June 2016 Russian Tax Brief EY’s Russian Tax & Law practice was named a leading Tax firm in Russia in “World Tax 2015,” an annual guide published by the International Tax Review. In the issue: The Investment Criterion in Tax Treaties: New Guidance from the Ministry of Finance 2 Debt Financing from a Parent Company to Address Cash-flow Shortages Signals the Receipt of an Unjustified Tax Benefit 3 Bill on Taxation of Electronic Services Adopted in Third Reading 4 Tax Control in Uncontrolled Transactions 7 Calculating Controlled Indebtedness: Separately or Altogether? 9
Transcript
June 2016
Russian Tax Brief
EY’s Russian Tax & Law practice was named a leading Tax firm in Russia in “World Tax 2015,” an annual guide published by the International Tax Review.
In the issue:
The Investment Criterion in Tax Treaties: New Guidance from the Ministry of
Finance 2
Debt Financing from a Parent Company to Address Cash-flow Shortages Signals
the Receipt of an Unjustified Tax Benefit 3
Bill on Taxation of Electronic Services Adopted in Third Reading 4
Tax Control in Uncontrolled Transactions 7
Calculating Controlled Indebtedness: Separately or Altogether? 9
The Investment Criterion in Tax Treaties: New Guidance from the Ministry of Finance
Authors: Nadezhda Konovalova, Victor Kalgin
The “investment” rules remain one of the most contentious issues that arise in regard to the application of reduced rates of withholding tax on dividend payments from Russia to recipients abroad. Many double tax treaties between Russia and other countries allow the application of a reduced rate (often 5% instead of the standard 15%) only if the foreign company receiving the dividends has invested a specified minimum amount in the Russian subsidiary (for example, 100,000 euros in the case of the Cyprus treaty).
Interpreting this rule often proves problematic. We have already written about the inconsistencies in the Finance Ministry’s position and relevant case law in our September 2015 tax brief.1
The Finance Ministry recently issued advice regarding the application of the Netherlands treaty in a situation where shares in a Russian company were transferred as a contribution to the capital of a Dutch company.2
The Treaty between Russia and the Netherlands provides for the application of a 5% rate of withholding tax on dividends where the Dutch company receiving the dividends “has invested” at least 75,000 euros in the Russian company.3
In the Finance Ministry’s view, the term “investment” includes both the acquisition of shares at the time of the initial or subsequent issues and the purchase of shares on the
2 Letter No. 03-08-13/30458 of the Ministry of Finance of the Russian Federation of 26 May 2016.
3 Paragraph 2 (a) of the Double Tax Treaty between Russia and the Netherlands.
securities markets or directly from their previous owner. The Ministry emphasises that the wording “has invested” implies that the investment must have been made directly by the actual recipient of the dividends.
The Ministry concludes from this that in a situation where shares in a Russian company were transferred by a third party as a contribution to the charter capital of a Dutch company, the Dutch company would not be regarded as meeting the “investment” criterion.
This is not the first time that the Finance Ministry has expressed this position. It has taken a similar view on previous occasions, such as in relation to the application of the reduced tax rate for dividends under the Cyprus treaty.4
It must be said that this new letter presents a somewhat broader interpretation of the “investment” condition compared with certain other clarifications issued by the Finance Ministry, including in regard to the Netherlands treaty. In one recent letter, for example, the Ministry took the view that only contributions to charter capital (and not, for example, the purchase of shares from a previous owner) could be regarded as investment5.
It is worth pointing out that case law on this issue often tends to be more favourable to taxpayers. For example, in the case involving Manezhnaya Ploshchad OOO6, the court supported the view that the Cypriot company, having received interests in a Russian company as a contribution to its capital, met the “direct investment” requirement for the purpose of the application of the reduced rate of withholding tax on dividends.
4 Letter No. 03-08-13 of the Ministry of Finance of the Russian Federation of 20 January 2009.
5 Letter No. 03-08-05/16539 of the Ministry of Finance of the Russian Federation of 25 March 2015.
6 Ruling No. 09AP-14151/2011-АК of the Ninth Arbitration Appeal Court of 22 June 2011.
Debt Financing from a Parent Company to Address Cash-flow Shortages Signals the Receipt of an Unjustified Tax Benefit
Author: Pavel Artamonov, Ekaterina Podgornaya, Tatyana Butuzova
Over the last few years there has been a significant rise in the number of cases in which taxpayers attempt to challenge additional charges imposed by tax authorities on the basis of the “unjustified tax benefit” concept. However, in view of the lack of uniformity in approaches taken by courts to evaluating the criteria for determining whether a taxpayer has received an unjustified tax benefit, arbitration case law on this issue varies and not all rulings go the taxpayer’s way.
