the full taxation (withholding) of income of the foreign investors in Kazakhstan. The provisions of part 2 of paragraph 2 of Art. 666 of the Tax Code, which require a tax agent to determine the fact that a non-resident forms a permanent establishment, on the basis of an agreement (contract) for the provision of services or work, as well as the documents referred to in paragraph 5 of Art. 666 Tax Code, should be interpreted in the same context.
In addition, we would like to direct your attention to the fact that the registered permanent establishment is an independent taxpayer in the Republic of Kazakhstan; the Kazakh tax legislation envisages a separate taxation procedure for cases where the foreign entities perform works or provide services in Kazakhstan together with their permanent establishment.9 Thus according to the Tax Code, if a foreign entity operates together with its permanent establishment, then income which such permanent establishment could gain in case if it was a separate independent enterprise will be considered to be an income of a permanent establishment.10
In this case, existence of a permanent establishment itself may not result in prohibition for applying the provisions of the Convention in terms of exemption from WT withholding. When comparing the foregoing provisions of the Tax Code and the Convention, this may be concluded that if the foreign investors carry out their activities in the Republic of Kazakhstan under certain projects with their permanent establishment, then the local tax agent shall determine the fact of formation of a new permanent establishment based on the activities of the foreign enterprises themselves. In case where actions of these enterprises have not resulted in formation of a new permanent establishment, the tax agent shall have the right to apply the provisions of the international agreements.
However, the Kazakhstani tax authorities apply the provisions of the Article 666 of the Tax Code almost in all cases when it relates to the cases of formation of a new permanent establishment by the foreign investors, which contradicts the provisions of the international agreements and local legislation.
In addition, the tax authorities apply the Article 666 of the Tax Code in relation to income from debt claims to be repaid to the non-residents.
We would like to make a point of the provisions of the Convention between the Republic of Kazakhstan and the Federal Republic of Germany in this context. According to the Convention, income from debt claims of any kind is defined by the term “interest”, and the provisions of this agreement envisage application of both a reduced tax rate for remuneration paid to the German investors, and their full exemption from the withholding tax. According to the Article 11.3 of the Convention, remuneration payable under the loans as guaranteed by the Federal Government of Germany (“Hermes-Cover” or “Hermes-Deckung” in German) is fully exempted from taxation, this means it is not subject to the withholding tax. Application of the Article 666.2 is not right, as it contradicts to this Convention between the Federal Republic of Germany and the Republic of Kazakhstan, and to the provisions of the Article 667.1 of the Tax Code.
We believe that the similar provisions are prescribed in the Conventions of other European states. Therefore, generally the interest paid under loans as guaranteed by the state insurance tools is completely exempted from the Kazakhstani tax.
With the following, we would like to re-describe the risks in more detail for the foreign investors due to viewpoint of the tax authorities of the Republic of Kazakhstan.
In many case the Kazakhstani tax authorities refer to the provisions of the Convention which envisage the possibility for offsetting the taxes of investors in other countries as paid to the Republic of Kazakhstan. It should be noted that for example, there are regulations in the German legislation which deprive the German taxpayers of possibility for offsetting taxes paid in the other State, if such State did not have the absolute right to receive them.11
Due to this reason, in cases where provisions of the Convention are not applied, or are applied in a wrong way, the foreign investors are subject to the double taxation both in the Republic of Kazakhstan and in other states.
A possibility for refunding the income tax paid in the Republic of Kazakhstan is prescribed for the foreign investors by the provisions of the Conventions and Tax Legislation of the Republic of Kazakhstan.12 In this case, when applied this procedure takes a long time and almost in all cases it results in the judicial disputes between the foreign investors and the local tax authorities which are not resolved for the benefit of investors.
Moreover it is relevant to note the exchange risks and liquidity risks born by the foreign investors due to the duration of the judicial disputes and procedures, including a decrease in liquidity.
As a practical matter, many foreign companies operate within the Republic of Kazakhstan together with their local subsidiaries. In the majority of cases, such local subsidiary enterprises are the tax agents in relation to income of the foreign parent companies from the Republic of Kazakhstan. Being guided by the provisions of the Convention, they do not withhold the withholding tax when paying such income.
As mentioned above, often in such cases, the Kazakhstani tax authorities forward a notice to the tax agent about the illegality of applying provisions of the Convention. If the tax agent does not agree with the viewpoint of the tax authorities, this may result in imposing sanctions that may be accompanied with the temporary suspension of the debit operations on bank accounts and limitation in disposing the property of the tax agent.13
Let us note using an example of the Convention between the Federal Republic of Germany and the Republic of Kazakhstan that this Convention signed by and between the Federal Republic of Germany and the Republic of Kazakhstan has been based on the ОECD Model Tax Convention (hereinafter referred to as the “MTC”) from 1997. In this case, the ОECD issues the Comments which provide the clear and exact instructions for applying provisions of the international agreements. However, the OECD Comments do not have any legal force in Kazakhstan, they are just non-regulatory (advisory in nature), which explains the ambiguity in its application.
Before the “Instructions of the Procedure for Applying the Conventions (Agreements) for the Avoidance of Double Taxation and Prevention of Tax Evasion for Income and Capital (Property) signed by and between the Republic of Kazakhstan and Foreign States” was valid in the Republic of Kazakhstan. These Instructions were approved by the Order issued by the Ministry of Finance of the Republic of Kazakhstan. Clarifications of the general principles for applying the Tax Conventions based on certain examples were provided in these Instructions. However, in 2009 this document was repealed. From then onwards, the legislative authorities of the Republic of Kazakhstan have not issued any similar documentation, which possibly explains the ambiguous practice of applying WHT exemption provisions.
In considering the existing situation in terms of income of the foreign investors, it is recommended to conduct an internal tax audit for the purpose to timely identify the potential risks for subsidiaries in the Republic of Kazakhstan. Moreover it is recommended to verify the expediency for restructuring the contractual relations with the parent companies in order to close the Branches (parent companies) or suspend their activities.
1 Article 645.1, Tax Code of the Republic of Kazakhstan2 Article 653.1, Tax Code of the Republic of Kazakhstan 3 Article 4.3, Constitution of the Republic of Kazakhstan/ Article 2.5, Tax Code of the Republic of Kazakhstan4 Article 220.9, Tax Code of the Republic of Kazakhstan
5 Article 666.2, Tax Code of the Republic of Kazakhstan6 Article 7.2, Convention7 Paragraph 1, Protocol of the Convention
8 Chapters 72-73, Tax Code of the Republic of Kazakhstan9 Article 651, Tax Code of the Republic of Kazakhstan10 Article 651.1, Tax Code of the Republic of Kazakhstan
11 Article 26, Law of the Federal Republic of Germany “On Corporate Tax Assessment”12 Article 672, Tax Code of the Republic of Kazakhstan
13 Article 116.1, Tax Code of the Republic of Kazakhstan
Michael Quiring
Attorney at Law (Germany)
Partner, Office head
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