Should business be broken down? Signs of tax evasion when breaking down a business, considering the position of the Russian Supreme Court

The Russian Federal Tax Service sent to all subordinate tax bodies to use in their work Ruling No.306-KG15-7673 of the Russian Supreme Court dated 27.11.2015 on case No.А12-24270/2014 (hereinafter the “Ruling”), in which the Russian Supreme Court supported the tax inspectorate in a dispute on obtaining unjustified tax benefits through the formal procedure of a taxpayer breaking down a business. 

The tax inspectorate imposed additional profit tax and VAT, as well as penalties and fines after making a conclusion on a taxpayer evading taxes through the formal conclusion of agency contracts with an individual entrepreneur (‘IP’) applying the unified tax on imputed income, with the terms and conditions allowing these entities to perform on each other’s behalf the actions on sale and purchase transactions with buyers of goods.

The tax body believes that the profit obtained by the IP when selling the goods is the company’s profit, leading to the profit tax and VAT. 

It is interesting that the courts of first and cassation instances supported the taxpayer in this dispute, referring to absence of due evidence that business operations between the company and IE were fictitious; however, the Russian Supreme Court agreed with the position of the tax authority. 

Taxpayers should consider the following arguments of the inspectorate supported by the Russian Supreme Court: 

• The availability of a unified production base, no production capacities owned by the IE, use of the same labor resources by the inspected taxpayer and the IE, purchase of goods from the same suppliers, which in aggregate formed the criteria for establishing the taxpayer’s bad faith; 

• IE being subordinate to the inspected taxpayer. That provided, an interesting conclusion is made on indirect subordination in connection with the fact that the company was the only source of the IE’s income; 

• Absence of a real business purpose and economic meaning in relations with IE; the purpose of the agency contracts is to decrease the respective tax obligation or to evade it. 

One should note that the tax inspectorates will start to actively apply the position of the Russian Supreme Court when attempting to impose additional taxes and to collect penalties and fines, so taxpayers need to check relations with their contractors once again in order to assess whether they are economically reasonable, and consider the justification of the business relations structure, which the companies will need to provide in a dispute with the tax inspectorate.

No.СА-4-7/465@ of the Russian Federal Tax Service dated 19.01.2016

Anastasya Kuzmina   Associate   St. Petersburg    akuzmina@cls.ru    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 Anastasia Kuzmina, St. Petersburg Office of Capital Legal Services.

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