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Key points to consider in transactions exempt from profit tax
Key points to consider in transactions exempt from profit tax
The topic is commented on by tax expert Azer Ganbarov. As is known, enterprises engaged in commercial activities may simultaneously enter into sponsorship agreements or agreements on the provision of donations (assistance) with third-party organizations and enterprises and make payments accordingly. In such cases, except for situations where advertising services are provided under sponsorship agreements, the expenses incurred for the payment amounts are classified as non-deductible expenses and recorded in accounting entries. However, in practice there are cases where an enterprise makes such donation (assistance) payments to state hospitals, entities operating in the fields of science and culture, and sports federations. In this case, provided that the payments are made in a non-cash manner, the expenses may be taken into account within a certain limit and deducted from profit.
According to Article 106.1.9 of the Tax Code of the Republic of Azerbaijan, except for public legal entities established on behalf of the state, the portion of a taxpayer’s profit for the reporting year not exceeding 15 percent, transferred in a non-cash manner for a period of five years starting from January 1, 2024, to enterprises, institutions, and organizations operating in the fields of science, education, healthcare, sports, and culture that meet the criteria determined by the body (institution) designated by the relevant executive authority, as well as to funds established for public and social purposes whose list is approved by the relevant executive authority (the Heydar Aliyev Foundation, the Karabakh Revival Foundation, and the “Yashat” Foundation), is exempt from profit tax. For this reason, when making such payments, enterprises may reduce their taxable profit by up to 15 percent of the respective amount. However, if the taxpayer fails to comply with the relevant requirements, additional tax risks and financial sanctions may arise during inspections conducted by the tax authorities.
Pursuant to Resolution No. 88 of the Cabinet of Ministers dated March 20, 2020, the “Criteria for enterprises, institutions, and organizations operating in the fields of science, education, healthcare, sports, and culture for the purposes of tax exemption in accordance with Article 106.1.18 of the Tax Code of the Republic of Azerbaijan” were approved. According to these criteria, although separate requirements are предусмотрены for each field (sports, culture, healthcare, science, education), general requirements are also stipulated. Failure to comply with these requirements means that the respective transaction will not serve as a basis for profit tax incentives and exemptions.
Enterprises, institutions, and organizations operating in the field of culture must meet at least one of the following criteria:
- being legal entities (excluding commercial legal entities) that organize and conduct artistic and cultural events, creative competitions, exhibitions, creative evenings, cultural and artistic presentations, festivals, conferences and symposiums, prepare and distribute publishing products, as well as produce films for the purpose of promoting, encouraging, and developing Azerbaijani culture and national cultural heritage;
- operating as a theater, library, or museum.
The criteria for enterprises and organizations operating in the field of science are as follows:
- their founding documents must provide for activity in the field of scientific activity as defined by Article 1.0.9 of the Law of the Republic of Azerbaijan “On Science”;
they must be accredited in accordance with Article 24 of the Law of the Republic of Azerbaijan “On Science”;
- they must conduct research in accordance with the main priorities of state policy in the field of science specified in Article 3.3 of the Law of the Republic of Azerbaijan “On Science”;
- they must have at least five (5) scientific employees.
Enterprises, institutions, and organizations operating in the field of education must meet at least one of the following criteria:
- being subordinate to state bodies, public legal entities established on behalf of the state, or legal entities that are state-owned or in which 51 percent or more of the shares (stakes) directly or indirectly belong to the state;
- holding a license obtained in accordance with the procedure established by the Law of the Republic of Azerbaijan “On Education”.
The criteria for enterprises, institutions, and organizations operating in the field of healthcare are as follows:
- being a medical institution included in the state healthcare system;
- using the transferred funds to finance expenses related to the protection of public health in accordance with the areas of activity provided for in their charter.
The criteria for enterprises, institutions, and organizations operating in the field of sports are as follows:
- being republican sports federations (associations) or sports clubs established in the form of public associations in accordance with the Law of the Republic of Azerbaijan “On Physical Education and Sports”;
- using the transferred funds for the purposes stipulated in the founding documents of sports federations (associations) or sports clubs.
The enterprise, institution, or organization receiving the payment must meet the following requirements established by the criteria for the relevant field of activity:
- when making payments to the persons stipulated in the criteria, the purpose of the payment must be correctly, fully, and clearly indicated in the payment document, and the payment must be made in a non-cash manner by transferring funds from the bank account of the payer to the bank account of the recipient. Payments without a specified purpose (or with an incorrectly or incompletely specified purpose), as well as amounts paid in cash, do not constitute grounds for tax exemption as provided for in Article 106.1.18 of the Tax Code of the Republic of Azerbaijan;
- the enterprise, institution, or organization receiving the payment must, within one (1) month after the end of the reporting year, provide the payer with documents confirming that the received funds were spent for their intended purpose (sales contracts, acceptance and transfer acts, payment orders, bank statements, etc.).
