What expenses cannot be taken into account when calculating profits tax?

PUBLICATIONS \ 17.05.2021

It is known that, when profits tax is calculated, expenses that meet the three following conditions can be taken into account: they are economically justified, are documented and are not included in the list of expenses that under no circumstances reduce the organization’s income (article 270 of the Tax Code of the Russian Federation).  According to the legislation, any expenses that are associated with business activities, that is are incurred to generate income, are considered economically justified.

However, this wording is still slightly uncertain, and the economic rationale of expenses is the most controversial area for all accountants. 

Anzhelika Maksimova took a look at controversial expenses of an organization, which at first glance are economically justified, but which cannot be taken into account, as well as expenses that are not obvious yet can still be taken into account specially for “Raschet” magazine.

Let us start with the expenses that the accountant may consider justified, but regarding which the inspection authorities have a different opinion.

1. Compensation of expenses for the payment of the cost of transporting travel and luggage to the place of a vacation and back for persons working in organizations located in regions of the Far North and equated localities. Article 325 of the Labour Code of the Russian Federation (the “Labour Code”), as well as clause 7 of article 255 of the Tax Code of the Russian Federation (the “Tax Code”) stipulate that such compensation is possible.  However, one needs to be careful, because the legislation states that the actual costs can be taken into account only to the place of a vacation in the Russian Federation. Therefore, if an organization takes into account a ticket abroad in its tax expenses, a dispute with the tax authorities cannot be avoided. The courts adhere to the same opinion – the Supreme Court’s ruling No. 303-ES19-7016 dated May 17, 2019.
2. We will mention another type of compensation that everybody would like to take into account in their expenses, but doing so contradicts the Labour Code. According to article 168 of the Labour Code, an employer is obliged to reimburse an employee for travel expenses when sending him on a business trip. In practice, there are often situations when employees stay on at the destination of the trip for a vacation – the expenses of return travel in this case cannot be taken into account as part of the expenses of the business trip, and nor is it possible to take into account travel to the trip destination if the employee goes there for a vacation before the date of the business trip.  Important! The official position of the Ministry of Finance is that if an employee was at the trip destination for several days before the start or after the end of the business trip, for example, during weekends or on public holidays (without taking vacation), then travel expenses are accounted for under the standard procedure.
3. Vacation allowance in advance and the dismissal of an employee. According to letter No. 03-03-07/13686 of the Ministry of Finance dated February 26, 2020, if the employer has incurred expenses on paying the employee for unworked days of vacation that has been granted, the employee is obliged to reimburse such expenses. If the employer decides to “forgive” the employee such debt, then the expenses incurred from the operation involving the forgiveness of the employee’s debt cannot be taken into account when determining the taxation base for profits tax, since debt forgiveness is a type of gift.
4. Reimbursement of another taxpayer’s expenses. The Ministry of Finance has repeatedly expressed in its letters the viewpoint that it is impossible to take into account the reimbursement of another taxpayer’s costs as part of the expenses – Letter No. 03-03-06/1/9422 dated February 12, 2020, and Letter No. 03-03-06/1/78573 dated October 14, 2019. However, despite the apparent banality and simplicity, the tax authorities may regard as compensation for the expenses of another taxpayer, and therefore recognize as unjustified, such expenses as: payment by the parent company of an audit of or consulting services for a subsidiary company; and advertising expenses, when one of the companies advertises goods of the entire group.
5. Maintenance of a property, if it is not used before being transferred to fixed assets. The Ministry of Finance explains that the cost of maintaining a fixed asset before it is put into operation is included in the initial cost. Therefore, for example, the cost of protecting and cleaning buildings or the cost of storage cannot be reflected in current expenses – such current expenses can only be accumulated as the initial cost of the property, and then after it is put into operation, they are written off by the accrual of depreciation. 

And now we turn to positive things: what expenses can be taken into account when calculating profits tax?

1. Expenses for sanitary and hygiene materials and accessories. It is the responsibility of an employer to ensure normal working conditions for its employees, which is the main argument when taking into account such expenses as expenses on soft tissue paper, napkins, washing powder and even washing-up liquid. It should be noted that the Ministry of Finance and the courts are increasingly taking the side of taxpayers – Letter No. 03-03-06/2/112 of the Ministry of Finance of Russia dated July 14, 2011, Resolution No. KA-A40/12681-06 of the Federal Commercial (‘Arbitration’) Court (“FAC”) of the Moscow District dated December 25, 2006 and December 27, 2006 in case No. A40-20791/06-118-198, and the Resolution of the FAC of the Volga District dated July 3, 2007 in case No. A65-20634/06
2. Office improvement expenses. These expenses are also closely associated with the ensuring normal working conditions for employees. However, from the viewpoint of the tax authorities, expenses on air conditioners, humidifiers, refrigerators, microwaves or, for example, aquariums represent a profligacy and a whim on the part of the employer, and it is not permissible to compensate such expenses by increasing the state budget’s losses.  It should be noted that, most often, when there is a justification for these expenses, the courts side with the taxpayer – for example, in decision No. 27-27287/2016 of the Commercial (‘Arbitration’) Court of the West Siberian District dated August 7, 2018, the court found that the purchase of stands, pots for indoor plants, framed pictures and other accessories was aimed at ensuring normal working conditions and creating a favourable image of the company. In another case, the taxpayers managed to defend the justification of including the cost of an aquarium in the tax expenses – decision No. A40-95142/10-13-451 of the Commercial (‘Arbitration’) Court of the Moscow District dated May 23, 2011.
3. Per diem allowance for a one-day business trip. It is known that an organization is not obliged to pay a per diem allowance for a one-day business trip. And if they are made at an employer’s own initiative, can such payments be taken into account in expenses? Yes, they can, if you use a little trick and, in the company’s internal Regulations on business trips, define such payments as compensation, and not as a per diem allowance. This position is also supported by the courts – Decision No. A43-18056/2019 of the Commercial (‘Arbitration’) Court of the Volga-Vyatka District dated January 24, 2020, and Decision No. F07-2310/12 of the FAC of the North-Western District dated July 30, 2012 in case No. A56-48850/2011.
4. Accounting for an unfinished construction project. As we mentioned above, all expenses incurred prior to a facility being put into operation are included in its initial cost. And what should be done if the organization refused the idea of construction for any reason? Is it possible to take the expenses incurred into account as part of the tax expenses? The opinion of the Ministry of Finance is expressed, for example, in its Letter No. 03-03-06/1/512 dated October 1, 2012 – such costs cannot be recognized as economically justified, and therefore be included in tax expenses. In turn, the courts often take the side of taxpayers – the Decision of the FAC of the North Caucasus District dated April 23, 2013 in case No. A32-7901/2012; Decision No. F09-4723/16 of the Commercial (‘Arbitration’) Court of the Ural District dated June 27, 2016 – in these cases, the courts note that the lack of a positive financial result from attempts to build a facility does not give grounds to recognize the expenses on its creation as unjustified.

Economic rationale is an evaluative category and there is no clear definition of it in any regulatory document, which is why there are so many disputes and discrepancies. 

In any case, the taxpayer needs to prepare the evidence base for the disputed expenses in as much depth as possible, regardless of whether the litigation practice regarding the particular type of expense in question has developed positively or negatively: to issue the orders of the CEO, to stipulate the necessary requirements or opportunities in the organization’s internal regulatory documents, and to issue the basic source documents properly.