Drug Certification

Medicines are subject to mandatory certification. The list of products for which Russian legislation requires mandatory certification is set out in Resolution of the Russian Gosstandart No. 64 of 30 July 2002, “Nomenclature of products for which mandatory certification is required by the legislation of the Russian Federation.” The list covers medicines, chemical-pharmaceutical products and medical-purpose products.

Resolution of the Russian Gosstandart No. 36 of 24 May 2002 approves the Rules for certification in the drug certification system of the GOST R certification system (the “Rules No. 36”).

According to Rules No. 36:

“The following medicines are subject to mandatory certification:

— those manufactured by drug manufacturers in the Russian Federation;

— those imported into the Russian Federation under the procedure established by applicable law.”

Groups of medicines exempt from mandatory certification are listed in Letter of the Russian State Committee for Standardization and Metrology No. IK-110-25/110 of 15 January 2003, “On medicines exempt from certification”:

“For your information: under the scope of the Rules for conducting certification in the Drug Certification System of the GOST R Certification System, approved by Russian Gosstandart Resolution No. 36 of 24 May 2002, and the Russian Consumer Protection Law, the following groups of medicines are not subject to mandatory certification:

— medicines without individual packaging (in bulk) not intended for retail sale;

— pharmaceutical substances used for manufacturing medicines;

— immunobiological products, vaccines, serums (not included in the list of goods requiring confirmation of mandatory certification).”

A certificate of conformity for a medicine is issued by drug-certification bodies after the medicine has been checked against the requirements of the regulatory documents approved by the federal executive authority in the healthcare area, issued to the applicant.

Drug quality certificate — a document confirming that the quality of the medicine meets the state quality standard for medicines (Article 4 of Law No. 86-FZ).

The certificate for a batch (series) of medicines has no fixed expiration date. The certificate is valid for the supply and sale of the batch of products throughout the shelf life of the drug as established by the regulatory documents.

The drug-certification procedure includes:

— submission of the application to the certification body;

— review of the application and the documents submitted by the applicant;

— decision on the application, selection of the certification scheme;

— sampling;

— product identification;

— testing;

— certification of quality management (production) systems if required by the certification scheme;

— analysis of the test and inspection results and decision on issuing (or refusing to issue) the certificate of conformity;

— issuing the certificate of conformity;

— inspection control over the certified product (if required by the certification scheme);

— corrective measures in the event of non-compliance of the product with the established requirements and misuse of the conformity mark;

— disclosure of the certification results.

Drug certification is not free: under Article 23(4) of Federal Law No. 184-FZ of 27 December 2002, “On Technical Regulation” (Law No. 184-FZ), mandatory certification work is paid for by the applicant. However, when incurring such costs, an organization does not always correctly record them in accounting and tax records, so let us look at these expenses in more detail.

In the accounting of a manufacturing organization, expenses for mandatory certification of own products are, under clause 5 of PBU 10/99, ordinary-activity expenses. Under clause 18 of PBU 10/99, they are recognized in the reporting period in which the organization incurred them, regardless of the actual date of cash payment.

There is another accounting document to keep in mind. Clause 65 of the Regulation on Accounting and Reporting states that:

“Expenses incurred by an organization in a reporting period but relating to future reporting periods are reflected in the balance sheet as a separate line, deferred expenses, and are written off in the manner set by the organization (evenly, pro rata to output volume, etc.) over the period to which they relate.”

A product certificate of conformity is issued for a definite period specified by the relevant technical regulation. Accordingly, if the certificate validity exceeds one month, the certification expenses should initially be reflected as deferred expenses. The cost of the certificate is then written off to the cost accounts gradually, in the manner defined by the organization’s internal order (evenly, pro rata to output, etc.), over the certificate’s validity period.

In tax accounting, expenses for mandatory certification of own products, under sub-clause 2 of clause 1 of Article 264 of the Russian Tax Code, are classified as other expenses related to production and sale. These expenses are included in the current-period expenses, similarly to licensing expenses.

Example 1.

LLC “Pharmacy” is a drug manufacturer. Under Russian law its products are subject to mandatory certification. Certification was performed by the organization in January of the current year. Certification expenses were:

— cost of the certification work — 7,080 rubles (including VAT — 1,080 rubles);

— cost of the medicines provided as samples — 400 rubles.

The certificate of conformity was issued to LLC “Pharmacy” for 3 years. Under the organization’s accounting policy, deferred expenses at LLC “Pharmacy” are written off to production costs evenly over the period to which they relate, and income and expenses for profit-tax purposes are recognized on the accrual basis.

LLC “Pharmacy” recorded the business transactions related to drug certification in its accounts as follows.

Accounts

Amount, rubles

Transaction description

Debit

Credit

In January of the current year

7,080

Payment of expenses for product certification

6,000

Certification expenses recognized as deferred expenses

1,080

VAT charged by the certification body for its services

400

Cost of items transferred for certification written off

1,080

VAT paid to the certification body accepted for deduction

Each month during the certificate’s validity period:

177.77

Mandatory-certification expenses recognized in the portion attributable to the current month

End of example.

Please note!

If the organization uses the accrual method for profit-tax purposes, in tax accounting the certification expenses must be allocated evenly over the entire validity period of the certificate. This rule follows from clause 1 of Article 272 of the Russian Tax Code.