As can be seen, if the purpose of the payment is not correctly indicated, the enterprise cannot obtain a tax exemption. For example, if a commercial enterprise makes a donation (assistance) payment to a football federation under an agreement on the specified grounds, it should indicate in the payment purpose phrases such as “For the development of football” or “For the purposes stipulated in the founding documents” and should request from the federation documents confirming the intended use of such payments (contracts, acceptance acts, invoices, customs declarations, e-invoices, payment documents).
Example 1. “AA” LLC, a resident legal entity, had revenues of AZN 3,000,000 for the reporting year, and deductible expenses of AZN 1,200,000. During the reporting year, it transferred AZN 100,000 in a non-cash manner as assistance to a duly registered Research Project Institute and obtained copies of documents confirming the intended use of the payment. Although the institute has around 50 employees, the number of scientific employees is 4. In this case, the portion of taxable profit amounting to AZN 1,800,000 × 15% = AZN 270,000, including the AZN 100,000 paid in the example, formally falls under the exemption; however, “AA” LLC will not be able to use this amount as a tax incentive.
Example 2. “YY” LLC, a resident enterprise, is a profit tax payer. Its revenues amounted to AZN 5,000,000, and deductible expenses were AZN 2,000,000. During the reporting year, it transferred AZN 400,000 in a non-cash manner as assistance to one of the duly registered private clinics and obtained copies of documents confirming the intended use of the payment. In this case, despite all documents being in order, an amount equal to 15% of the taxable profit, i.e., AZN 3,000,000 × 15% = AZN 450,000, including the AZN 400,000 paid in the example, could have been deducted from taxable profit. However, since the clinic is not a medical institution included in the state healthcare system, the enterprise will not be able to benefit from this incentive.
Example 3. “XX” LLC, a resident enterprise, is a profit tax payer. Its revenues amounted to AZN 6,000,000, and deductible expenses were AZN 4,500,000. During the reporting year, it transferred AZN 250,000 in a non-cash manner as assistance to a football federation established in the form of a public association. However, it did not obtain copies of documents confirming the intended use of the payment. In this case as well, despite all documents being in order, an amount equal to 15% of the taxable profit, i.e., AZN 1,500,000 × 15% = AZN 225,000, could have been deducted from taxable profit. However, if “XX” LLC does not obtain and retain these documents until the next on-site tax audit to be conducted, it will not be able to benefit from these incentives.
In the above-mentioned cases, tax incentives and exemptions must be applied correctly by taxpayers in accordance with the relevant procedures. Otherwise, during inspections, the taxpayer may face tax risks and incur additional financial losses.
The topic is commented on by tax expert Azer Ganbarov. As is known, enterprises engaged in commercial activities may simultaneously enter into sponsorship agreements or agreements on the provision of donations (assistance) with third-party organizations and enterprises and make payments accordingly. In such cases, except for situations where advertising services are provided under sponsorship agreements, the expenses incurred for the payment amounts are classified as non-deductible expenses and recorded in accounting entries. However, in practice there are cases where an enterprise makes such donation (assistance) payments to state hospitals, entities operating in the fields of science and culture, and sports federations. In this case, provided that the payments are made in a non-cash manner, the expenses may be taken into account within a certain limit and deducted from profit.
According to Article 106.1.9 of the Tax Code of the Republic of Azerbaijan, except for public legal entities established on behalf of the state, the portion of a taxpayer’s profit for the reporting year not exceeding 15 percent, transferred in a non-cash manner for a period of five years starting from January 1, 2024, to enterprises, institutions, and organizations operating in the fields of science, education, healthcare, sports, and culture that meet the criteria determined by the body (institution) designated by the relevant executive authority, as well as to funds established for public and social purposes whose list is approved by the relevant executive authority (the Heydar Aliyev Foundation, the Karabakh Revival Foundation, and the “Yashat” Foundation), is exempt from profit tax. For this reason, when making such payments, enterprises may reduce their taxable profit by up to 15 percent of the respective amount. However, if the taxpayer fails to comply with the relevant requirements, additional tax risks and financial sanctions may arise during inspections conducted by the tax authorities.
Pursuant to Resolution No. 88 of the Cabinet of Ministers dated March 20, 2020, the “Criteria for enterprises, institutions, and organizations operating in the fields of science, education, healthcare, sports, and culture for the purposes of tax exemption in accordance with Article 106.1.18 of the Tax Code of the Republic of Azerbaijan” were approved. According to these criteria, although separate requirements are предусмотрены for each field (sports, culture, healthcare, science, education), general requirements are also stipulated. Failure to comply with these requirements means that the respective transaction will not serve as a basis for profit tax incentives and exemptions.
Enterprises, institutions, and organizations operating in the field of culture must meet at least one of the following criteria:
- being legal entities (excluding commercial legal entities) that organize and conduct artistic and cultural events, creative competitions, exhibitions, creative evenings, cultural and artistic presentations, festivals, conferences and symposiums, prepare and distribute publishing products, as well as produce films for the purpose of promoting, encouraging, and developing Azerbaijani culture and national cultural heritage;
- operating as a theater, library, or museum.