The unjustified tax benefit concept was formulated in Ruling No. 53 of the Plenum of the Supreme Arbitration Court of the Russian Federation7. According to that ruling, a tax benefit is understood to mean a reduction in the amount of a tax liability resulting, in particular, from a reduction of the tax base, the receipt of a tax deduction or tax concession or the application of a lower tax rate, and the receipt of a right to a refund (offset) or reimbursement of tax.
When a taxpayer claims profits tax deductions for expenses which are typically associated with the receipt of an unjustified tax benefit, there is a risk of the tax authorities challenging the deduction of those expenses, including in some cases the offset of VAT, and charging additional profits tax, fines and penalties.
One recent example of negative case law on this issue is the case involving Continental Tyres Rus OOO (“the Taxpayer”). In Determination No. 305-KG16-1901 of 5 April 2016 on that case,
7 Ruling No. 53 of the Plenum of the Supreme Arbitration Court of the Russian Federation of 12 October 2006 “Concerning the Evaluation by Arbitration Courts of the Legitimacy of the Receipt by a Taxpayer of a Tax Benefit”.
the Supreme Court declined to support the Taxpayer’s position in the matter of the tax deductibility of interest on an intra-group loan on the basis that it was aimed at receiving an unjustified tax benefit.
The activities of the Taxpayer, which is part of an international holding group, consisted in the sale in Russia of vehicle tyres purchased from foreign affiliated companies. The tax authority concluded on auditing the Taxpayer that interest paid under loan agreements with the parent company had been improperly deducted. The Taxpayer argued that the purpose of the loans was to remedy a working capital deficiency and overcome cash-flow shortages, and they were used for the purposes of the Company’s business activities. The tax authority took the view that the Taxpayer had artificially engineered the cash-flow shortages with a view to financing them with short-term loans from the parent company and deducting interest on the loans, thereby receiving an unjustified tax benefit.
After examining the arguments presented by the parties, the court concluded that the inspectorate’s decision was valid on the following grounds:
The payment deferral provided for in supply contracts with affiliated companies was 30-40 days. Contracts with buyers, on the other hand, provided for a payment deferral of 90-180 days and granted various discounts, rewards and bonuses. The difference in the timing of receipts of funds from buyers, coupled with the need to make regular payments for goods purchased, resulted in cash-flow shortages;
In order to cover these cash-flow shortages, the Taxpayer obtained short-term (one to two months) loans from the foreign parent company and paid appropriate interest. Subsequently, each successive loan was used to settle the one received before it;
The foreign parent company made losses, and the interest income was set off against those losses. The Taxpayer deducted the interest in Russia.
In this situation, the court took the side of the tax authorities, maintaining that the Taxpayer had received an unjustified tax benefit by reason of the fact that the conclusion of loan agreements with the foreign parent company did not serve a specific business objective and the funds received from the foreign company were not actually used in financial and economic activities but were used to settle loans previously received.
Furthermore, the rulings of the earlier court instances asserted that the parent company had provided the loans to the Taxpayer with the object of taking assets and profit out of the scope of Russian taxation and creating fictitious “income” in Germany on which no taxes were actually paid owing to the losses declared by the parent company.
Significance of the Decision
The main conclusion to be drawn here is that, in the absence of a uniform approach to the evaluation of the receipt of an unjustified tax benefit and in view of the increased focus by tax authorities on the use of the unjustified tax benefit concept in challenging taxpayers’ expenses, taxpayers should pay greater attention to intra-group transactions.
When concluding transactions that are not classed as controlled for transfer pricing purposes with interdependent companies, an assessment must be made of whether a transaction has a specific business purpose and is economically justified. In addition, taxpayers must prepare arguments and reasoning to support the validity of their transactions and be ready to defend their position in court.
