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General Review of Tax Disputes in Russia

June 2009 - Tax & Private Client. Legal Developments by Pepeliaev Group.

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When a company operates in a foreign country, it has to comply with local tax obligations. At the same time it can sometimes appear more important to know about the specifics of tax law practice and the modus operandi of the tax authorities than legal norms. In this article we draw the attention of readers to the most typical claims of the Russian tax authorities.

One of the main goals of any tax authority is to check whether taxpayers comply with legal requirements. A tax office files claims when it establishes violations of the rule of law.

The claims of the Russian tax authorities, however, are not always related to legal violations by taxpayers.

In some cases, on the contrary, a company can be held liable under tax legislation for exercising its rights. For example, in accordance with article 258 of the Russian Tax Code, a company may write off 10% of capital expenditure from the historical cost of its fixed assets on a non-recurring basis. At the same time, law does not stipulate any exceptions for specific categories of taxpayers. In practice, however, the tax authorities often disallow this benefit to leasing companies (in state arbitration courts these disputes tend to be won by taxpayers - see Resolution No. F09-4482/07-S3 of the Federal Arbitration Court for the Urals Circuit on case No. –ź07-25671/06 dated 14 June 2007). As a result lessors tend not to exercise this legal right.

In other cases the tax authorities explicitly ignore obligations as established by the Russian Tax Code. For example, a taxpayer may file objections to a tax audit act within 15 working days of receipt of the act from a tax office. The tax office may only appoint a date for considering the company's objections and issue a decision on the expiry of this term. Recently, however, the employees of the tax authorities have been appointing the date for considering the audit materials before the expiry of said term for the filing of objections by a taxpayer, thereby reducing the 15-day term stipulated by law.

Another trend has unfortunately become common practice: non-fulfillment of decisions on tax disputes issued by arbitration courts of the first instance and appellate instance. This is attributable to the fact that under Russian laws on arbitration proceedings a court ruling on the invalidation of an individual non-regulatory act of a tax authority is subject to immediate fulfillment (there is no need to wait for the ruling to become legally enforceable). The ruling remains unfulfilled, however, until the courts of arbitration and cassation uphold the ruling of the court of first instance with their resolutions. Consequently, if a company filed a lawsuit to revoke the arrest of its bank accounts and won the case, said company will have difficulty lifting the arrest on its bank accounts until the judicial ruling has been contested in two appellate instances further to appeals from the tax office.

Many claims of the tax authorities are also characterised by the absence of a systematic approach to additional assessments of taxes. A taxpayer's erroneous accounting of expenses in a later period should not lead to the accrual of arrears, default interest and penalties. These costs could have been deducted at an earlier period (in other words overpayment of tax). The amount of overpayment is equal to the amount of arrears. Consequently the taxpayer did not generate any losses for the state budget. In such cases, however, the tax authorities tend to additionally assess arrears, default interest and penalties, irrespective of tax overpayments in previous periods (Resolution of the Federal Arbitration Court for the North-Western Circuit dated 24 March 2008 on case No. –ź56-31877/2006).

The most common grounds used by the tax authorities to impose additional taxes relate to the concept of "unsubstantiated tax benefit" outlined in Resolution No. 53 of the Plenum of the Supreme Arbitration Court of Russia dated 12 October 2006 "On Assessment by the State Arbitration Courts of the Substantiation of the Receipt of a Tax Benefit by a Taxpayer". As a rule in these cases the tax authority substantiates its claims on the basis of non-payment of taxes by contractors and counterparties of the taxpayer, the holding of bank accounts in the same bank, the immateriality of the profit gained in the transaction and suspicions that the company is involved in tax evasion. In some cases these claims are substantiated. In most cases, however, the tax authorities apply this concept to avoid the rule of law. For example, when a tax authority accuses a company of understating sales revenues, it should be guided by article 40 of the Russian Tax Code, which stipulates the rules for defining a market price (transfer pricing). In this case, however, the tax authority has to undergo a cumbersome process of determining the market price and present a significant amount of evidence. In practice the tax authorities find this difficult to do. Application of the "unsubstantiated tax benefit" concept per se enables the tax authority to overcome these difficulties. The tax authority simply has to refer in a resolution to the lack of a business purpose in transactions, for example, the small amount of profits that were obtained.

A similar approach is applied to profit tax expenses and VAT deductions on the transactions of a taxpayer with "bad faith" suppliers (suppliers that do not pay taxes to the government, do not have employees on their payroll or are registered under forged documents, etc.). The tax authorities file claims against taxpayers that buy services from said suppliers, irrespectively of whether these companies are related and whether the taxpayer was supposed to know that they were "bad faith" suppliers. Unfortunately, arbitration courts tend to uphold the position of the tax authorities on this issue.

Therefore, the most frequent claims of the tax authorities are mainly based on the application of the "business purpose" doctrine rather than the rule of law. Moreover, in these cases the tax authorities simply refer to signs that the taxpayer may be developing an unlawful scheme for tax evasion, without submitting evidence to this effect (it is up to the taxpayer to prove its innocence). Recently the state arbitration courts have started indicating to the tax authorities that they need to submit supporting documents to confirm that the taxpayer developed an unlawful tax evasion scheme (Resolution No. 6273/08 of the Presidium of the Supreme Arbitration Court dated 28 October 2008).

Consequently, as noted above, the tax authorities do not file that many claims regarding the incorrect application of tax legislation. Most claims involve accusations that the taxpayer complied with the law on a pro-forma basis and sought to reduce taxes through tax evasion (in most cases taxpayers win these disputes in state arbitration court, but first of all they have to submit a significant amount of evidence). These arguments are often raised in cases where the taxpayer incurs losses at the end of the reporting period and taxes were not paid or in cases where a company is entitled to recover the tax from the government. The reduction in the number of "legitimate" disputes is also attributable to the fact that in a number of cases the tax inspectors lack the requisite qualifications and are inept at supervising tax compliance.

The position of the taxpayer is rendered more difficult by the repeat nature of the claims filed by the tax authorities. For example, a company may be held liable on the same grounds at the end of each reporting period for VAT (quarter). This happens fairly frequently even in cases where the taxpayer won the previous dispute in a state arbitration court. In some cases this development can have an adverse impact on the operations of the company.

Legislation stipulates the liability of a tax authority and its officials for causing damage to a company owing to the issue of unlawful decisions. It is virtually impossible to prove this fact in practice. Consequently the provision has rarely been applied. At this moment in time ways of rectifying this development are being discussed by the state authorities and the business community. Amendments to legislation on this issue constitute a very important step in developing law enforcement practice and would without a doubt affect the operations of the tax authorities.

Anton Nikiforov



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