The criteria for enterprises and organizations operating in the field of science are as follows:
- their founding documents must provide for activity in the field of scientific activity as defined by Article 1.0.9 of the Law of the Republic of Azerbaijan “On Science”;
they must be accredited in accordance with Article 24 of the Law of the Republic of Azerbaijan “On Science”;
- they must conduct research in accordance with the main priorities of state policy in the field of science specified in Article 3.3 of the Law of the Republic of Azerbaijan “On Science”;
- they must have at least five (5) scientific employees.
Enterprises, institutions, and organizations operating in the field of education must meet at least one of the following criteria:
- being subordinate to state bodies, public legal entities established on behalf of the state, or legal entities that are state-owned or in which 51 percent or more of the shares (stakes) directly or indirectly belong to the state;
- holding a license obtained in accordance with the procedure established by the Law of the Republic of Azerbaijan “On Education”.
The criteria for enterprises, institutions, and organizations operating in the field of healthcare are as follows:
- being a medical institution included in the state healthcare system;
- using the transferred funds to finance expenses related to the protection of public health in accordance with the areas of activity provided for in their charter.
The criteria for enterprises, institutions, and organizations operating in the field of sports are as follows:
- being republican sports federations (associations) or sports clubs established in the form of public associations in accordance with the Law of the Republic of Azerbaijan “On Physical Education and Sports”;
- using the transferred funds for the purposes stipulated in the founding documents of sports federations (associations) or sports clubs.
The enterprise, institution, or organization receiving the payment must meet the following requirements established by the criteria for the relevant field of activity:
- when making payments to the persons stipulated in the criteria, the purpose of the payment must be correctly, fully, and clearly indicated in the payment document, and the payment must be made in a non-cash manner by transferring funds from the bank account of the payer to the bank account of the recipient. Payments without a specified purpose (or with an incorrectly or incompletely specified purpose), as well as amounts paid in cash, do not constitute grounds for tax exemption as provided for in Article 106.1.18 of the Tax Code of the Republic of Azerbaijan;
- the enterprise, institution, or organization receiving the payment must, within one (1) month after the end of the reporting year, provide the payer with documents confirming that the received funds were spent for their intended purpose (sales contracts, acceptance and transfer acts, payment orders, bank statements, etc.).
As can be seen, if the purpose of the payment is not correctly indicated, the enterprise cannot obtain a tax exemption. For example, if a commercial enterprise makes a donation (assistance) payment to a football federation under an agreement on the specified grounds, it should indicate in the payment purpose phrases such as “For the development of football” or “For the purposes stipulated in the founding documents” and should request from the federation documents confirming the intended use of such payments (contracts, acceptance acts, invoices, customs declarations, e-invoices, payment documents).
Example 1. “AA” LLC, a resident legal entity, had revenues of AZN 3,000,000 for the reporting year, and deductible expenses of AZN 1,200,000. During the reporting year, it transferred AZN 100,000 in a non-cash manner as assistance to a duly registered Research Project Institute and obtained copies of documents confirming the intended use of the payment. Although the institute has around 50 employees, the number of scientific employees is 4. In this case, the portion of taxable profit amounting to AZN 1,800,000 × 15% = AZN 270,000, including the AZN 100,000 paid in the example, formally falls under the exemption; however, “AA” LLC will not be able to use this amount as a tax incentive.
Example 2. “YY” LLC, a resident enterprise, is a profit tax payer. Its revenues amounted to AZN 5,000,000, and deductible expenses were AZN 2,000,000. During the reporting year, it transferred AZN 400,000 in a non-cash manner as assistance to one of the duly registered private clinics and obtained copies of documents confirming the intended use of the payment. In this case, despite all documents being in order, an amount equal to 15% of the taxable profit, i.e., AZN 3,000,000 × 15% = AZN 450,000, including the AZN 400,000 paid in the example, could have been deducted from taxable profit. However, since the clinic is not a medical institution included in the state healthcare system, the enterprise will not be able to benefit from this incentive.
Example 3. “XX” LLC, a resident enterprise, is a profit tax payer. Its revenues amounted to AZN 6,000,000, and deductible expenses were AZN 4,500,000. During the reporting year, it transferred AZN 250,000 in a non-cash manner as assistance to a football federation established in the form of a public association. However, it did not obtain copies of documents confirming the intended use of the payment. In this case as well, despite all documents being in order, an amount equal to 15% of the taxable profit, i.e., AZN 1,500,000 × 15% = AZN 225,000, could have been deducted from taxable profit. However, if “XX” LLC does not obtain and retain these documents until the next on-site tax audit to be conducted, it will not be able to benefit from these incentives.
In the above-mentioned cases, tax incentives and exemptions must be applied correctly by taxpayers in accordance with the relevant procedures. Otherwise, during inspections, the taxpayer may face tax risks and incur additional financial losses.