Bill on Taxation of Electronic Services Adopted in Third Reading
Authors: Yulia Kolesnikova, Yulia Antipova
On 29 June the Federal Council adopted Draft Law No. 962487-6, which lays down new rules for the taxation of electronic services8.
The draft law provides that the VAT exemption applicable when rights to use software and databases are granted under a licence agreement remains in force. However, the previously proposed profits tax concessions for Russian suppliers of electronic services and the offset of input VAT on expenses relating to sales of electronic services to foreign purchasers have been excluded from the draft.
The law is expected to enter into force from 1 January 2017.
Analysis of Amendments
In this article we examine the new VAT rules for electronic services under the final version of the bill as passed in the third reading. The content of the version of the bill submitted to the State Duma in the first reading was discussed in previous EY alerts dated 30 December 2015 and 2 March 20169.
Definition of Electronic Services
The provision of services in electronic form means the provision of services via a telecommunications network, including the Internet. The new version of the bill contains an updated list of operations which are classified as electronic services, and specifically:
8 The second reading of the bill took place on 8 June and resulted in a revised version of the bill being passed. Accordingly, the bill has remained essentially unchanged after the third reading.
the sale of (transfer of rights to use) computer programs (including computer games) and databases via the Internet;
the provision of Internet advertising services;
the provision of services involving the Internet posting of offers to buy (sell) goods (work and services) and property rights;
the provision via the Internet of services involving the provision of technical, organizational, information and other resources, carried out using information technologies and systems, for the purpose of enabling communication and the conclusion of transactions between sellers and buyers;
the provision and (or) maintenance of a commercial or personal Internet presence, the maintenance of electronic resources of users, the provision of access to those resources to other users and the enabling of users to modify those resources;
the storage and processing of information, provided that the person who provided that information has Internet access to it;
the real-time provision of computing capacity, including disk space to store information on an information system upon request;
the provision of domain names and the rendering of hosting services;
the provision of remote system administration and remote software support services for information systems and Internet sites;
the provision of services performed automatically via the Internet upon the input of data by the purchaser of the service, automated data search, selection and ordering services and the provision of selected data via telecommunications networks;
the sale (provision) via the Internet of electronic books and other electronic publications, information and educational materials, graphic illustrations, musical
works without or without text and audiovisual works;
the provision of services involving the search for and provision to a client of information on potential customers;
the provision of access to Internet search engines;
the maintenance of statistics on Internet sites.
The bill also includes the following list of operations that are not classed as electronic services:
the sale of goods (work and services) where goods (work and services) ordered via the Internet are supplied without using the Internet;
the sale of (transfer of rights to use) computer programs (including computer games) on physical storage media;
the provision of consulting services by electronic mail;
the provision of Internet access services.
In practical terms, companies should compare the range of services they provide with the above list of electronic services and assess the tax effect of the new tax legislation as stated further on in this article.
Place of Sale of Electronic Services
According to the bill, sales of electronic services are taxed at the location of the buyer. The place of activity of an individual who purchases electronic services is deemed to be Russia if any of the following conditions is met:
the purchaser is resident in Russia;
the bank with which the purchaser holds the account used to pay for the services or the electronic money operator through which the purchaser makes payment for the services is located in Russia;
the network address used by the purchaser in acquiring services is registered in Russia;
the international country code of the telephone number used to buy or pay for services is that of the Russian Federation.
If, based on these criteria, the purchaser’s place of activity is deemed to be Russia, and at the same time the purchaser’s place of activity is deemed to be a foreign state under the laws of that foreign state, the seller may independently determine the purchaser’s place of activity.
Documents that confirm the place of provision of electronic services to individuals include transaction registers containing information on the meeting of one or more criteria defining an individual’s location and on the cost of the services.
VAT Payers
Foreign companies that provide services to individuals in electronic form are obliged, if those services are deemed to be rendered in Russia, to pay tax as taxpayers, unless it is stipulated that a tax agent is responsible for the payment of tax.
Where services are provided by a foreign company (or a foreign intermediary) to a company or individual registered with the Russian tax authorities, the purchaser of the services is a tax agent. Where services are provided by a branch of a foreign company that is registered in Russia, the tax agent mechanism does not apply.
