On October 25, 2017, the Economic Chamber of the Russian Supreme Court confirmed that the Russian Federal Tax Service has the right to cancel resolutions of subordinate tax authorities on its own initiative.

The circumstances of the reviewed dispute are described below:

(1) By resolution of a tax authority dated July 30, 2014, a jewelry factory, Aquamarine LLC, located in Kostroma Region (the “Company”), was subjected to tax liability resulting from a resolution of the Territorial Inspectorate on unlawful VAT recovery.

(2) The Company filed an appeal with the Federal Tax Service Directorate for Kostroma Region. By the Directorate’s resolution dated November 07, 2014 (the “Directorate Resolution”), the Company’s claims were satisfied, and the resolution of the Territorial Inspectorate was cancelled for failure to prove conclusions of the tax authority on absence of actual business activities of the Company’s contracting parties and the Company’s failure to exercise due diligence when entering into agreements with them.

(3) However, 13 months after the Directorate Resolution was adopted, the Russian Federal Tax Service Directorate in the course of monitoring activities of subordinate tax authorities adopted a resolution dated December 23, 2015 cancelling the Directorate Resolution (the “Russian Federal Tax Service Resolution”) as being non-compliant with the provisions of legislation on taxes and duties based on Clause 3 Article 31 of the Russian Tax Code and Articles 6 and 9 of Russian Law No.943-1 dated March 21, 1991 “On tax authorities of the Russian Federation” (the “Tax Authorities Law”).

Following such course of events so unexpected for the taxpayer, the Company applied to the court, seeking invalidation of the Russian Federal Tax Service Resolution as being non-compliant with the Russian Tax Code regulations. However, all three instances upheld the decision of the Russian Federal Tax Service and highlighted the right to oversee activities of subordinate tax authorities, including beyond the scope of supervisory measures.

In addition to the practically unlimited powers of the Federal Tax Service to review and cancel any decision, in this situation the taxpayer faced the obvious risk of no time limits for such review, which, however, did not confuse the lower-level courts in the course of examining the case in point. Moreover, the taxpayer was deprived of its right to file its objections with the Federal Tax Service and to substantiate its position.

Having not agreed with the resolutions of the lower-level instances, the Company filed an appeal with the Russian Supreme Court. By decision of court judge Ms. M.K. Antonova dated September 29, 2017, the case was sent to the Economic Chamber of the Russian Supreme Court for further examination.

Taxpayer’s point of view:

At a hearing that took place on October 25, the Company representative, not disputing the powers of the Russian Federal Tax Service to perform monitoring, insisted that arbitrary interpretation of Clause 3 Article 31 of the Russian Tax Code is unacceptable and justly referred to the lack of a clearly defined procedure and timeframes for such review, which surely violates the interests of taxpayers. From the Company’s point of view, in the situation under consideration it is possible to apply by analogy the rules of Articles 139-140 of the Russian Tax Code regulating procedures for taxpayers when filing claims with the Russian Federal Tax Service and setting a 1-year period for such processing.

Federal Tax Service’s point of view:

The Russian Federal Tax Service, in its turn, referred to the fact that in the course of overseeing the work of subordinate tax authorities resolutions are adopted, that there are about 27 resolutions, and only 3 of them are against the taxpayers. However, it was not specified based on whose claims they were reviewed in those cases, and hence whether the review was conducted as per Articles 139-140 of the Russian Tax Code or arbitrarily (as in the case under consideration). We believe that such statistics are of essential meaning for the argument of the Russian Federal Tax Service.

In response to the Company’s argument on the need to apply procedures described in Articles 139-140 of the Russian Tax Code for purposes of the performed review, the Russian Federal Tax Service objected that in the particular case the analogy does not apply since different principles of control are used and the taxpayer has already had the opportunity to file its objections twice, thus, its right to defense was not violated.

