Taxation & Investment in Azerbaijan
The taxation system in Azerbaijan consists of several regimes:
•The statutory tax regime governed by the Tax Code;
•The tax regime established by existing Production Sharing Agreements (PSAs);
•The taxation regime established by two Host Government Agreements (HGAs), including the main export Baku-Tbilisi-Ceyhan Pipeline, and the South Caucasus Pipeline, carrying Shah Deniz gas; and
•The tax regime of special economic zones.
Below is a general overview of the taxes applicable under the statutory taxation regime.
1. Profit Tax
1.1. Tax Jurisdiction & Payers of Profit Tax
Legal entities incorporated in Azerbaijan are normally treated as residents and are taxable on their worldwide income. Legal entities incorporated abroad are normally treated as non-residents and are taxable on income from sources in Azerbaijan.
Both resident and non-resident enterprises in Azerbaijan pay profit tax.
1.2. Taxation of Resident Entities
Legal entities are taxed on profit, which is determined as gross income from economic activities less allowable deductions at a flat rate of 20%.
The Tax Code allows some expenses incurred in the course of economic activities to be deducted from the gross income earned from such activities. Expenses not connected with income earning activity, personal expenses, and entertainment expenses are not deductible (unless entertainment is considered to be the taxpayer’s economic activity). Deductions are also not allowed for the acquisition of fixed assets and intangible assets, although such assets may be depreciated.
The Tax Code also provides rules and limitations relating to specific deductions. Some specific allowable deductions are as follows: interest payments subject to limitations, bad and doubtful debts, insurance reserve funds, costs of scientific research and experimental design, depreciation of fixed and intangible assets, repair expenses, insurance payments, geological exploration, and extraction of natural resources.
Tax payment & reporting
Companies pay profit tax at a rate of 20% and are required to make quarterly advance tax payments calculated either as 25% of the previous year’s tax liability or by multiplying the amount of their income in the current quarter with a weighted tax coefficient of the gross income for the previous year.
The annual profit tax return is due no later than March 31 of the following reporting year.
1.3. Taxation of Non-residents of Azerbaijan
Tax jurisdiction over non-residents
A non-resident enterprise operating in Azerbaijan through a permanent establishment pays tax on its profit, i.e. on gross income generated from Azerbaijani sources in connection with the permanent establishment, less the amount of expenses incurred with respect to such income as per the Tax Code. The tax rate is a flat rate of 20%.
The gross income of a non-resident enterprise that is not connected with the permanent establishment is taxed at the source of payment without the deduction of expenses.
A non-resident enterprise generating income through the supply of property not connected with the permanent establishment pays tax on the said gross income received during a calendar year from an Azerbaijani source. The tax is paid after the deduction of expenses relating to income generation.
In terms of the Azerbaijan Tax Code, a foreign individuals’ or legal entities’ permanent establishment in Azerbaijan is an establishment through which a taxpayer’s economic activity is carried out either fully or partially for 90 or more days within a 12-month period, including the activities of an authorized representative.
A place is not considered a non-resident enterprise’s permanent establishment in Azerbaijan if used (regardless of the user) exclusively to store goods or products owned by the non-resident enterprise; to keep a stock of goods or products owned by the non-resident enterprise only for the purpose of their eventual processing and subsequent export from Azerbaijan by a third party; the purchase of goods or manufacturing of products by a non-resident enterprise for its own needs; or to conduct any preparatory or support activity by a non-resident enterprise for its own needs.
Azerbaijani source income
Unless otherwise specified in the effective double tax treaties that Azerbaijan has entered into, the following withholding tax rates normally apply to the following items of income from Azerbaijani sources payable to non-residents, provided that such income is not attributable to a non-resident’s permanent establishment in Azerbaijan. (See Table 1).
The Tax Code envisages the following exemptions from profit tax: income of charitable organizations, except for that coming from entrepreneurial activity; grants, membership fees, and donations received by non-commercial organizations; and income of international, interstate, and intergovernmental organizations, except for that received from entrepreneurial activity.
Double tax treaty relief in Azerbaijan
Azerbaijan has agreed double tax treaties with 41 countries that generally follow the OECD Model Income Tax Convention, and 37 out of the 41 double tax treaties are effective.