Intermediaries (Russian and foreign companies) that carry on business with direct participation in settlements with individuals on the basis of agency, commission agency or other similar agreements with foreign companies that provide electronic services to Russian individuals are obliged to pay VAT as tax agents.
Where a number of intermediaries are engaged to provide electronic services, the tax agent is the company that makes settlements directly with individuals, regardless of whether it has a contract with the foreign company that provides the services.
Calculation and Payment of VAT
Foreign suppliers of electronic services are obliged to submit a VAT declaration in electronic form via a taxpayer personal account within the standard time limits (not later than the 25th of the month following a quarter which has ended).
The tax base will be determined as the cost of electronic services inclusive of VAT. A tax-inclusive rate of 15.25% is to be applied to the tax base in calculating tax. VAT must be paid by foreign companies not later than the 25th of the month following a quarter which has ended.
Foreign suppliers of electronic services will not be able to claim offsets for amounts of VAT which they were charged on acquiring goods (work and services) in Russia.
Registration (Deregistration) with Tax Authorities
Where services are rendered to individuals who are actually located in Russia, a foreign supplier (or intermediary which is classed as a tax agent) will be obliged to register with the Russian tax authorities. It should be pointed out that such registration would not give rise to a permanent establishment of the foreign company in Russia.
Registration will take place on the basis of an application and other documents, the list of which is to be approved by the Federal Tax Service. The documents may be submitted to the tax authority via a representative, by registered mail or in electronic form via the official website of the FTS without the use of an enhanced qualified electronic signature.
The bill also gives tax authorities the right to deregister a foreign company that provides electronic services to Russian customers in the event that the following grounds arise:
discovery by a tax authority of inaccurate information provided for registration purposes;
failure to pay tax, penalties or a fine within a year after the expiry of the deadline specified in a demand;
failure to comply with a demand to provide documents within three months after the expiry of the deadline for complying with that demand;
failure to submit a declaration within six months after the expiry of the deadline for the submission of that declaration.
Where a foreign company has been deregistered on the grounds listed above it will not be able to re-register via a taxpayer personal account
within one year after that deregistration. Declarations and other documents relating to the provision of electronic services must be provided via telecommunications channels through an electronic document interchange operator.
When a foreign company is re-registered, any amounts of arrears and outstanding penalties and fines that have been classed as bad debt will be reinstated.
Tax Control
According to the bill, an in-house audit of a foreign company’s VAT declaration will be carried out within six months. Tax authorities may request documents (information) proving that the place of provision of electronic services is Russia and other information regarding the electronic services. The foreign company will have 30 days to provide the requested documents.
The bill also gives tax authorities the right to request information on transfers of funds made to a foreign provider of electronic services from a national payment card system organization, money transfer operators, operational centres, payment clearing centres, central clearing counterparties and communications operators.
Practical Effect of the Changes on Businesses
Companies that provide or participate in the provision of Internet services will need to prepare in advance for the planned changes. Practical steps that may be taken to prepare for the new rules governing the taxation of electronic services include the following:
analysing a company’s activities to identify operations which may be VATable under the new rules;
assessing the possibility and/or necessity of changing the business model, the financial model, processes and/or documents for the purpose of complying with the new rules and lowering tax risks;
developing/modifying the mechanism for the payment of VAT in supply chains
developing methods for the separate recording of input VAT and configuring
ERP systems for Russian companies that provide electronic services to foreign customers.
Some of these steps may require considerable effort on the part of companies.
Tax Control in Uncontrolled Transactions
Authors: Vladimir Anosov, Afag Bairamova
Until recently, the case law on the issue of the power of territorial tax authorities to examine prices in uncontrolled transactions was inconsistent10. But the Supreme Court’s appellate ruling on the case involving Minvody-Krovlya OOO (“the Company”)11 has served to develop and reaffirm the Supreme Court’s own stated position on this issue.
It will be recalled that the Company filed a petition with the Supreme Court for paragraph 12 of Letter No. 03-01-18/8-145 of the Finance Ministry of 18 October 2012 to be declared inoperative. According to that paragraph, where tax evasion is alleged to have occurred as a result of price manipulation by a taxpayer, the fact that the taxpayer received an unjustified tax benefit must be proved in the context of on-site and in-house audits, including through the use of the methods prescribed by Chapter 14.3 of the Tax Code.
