Study of Small and Medium Enterprises in Azerbaijan - IFC

7.3.2 Tax inspections negatively affect businesses and
increase corruption
Box 7.2 Tax Inspections
Tax Inspections can be conducted off-site and on-site. An off-site tax inspection must be carried out on the basis of documents in the
possession of the tax authorities or provided by the taxpayer as well as other documents that reflect the calculation and payment of taxes,
and documents on the taxpayer’s business activity. Off-site tax inspections must be carried out within 30 days from the date the taxpayer
provides the documental basis for tax calculation and payment. An on-site tax inspection must cover the period not exceeding three
calendar years of taxpayers’ activity related to profit, income, property, road, and land taxes. As for other taxes, on-site inspection must cover
the period not exceeding three years, including the year of inspection. On-site tax inspection can be conducted on a scheduled date with
15 days substantiated written notice prior to inspection, whereas unannounced tax inspections can be conducted in urgent circumstances
enlisted in the Tax Code, such as the discovery of misrepresentation in tax reporting (a taxpayer may instigate such inspection as well). A
taxpayer may sue tax authorities for violations of inspectors.
Tax compliance is most often pursued through tax inspections, which as a result of
incomplete regulation leave a high degree of discretion to the tax inspectors that are
as such prone to corruption. A typical example of these procedures is the so-called
“chronometry measurement,” which is supposed to determine the yearly income of
businesses based on a subjective evaluation of generated revenues during inspections,
creating a clear conflict of interest and leaving ample room for unofficial payments.
In accordance with the IFC survey, an average of one in four entrepreneurs, regardless
of the legal status of its enterprise, makes unofficial payments during inspections.
Many companies prefer entering the shadow economy and paying unofficial taxes in
order to remain competitive rather than paying a heavy tax burden.
As mentioned in page 91 of the Business Inspections chapter, 81 percent of all
individual entrepreneurs and 70 percent of SMEs, as surveyed by IFC, are being
inspected every year. Of those, approximately 90 percent claim to have been inspected
by the Ministry of Taxes. When it comes to the results of inspections, the IFC survey
showed that one in five inspected entrepreneurs was penalized during the last 12
months; and more than half of inspections were closed without any sanctions, but the
rest of inspections resulted in penalties (on average 334 Azerbaijani manats, or $412)
or unofficial payments. Moreover, 59 percent of all inspections conducted by the
Ministry of Taxes are not registered in the registry of inspections that entrepreneurs
are required to maintain.
7.3.3 CPT and dividend tax result in double taxation of
corporate earnings
Dividends paid by an Azerbaijani resident are subject to a 10 percent withholding
tax. Thus, corporate earnings are taxed twice: first as 22 percent CPT, and then as
10 percent dividend tax, if such income is distributed to stakeholders. Such double
taxation of corporate earnings reduces capital returns and makes equity financing less
attractive for investors as unlike interest payments, dividends are not tax deductible.
This leaves the businesses with a limited choice: debt financing, which as a rule is used
Aze r b a i j a n Bu s i n e s s En a b l i n g En v i r o n m e n t Pr o j e c t 121