The provisions of Article 54.1 of the Russian Tax Code have been in effect since August 2017. These provisions legally codify the concept of an unjustified tax benefit, which in practice has long been known to all taxpayers.

In terms of Article 54.1 of the Tax Code, the concept sets the following restrictions:

a)  The tax base cannot be decreased by distorting facts concerning business activity and objects of taxation; and at the same time

b)  Decrease of the tax base is allowed if i) tax evasion is not the main goal of the transaction and ii) the transaction is performed specifically by the party to the agreement or a party authorized under the agreement or the law.

Soon after these amendments were adopted, the Russian Tax Service issued a letter¹ explaining the application of the new norms. However, due to questions from taxpayers continuing to pour in, the Tax Service issued another recommendation letter² which additionally explained certain aspects of the new regulations, at the same time noting that this is not codification of the old rules set by the famous Decree No.53 of the Russian Supreme Commercial Arbitration Court, but a new approach to the issue of tax abuse.

In the letter, the tax authority finally explained what should be deemed a typical sign of “distortion” of facts concerning business activity and objects of taxation mentioned in Article 54.1 of the Tax Code, namely:

• ­  Income from sale not being shown, including when controlled entities are involved in the taxpayer’s business activity;
• ­  Taxpayers knowingly showing false information on tax objects in the accounting and tax registers;
• ­  Creating a scheme of “business fragmentation” aimed at unlawfully applying special taxation regimes;
• ­  Actions aimed at artificially creating conditions for using reduced tax rates, tax benefits and tax exemptions;
• ­  Creating a scheme aimed at unlawful application of the rules under international double tax treaties;
• ­  Sham transactions (transactions that were not actually carried out).

At the same time, the Tax Service stresses that a methodical (legal) error of a taxpayer cannot in itself be deemed “distortion” for purposes of Article 54.1 of the Tax Code and serve as evidence of unjustified tax benefit.

In order to apply the concept of unjustified tax benefit, the taxpayer’s intent must be established, expressed in conscious distortion of the facts concerning business activity and objects of taxation. The burden of proof of the taxpayer’s intent lies on the tax authority, and the Tax Service notes that specific acts of the taxpayer and its officials must be indicated as evidence of a violation, and proof of the intent to cause damage to the state budget must be given.

In elaborating on the concept provisions to the effect that a transaction cannot be aimed solely at gaining a tax benefit, the Tax Service indicated that the main goal of a transaction should be a specific reasonable business goal rather than tax savings. Evidence of unreasonable tax savings could be, for example, a business decision that is not in line with general business practices (e.g. accession of a company with accumulated losses and without assets if there is no economic reason for it, etc.) and which cannot be justified from the point of view of business risk, which is in fact undertaken not in the company’s interests, but in the interests of another entity with the aim of concealed financing.

The Tax Service also confirms that through Article 54.1 of the Tax Code lawmakers actually restrict the taxpayer’s right to account for expenses and deductions under a transaction if it was performed by an entity not indicated in the source documents. However, in the opinion of the Russian Ministry of Finance in letter No.03-03-06/1/68944 dated 20.10.2017, this right cannot be restricted if a subcontractor performed the obligations.

A very important conclusion in the Tax Service’s letter is that the Russian Tax Code does not restrict the right itself for a taxpayer to structure its activity in such a way so as to minimize the tax consequences.

Similar explanations have been repeatedly voiced by higher courts,³ since there have been frequent cases where the tax authorities attempted to dispute any fact of minimizing the tax burden, even if done lawfully.

One should hope that the explanation on the level of the Russian Tax Service that taxpayers are free to choose for themselves the options for their activity, including in a way that decreases the tax burden through lawful methods, will help limit unjustified requests and claims from the tax authorities. This is particularly important in light of the Decree of the Russian Constitutional Court, which recognized the tax authority’s right to intervene in business decisions on structuring business if a taxpayer is suspected of “unlawful decrease of tax payments to the state budget” (Decree of the Russian Constitutional Court dated 04.07.2017 on the Master-Instrument LLC case).

Trends in court practice

Following the above review, please find below the conclusions from some court decisions on disputes over unjustified tax benefit in the recent year.

The Judicial Board for Economic Disputes of the Russian Supreme Court supported the taxpayer and indicated that the company selling real estate to independent entities at a price below the market does not lead to unjustified tax benefit. The Supreme Court noted that the mere fact of the price not being in line with the market does not evidence tax evasion (Decree No.308-KG16-10862 of the Russian Supreme Court dated 01.12.2016 on case No.А32-2277/2015).