Azerbaijani tax legislation establishes rules on claiming a refund of taxes withheld from payments to non-residents who are subject to the provisions of double tax treaties signed between Azerbaijan and other countries.
2. Value-Added Tax (“VAT”)
2.1. Concept of VAT
The concept of VAT according to Azerbaijani tax legislation is similar to principles used in most European countries. In accordance with Azerbaijani law, VAT payers are entitled to recover VAT paid on purchases (input VAT) exceeding VAT that was received from their taxable supplies (output VAT).
2.2. Payers of VAT
Mandatory VAT registration requirement is calculated based on a consecutive 12-month period, with the amount of taxable supplies triggering registration set at AZN90,000 (approximately $114,300) for individuals and AZN150,000 (approximately $190,500) for legal entities.
The Tax Code also envisages voluntary registration for VAT purposes.
2.3. Objects of Taxation
Under the Tax Code, the supply of goods/rendering of services and import of goods are subject to VAT. Taxable transactions do not include services rendered or work completed outside Azerbaijan.
2.4 VAT Rate
The current VAT rate is 18%.
2.5 VAT Refund
The reporting period for VAT is a calendar month. According to the Tax Code, the amount of input VAT remaining after the offset against a taxpayer’s output VAT in the current month is automatically transferred to the next three months and should be offset with VAT liability arising during that period.
The tax authorities have the right to offset VAT receivables from the budget against liabilities with respect to other taxes, interest charges for late tax payment, financial sanctions, and administrative penalties. Taxpayers are also entitled to request the tax authorities to transfer the repayable VAT to the balance of other tax liabilities.
If, after the three-month period the input VAT is not fully offset, the remaining amount must be refunded to the taxpayer within 45 days upon their submission of an application to the tax authorities. Daily interest of 0.1% is payable by the tax authorities if the amount of tax due to the taxpayer is not repaid within that period.
The right of a taxpayer to claim overpaid taxes is limited to five years from the date when the tax-reporting period ended.
2.6 VAT Deposit Account
All input VAT must be paid through a VAT Deposit Account (VDA), which is a type of escrow bank account administered by the government. Legislation requires every VAT payer to have a VAT sub-account (VSA). A VSA is a part of a VDA. Only input VAT paid to the supplier’s VDA is recoverable.
3. Property Tax
3.1. Property Tax for Individuals
Payers of property taxes are resident and non-resident individuals who personally own buildings and their parts, as well as water and air transport facilities.
Individuals pay property tax from:
•The inventory value of the building in their ownership; and
•Water and air transport facilities.
3.2. Property Tax for Legal Entities
With respect to legal entities, taxable objects include:
•Average annual value of fixed assets on theenterprise’s balance sheet; and
•For non-resident enterprises carrying outbusiness activity through a permanent es-tablishment in Azerbaijan, only the averageannual value of fixed assets connected withthe permanent establishment.
Enterprises pay tax at a rate of 1% of the average annual residual value of the fixed assets, which
is determined by adding up the residual value of the enterprise’s property (excluding vehicles) as of the beginning and the end of the reporting year and dividing the resulting sum by two.
Quarterly advance payments of property tax should be made in an amount equal to 20% of the previous year’s property tax no later than the 15th day of the second month of each quarter. The annual property tax return should be submitted no later than March 31 of the next reporting year.
4. Personal Income Tax
4.1. Tax Residency
Individuals who are present in Azerbaijan for more than 182 cumulative days during a calendar year, or those with a place of permanent residence, a center of vital interests, or a habitual abode in Azerbaijan, or who have Azerbaijani citizenship, are considered to be tax residents of Azerbaijan.
4.2. Tax Rates
The worldwide income of tax residents and Azerbaijani source income of non-residents received from employment are subject to the marginal income tax rates displayed in Table 2.
4.3. Payment & Reporting of Personal Income Tax
An employee’s employment income is subject to withholding by the employer at source. Taxes withheld are to be remitted by the employer to the budget within 20 days of the following month. Legal entities and entrepreneurs that are registered for VAT purposes, or simplified taxpayers paying employment income to individuals, must submit tax returns to the tax authorities before January 31 of the following reporting year.