There is, however, an opposite view. Some specialists argue that an organization may write off product certification expenses in a lump sum rather than spread them across reporting periods, citing the same Article 272 — specifically sub-clause 3 of clause 7, which provides that expenses in the form of funds paid to third parties for work performed are recognized for tax accounting on the date:

— of settlements under the terms of the contracts;

— when documents serving as the basis for settlement are presented to the taxpayer;

— on the last day of the reporting (tax) period.

In the case of product certification we have a contract between the organization and the certification body under which the latter performs a defined scope of work (Articles 20 and 25 of Law No. 184-FZ). Accordingly, once that work is completed and the taxpayer has received the supporting documents, the transaction is closed and the organization may reduce its taxable income by these expenses.

Note that tax authorities usually take the position that certification expenses must be written off in equal instalments over the entire validity period of the certificate. Such a view was expressed by tax-service officials in the Methodological Recommendations on the Application of Chapter 25 “Profits Tax for Organizations” of Part Two of the Russian Tax Code, approved by Order of the Russian Ministry for Taxes and Duties No. BG-3-02/729 of 20 December 2002. Even though those Methodological Recommendations were repealed by Order of the Russian Federal Tax Service No. SAE-3-02/173@ of 21 April 2005, in practice field tax officers still demand this treatment.

Therefore, if an organization writes off such expenses in a single instalment, it may have to defend its position in court.

Please note!

As of 1 January 2006 the taxpayer has the right to apply their own approach when writing off such expenses in tax accounting. This right is granted by the “new” wording of clause 1 of Article 272 of the Russian Tax Code, so in our view disputes over writing off expenses for obtaining a certificate should no longer arise.

Organizations using the cash method can recognize certification expenses in a single instalment after actual payment. This procedure is established by Article 273 of the Russian Tax Code.

One more point worth emphasizing.

Certification services are subject to VAT. The certification body issues an invoice to the applicant for the value of the services plus the tax amount. A VAT taxpayer is entitled to recover the VAT paid for certification work from the budget under Articles 171 and 172 of the Russian Tax Code. When exercising this right, accountants often ask: can the entire “input” VAT be reclaimed immediately, or must it be recovered in instalments as the cost of the certificate of conformity is allocated to expenses?

Two views exist on this question: one is that the “input” VAT on the certification body’s services can be deducted immediately; the other is that the “input” VAT must be recovered in stages.

We outline both views; the organization that has certified its products decides which to follow.

VAT on certification services is recovered in stages.

A manufacturing organization that receives a certificate of conformity for its products initially records the costs of obtaining the certificate on account 97 “Deferred expenses.” Under Article 170 of the Russian Tax Code, VAT amounts charged to a taxpayer when purchasing goods (work, services) are not included in deductible expenses for profits (income) tax purposes.

This means that the debit of account 97 “Deferred expenses” should carry the certification expenses net of VAT (provided that a proper invoice is available). VAT on the purchased service is recorded on the debit of account 19 “VAT on acquired valuables.”

Deferred expenses are written off to production and sales costs evenly over the certificate’s validity period. Accordingly, the VAT amounts should also be deducted in the same manner. This view is expressed by the tax authorities and is supported by Letter of the Russian Tax Service for the City of Moscow No. 24-11/52247 of 10 August 2004, “On the lawfulness of VAT deduction.”

VAT on certification services is recovered immediately in full.

The text of Chapter 21 “VAT” of the Russian Tax Code does not directly state that VAT on deferred expenses may be deducted only when those expenses are charged to the cost of goods sold, i.e. in stages. Since 1 January 2006 the VAT legislation has imposed three requirements on a VAT taxpayer claiming a deduction:

the acquired goods (work, services) and property rights must be used by the taxpayer for VAT-taxable transactions;

the goods (work, services) and property rights must have been recognised by the taxpayer;

the taxpayer must hold a properly completed invoice.

In the case of a manufacturing organization obtaining a certificate of conformity for its products:

the certificate is required by the organization for VAT-taxable activities;

the certification body provided a certification service (evidenced by a signed service-acceptance act);

the organization has recognised the service — the accountant recorded the cost of the service on the balance sheet as deferred expenses;

the organization holds an invoice.

That is, the VAT taxpayer organization has met all statutory requirements, so the full “input” VAT may be deducted at once.

Relying on the second view may lead to litigation, but we have set out the arguments a taxpayer can use to defend that position. If you are not ready to take on the tax authority, use the first view.

Please note!

Before 1 January 2006, payment for goods (work, services) was also a necessary condition for a VAT deduction. From that date the payment requirement imposed on a taxpayer claiming a deduction is effectively removed. These changes were introduced into Article 171 of the Russian Tax Code by Federal Law No. 119-FZ of 22 July 2005, “On amendments to Chapter 21 of Part Two of the Russian Tax Code and the invalidation of certain provisions of Russian tax legislation” (Law No. 119-FZ). Thus, since 1 January 2006 a VAT taxpayer claiming a deduction must meet only three conditions: the tax amount must have been charged to them, they must hold a properly completed invoice, and the purchased goods (work, services) and property rights must have been recognised.