That said, having agreed with the Company, the Russian Federal Tax Service pointed out the need to determine the time limits for such review and suggested to use the three-year limit specified in Articles 78-79 of the Russian Tax Code for crediting and refunding overpaid taxes.

Supreme Court resolution:

Based on assessment of the case circumstances, the Russian Supreme Court supported the Russian Federal Tax Service’s position, upheld the resolution of the lower-level instances and denied the Company’s appeal. Taking into account the purely formal approach of all three courts referring to rather abstract regulations of Clause 3 Article 31 of the Tax Code and Articles 6 and 9 of the Tax Authorities Law and the absence of assessment of the balance of public and private interests, one should hope that the Russian Supreme Court in the explanatory section of its resolution will dedicate attention to the taxpayer’s arguments on the need for a clearly defined procedure and exact timeframes and will try to clarify and define them.

What was the reason for the Russian Federal Tax Service’s initiative?

It is notable that the Company learned the reason for the Directorate Resolution being cancelled only from the response of the Russia Federal Tax Service to the Company’s appeal to the Russian Supreme Court. It was due to a query by the Russian Ministry of Internal Affairs on criminal proceedings against the Company’s contractors. It is interesting that earlier this fact was not mentioned in the case files. It is tentatively reported that up to now the law enforcement authorities have not adopted any specific resolutions regarding the relevant contractors. Moreover, for the purpose of the criminal proceedings, different tax periods were considered, and one of the cases has even been dismissed due to lack of elements of a crime.

The Russian Federal Tax Service’s representative also referred to the fact that the Russian Federal Tax Service has no right to ignore a query of law enforcement authorities and, on the other hand, has no right to transfer criminal investigation records to the Company.

Our assessment

The fact of unlimited powers to cancel any resolution without a regulated procedure surely raises many questions from the point of view of guaranteeing the taxpayers’ rights.

While the practice in this area is just being formed and the procedure and taxpayers’ rights and guarantees are not clearly regulated, companies need to consider the arising risks and develop a thorough behavior strategy for disputes with tax authorities.

• The facts of this case once again illustrate the importance of vetting contracting parties both before entering into contracts and in the course of interaction.

In this situation, it is necessary to focus attention on the reasons for such review in respect of the Directorate Resolution by the Russian Federal Tax Service – the query of the Russian Ministry of Internal Affairs on the grounds of criminal proceedings being instituted against the Company’s contractors.

Thus, flaws in the work of contractors for which their officials were in the end not even prosecuted became the key reasons for the Russian Federal Tax Service checking the Directorate Resolution and the subsequent negative consequences for the Company. Vetting the contractors should not be limited to “due diligence” in the event of tax inspections; companies should be ready for their relationship with contractors to also be reviewed by law enforcement authorities. Of course, nobody knows all the facts of the economic activities of their contractors; however, in most cases, a thorough check can protect you from unforeseen negative consequences.

• Possible options for further protection of the taxpayer’s rights in the situation in point.

Despite the course of the events so unexpected for the taxpayer, we believe that the taxpayer can still protect their rights as follows:

1. The taxpayer has the right to appeal to the Commercial Arbitration Court against the Russian Federal Tax Service Resolution in accordance with the procedure specified in Clause 1 Article 138 of the Russian Tax Code and Clause 2 Article 197 of the Russian Commercial Arbitration Procedure Code. In general, such appeal may be submitted to the Commercial Arbitration Court within three months from the date the company became aware of a violation of its rights and legitimate interests.
2.  File a VAT refund application and receive a tax authority’s resolution on denial of the refund, which in the future can be appealed in court, regardless of a resolution on the imposition of sanctions; moreover, for these purposes, no special pre-trial procedure is required (Clause 65 of Decree No.57 of the Plenum of the Russian Supreme Commercial Arbitration Court). The appropriate claim may be filed within three years from the time a taxpayer became aware of violation of its rights; as a rule, this is the time a resolution on denial of a VAT refund is received.

Anastasya Kuzmina   Senior 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 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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