During the hearing of the case the Company claimed that the contested provision effectively modified the scope of powers vested in territorial tax authorities by the Tax Code by extending the grounds on which the prices of transactions between interdependent persons could be examined. However, the first instance court refused to declare the paragraph in question inoperative, arguing that:
10 The criteria for classing transactions as controlled are stated in Article 105.14 of the Tax Code.
11 Appellate Determination No. APL16-24 of the Supreme Court of the Russian Federation of 12 May 2016.
proving the occurrence of an unjustified tax benefit is not an instance of price examination;
the letter does not confer powers on territorial tax authorities to examine prices in transactions between interdependent persons;
the letter does not state that the prices of any transactions between interdependent persons must be reviewed specifically by territorial tax authorities;
tax authorities have the right to take steps to prove that an unjustified tax benefit was received;
the use of the term “price manipulation” does not in itself signify an extension of the grounds for the examination of prices in transactions between interdependent persons.
The court also concluded that the contested provision was not regulatory in nature, did not go beyond the bounds of reasonable interpretation of the provisions of tax legislation and did not affect taxpayers’ rights. It did not, however, address the issue of whether the fact that a price deviates from the market level is in itself sufficient to indicate an unjustified tax benefit, as tax authorities have claimed in a number of cases.
Disagreeing with the decision of the Supreme Court, the Company filed an appeal with the appellate board of the Supreme Court, which partially amended the decision by excluding from the reasoning section the conclusion that paragraph 12 of the Finance Ministry’s letter was not addressed to territorial tax authorities.
The appellate instance of the Supreme Court rejected as invalid the Company’s arguments that the concept of an unjustified tax benefit is not contained in legislation. A tax benefit is defined by Supreme Arbitration Court Ruling No.
5312 as a reduction in the amount of a tax liability resulting, in particular, from a reduction of the tax base, the receipt of a tax deduction or tax concession or the application of a lower tax rate, and the receipt of a right to a refund (offset) or reimbursement of tax from the budget. A tax benefit may be deemed unjustified, in particular, where operations have been taken into account for taxation purposes not in accordance with their true economic intent or operations have been taken into account which were not occasioned by reasonable economic or other grounds (business objectives).
A tax benefit cannot be deemed justified if it was received by a taxpayer outside the context of genuine entrepreneurial or other economic activities. In this respect, the fact that the same economic result could have been achieved with a lesser tax benefit accruing to the taxpayer through the performance of other operations which are provided for or not prohibited by law does not constitute grounds for declaring a tax benefit to be unjustified (clauses 1, 3 and 4 of the Ruling).
It follows from the Ruling that the unjustified nature of a tax benefit might also be evidenced by substantiated arguments presented by a tax authority regarding the existence of the following circumstances: the taxpayer could not have carried out the operations in question in view of the time, the location of assets or the quantity of material resources that are economically necessary for the production of goods, the performance of work or the rendering of services; the absence of the conditions required to achieve the results of the economic activity in question in view of the absence of management or technical staff, fixed assets, production assets, storage facilities or means of transport; the fact that only economic
12 Ruling No. 53 of the Plenum of the Supreme Arbitration Court of the Russian Federation of 12 October 2006 “Concerning the Evaluation by Arbitration Courts of the Legitimacy of the Receipt by a Taxpayer of a Tax Benefit”
operations which give rise to a tax benefit have been taken into account for taxation purposes, when other economic operations also need to be performed and taken into account for the type of activity in question; operations have taken place involving goods which were not produced or could not have been produced in the quantity specified by the taxpayer in accounting documents. At the same time, interdependence between the parties to transactions cannot in and of itself constitute a basis for a tax benefit to be declared unjustified (clauses 5 and 6 of the Ruling).
The appellate court asserted that the amount of the unjustified tax benefit could be determined using, inter alia, the methods prescribed by Chapter 14.3 of the Tax Code.
Given the position expressed by the Supreme Court, it may be concluded that prices in transactions which are not controlled may be adjusted for taxation purposes by territorial tax authorities in the context of on-site and in-house audits provided that the receipt of an unjustified tax benefit has been demonstrated in line with Ruling No. 53. It follows that the mere fact that prices deviate from the market level is not a sufficient basis for adjusting them. The methods prescribed by Chapter 14.3 of the Tax Code may be used to determine the amount of an unjustified tax benefit.