The Commercial Arbitration Court of the West Siberian Circuit also supported the taxpayer, indicating that absence of real expenses in business operations leads to unjustified VAT refunds only if the tax authority provides sufficient proof of a fictitious document turnover, and that the tax authority’s mere presumptions are not enough (Decree No.F04-4688/2016 dated 17.10.2017 of the Commercial Arbitration Court of the West Siberian Circuit on case No.A70-16509/2015). What’s important is that in this case the court once again noted that judicial control is not intended for checking the economic expediency of decisions made by businesses which are independent and have broad discretion.

Recent practice of applying the concept also contains conclusions in favor of businesses, namely, securing of the principle that the tax authority’s position is to be denied if “the case materials do not contain proof of concerted actions aimed at a transaction for tax evasion purposes, and no proof is given of contracting parties being controlled or of other facts of fictitious business and/or proof that transaction parties are affiliated” (Decree No.13AP-14558/2017 dated 13.09.2017 of the 13th Commercial Arbitration Court of Appeal on case No.A56-28927/2016).

Analysis of court decisions against taxpayers allows to note, in particular, the following circumstances which, if existing and proven, could evidence unjustified tax benefit:

• As before, the absence of due diligence when choosing a contracting party (Decree No.F05-21375/2016 dated 17.02.2017 of the Commercial Arbitration Court for Moscow Circuit on case No.A40-188774/2015; Decree No.16AP-2795/17 dated 07.08.2017 of the 16th Commercial Arbitration Court of Appeal on case No.A63-14345/2016).

Please note that new provisions of Article 54.1 of the Tax Code do not cancel the approaches worked out earlier as to due diligence, and in no way cancel the need to check your contractors. For example, in a recent case, the taxpayer attempted using Article 54.1 of the Tax Code to justify the idea that under the new regulations it is no longer obligated to exercise due diligence when choosing a contractor; however, the court denied this argument, since the Tax Code does not contain such conclusions (Decree No.17AP-10225/2017-AK dated 31.08.2017 of the 17th Commercial Arbitration Court of Appeal on case No.A50-4720/2017).

• Lack of proof of the fact and amount of expenses borne for certain operations, as well as contradictory data in source documents, evidencing intended overstatement of expenses affecting the size of the tax base for profit tax purposes and VAT deductions (Decree No.310-KG16-20879 dated 31.01.2017 of the Russian Supreme Court on case No.A09-11693/2015).
• Transactions with promissory notes among interdependent entities, as before, attract inspectors’ attention and can evidence unjustified VAT benefit if it is established that securities were transferred without documenting the title to them and there was no cash flow as payment for the acquired goods (Decree No.F09-12451/16 dated 21.02.2017 of the Commercial Arbitration Court for the Ural Circuit on case No.A60-17261/2016).

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¹ Letters No.SA-4-7/16152@ of the Russian Tax Service dated 16.08.2017 “On applying norms of Federal Law No.163-FZ dated 18.07.2017 ‘On introducing amendments to Part One of the Tax Code of the Russian Federation’”.

² Letter No.ED-4-9/22123@ of the Russian Tax Service dated 31.10.2017 “On recommendations on applying provisions of Article 54.1 of the Tax Code of the Russian Federation”.

³ See e.g. Decree No.11542/07 of the Presidium of the Russian Supreme Commercial Arbitration Court dated 26.02.2008 on case No.A40-48303/06-142-294; Decree No.9-P of the Russian Constitutional Court dated 27.05.2003.

Anastasya Kuzmina   Senior Associate   St. Petersburg   Tel.: +7 (812) 346 79 90

Ekaterina Chernenkova   Associate   St. Petersburg  Tel.: +7 (812) 346 79 90

Additional notes

Should any questions arise in connection with the above or if you need any additional materials, please contact Anastasya Kuzmina or Ekaterina Chernenkova, St. Petersburg Office of Capital Legal Services.

This Information letter keeps the clients of Capital Legal Services and other interested parties abreast of information that may, to any extent, affect their activity or cater to their particular interests. The opinions and commentaries expressed in this information letter shall not be deemed as legal opinions and do not cancel the need to obtain legal advice or legal opinion on separate issues. 

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