5. Social Insurance
According to Azerbaijani law, social insurance contributions are paid by both Azerbaijani nationals and foreign individuals.
Employers are liable for paying social insurance contributions at a rate of 22% of the employee’s gross salary, and 3% is deducted from the employee’s gross salary as the employee’s portion of the social insurance contribution.
6. Mining Tax
Legal entities and individuals extracting mineral resources in Azerbaijan and on the Caspian shelf pay mining tax at rates ranging from 3% to 26%. The tax is paid after the extraction of minerals on a monthly basis by the 20th day of the month following the accounting month. Mining tax is deductible for profit tax purposes.
Payers of mining tax submit tax returns on a monthly basis no later than the 20th day of the month following the accounting month.
7. Land Tax
A land tax is imposed on the owners and users of land plots, the amount of which depends on the use and location of the land. For instance, in Baku, the tax rate on industrial land is AZN10 (approximately $12.70) per 100 sqm.
Legal entities calculate land tax on an annual basis based on the total area of the land and the respective land tax rates and then submit their calculations to the tax authorities no later than May 15 each year.
Land tax is paid semi-annually in equal installments no later than August 15 and November 15.
8. Excise Tax
All individuals and legal entities producing excisable goods in Azerbaijan or importing excisable goods are subject to excise taxes.
Tobacco products, alcoholic beverages, and petroleum products are subject to excise tax at fixed rates, e.g. AZN0.8 (approximately $1) per liter of spirits or 12.5% of the sales price of cigarettes produced in Azerbaijan.
The export of excisable goods is not subject to tax.
9. Road Tax
Road tax is paid by non-resident entities and individuals entering Azerbaijan, as well as by the owners and users of vehicles in Azerbaijan.
The tax payable by non-resident entities and individuals entering Azerbaijan is collected by the customs authorities at different rates depending on the type of vehicle, distance driven within Azerbaijan, and the length of time spent in the country.
The tax applicable to owners and users of vehicles in Azerbaijan is payable annually based on the following rates:
•For cars with an engine volume of less than2,000 cubic cm; AZN0.01 for each cubic cm
•For cars with an engine volume of morethan 2,000 cubic cm; AZN20 plus AZN0.02for each cubic cm exceeding 2,000 cubic cm
•For buses and other vehicles; AZN0.02 foreach cubic cm of engine volume
10. Simplified Tax
Individuals and legal entities involved in entrepreneurial activity that are not registered VAT payers have the right to pay simplified tax. However, the following entities are not entitled to do so:
•Producers of excise goods;
•Credit and insurance entities, investment funds, professional securities marketparticipants;
•Non-governmental pension funds;
•Those obtaining income from leasing property or royalty; and
•Those that own property with a residualvalue exceeding AZN1 million (approxi-mately $1.27 million).
Simplified tax is calculated from the revenue obtained from the supply of goods, provision of works, rendering of services, and non-sale profits at the following rates:
•Other regions: 2%
Simplified taxpayers are obliged to make simplified tax payments and file tax returns no later than the 20th day of the month following each reporting calendar quarter.
The Law on Accounting of Azerbaijan provides the standards of accounting. The Law recognizes three categories of entity and provides terms on which financial statements should be prepared by each category. Below is the description of each category and terms of financial statements preparation:
A. Entities of public importance that include credit organizations, insurance companies, investment funds, etc. are required to prepare financial statements in accordance with International Financial Reporting Standards (IFRS).
B. Small entrepreneurship entities are required to prepare financial reports in accordance with the Rules on Simplified Accounting. However, National Financial Reporting Standards (NFRS) may be used depending on the choice of the entity.
C. Commercial organizations are required to prepare financial reports either in accordance with the NFRS or IFRS depending on their choice.
The Civil Code of Azerbaijan requires the independent (external) annual audit of financial statements of Limited Liability Companies and Open and Closed Joint Stock Companies. According to the Code of Administrative Violations, a penalty from AZN1,500 (approximately $1,905) to AZN2,500 (approximately $3,175) is imposed on legal entities for failure to comply with the mandatory audit requirements required by the legislation.
© The Business Year
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
TBY would like to thank Deloitte for compiling this analysis.