It will be recalled that a similar conclusion follows from the Supreme Court’s determination on the case involving Stavgazoborudovaniye OOO.13 In that case the court stated, inter alia, that the tax authority had not established from its audit of the taxpayer any circumstances other than the fact that the parties were interdependent on the basis of which to challenge the transactions as lacking reasonable economic grounds or as being aimed at artificially creating conditions for the receipt of an unjustified benefit. It therefore followed that the territorial tax authority had had no grounds
13 Decision No. 308-KG15-16651 of the Supreme Court of 11 April 2016.
on which to adopt the contested decision to charge additional tax amounts, penalties and fines in relation to a transaction which was not controlled.
Calculating Controlled Indebtedness: Separately or Altogether?
Authors: Alexander Bortsov, Darya Senilova
Federal Law No. 25-FZ of 15 February 2016 (“the Law”) made substantial amendments to Article 269 of the Russian Tax Code, which lays down rules governing the treatment of debt interest14. In particular, the Law introduces a new procedure for calculating controlled indebtedness under which, as from 1 January 2017, it will be calculated on the basis of the aggregate amount of controlled indebtedness arising from all obligations of the taxpayer which the Law classes as controlled. It is stated in the explanatory note to the Law that it serves only to clarify the existing definition of “controlled indebtedness”, but current tax law does not make clear whether controlled indebtedness to different companies should be added together for the purpose of determining the amount of controlled indebtedness, and the positions of the courts, the Finance Ministry and the tax authorities do not always coincide. The absence of a uniform position on this issue is reaffirmed by recent case law.
For example, in March 2016, in its ruling on the case involving Kolvinskoye ZAO, the Supreme Court established that the taxpayer should consider aggregate indebtedness to foreign sister companies in calculating the capitalization coefficient15. The court took the view that any other interpretation of the thin capitalization rules would be contrary to the principle established in Article 269. In February 2013
14 Federal Law No. 25-FZ of 15 February 2016 “Concerning the Introduction of Amendments to Article 269 of Part Two of the Tax Code Regarding the Definition of the Concept of Controlled Indebtedness”.
15 Determination No. 307-KG16-1257 of the Supreme Court of 28 March 2016 on Case No. А05-12258/2014.
similar conclusions were drawn by the Supreme Arbitration Court on the case involving Bryansky Mashinostroitelny Zavod Management Company ZAO16. In both cases the courts took the view that since all the companies were affiliated to one foreign company, the capitalization coefficient must be calculated on the basis of the entire amount of loans owed to them.
However, the Finance Ministry and the tax authorities state in their letters that the amount of controlled indebtedness should be determined for each individual company on the basis of all debt obligations owed to that company17. There is also case law in which this approach is adopted. In March 2015, the Federal Arbitration Court of the East Siberian Court issued a decision on the case involving YUII-Sibir OOO. In the situation concerned the company had controlled indebtedness to Maxam Rusia OOO, which was affiliated to Maxamcorp International S.L. The court took the opposite view to the one expressed by the Supreme Arbitration Court and asserted that the capitalization coefficient must be determined separately for outstanding indebtedness to each company in relation to which a debt obligation exists18.
16 Determination No. VAS-17204/12 of the Supreme Arbitration Court of 20 February 2013 on Case No. А09-3038/2011.
17 Ministry of Finance Letter No. 03-03-06/1/10911 of 26 February 2016, Ministry of Finance Letter No. 03-03-06/1/366 of 27 July 2012, Ministry of Finance Letter No. 03-03-06/1/2538 of 27 January 2015, Letter No. 16-15/050574@ of the Moscow Administration of the Federal Tax Service of 7 June 2012.
18 Ruling No. F02-711/2015 of the Arbitration Court of the East Siberian District of 19 March 2015 on Case No. А33-23100/2013.
Thus, even if a company acts in accordance with the approach set out in the Finance Ministry’s letters, there can be no guarantee that an on-site tax audit will not result in additional charges being imposed in accordance with Article 269. It should also be borne in mind that the courts may take the side of the tax authorities despite the fact that the changes to the Tax Code indicating that amounts of controlled indebtedness should be added together enter into force only from 1 January 2017.
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