Accounting for interim dividends for profit tax purposes if a company incurs losses at the end of the tax reporting period.

15.05.2009

LEGAL UPDATE No. 37.

Goltsblat BLP advises that Letter No. ShS-22-3/210@ of the Federal Tax Service of 19 March 2009 “On the Accounting Procedure for Interim Dividends for Profit Tax Purposes” has been adopted on agreement with the Ministry of Finance of the Russian Federation (hereinafter the Letter).
The contents of the Letter will be of interest to all companies that decide to pay (distribute) dividends (net profit) to shareholders (participants) on the basis of their operating results in the first quarter, half-year or nine months of a financial year (interim dividends).

The Letter clarifies that interim dividends paid during the year may not be classified as dividends for tax purposes if financial reporting data indicate that a loss was incurred at the end of the tax period for profit tax purposes.

The Letter provides the following substantiation for this position: the Tax Code of the Russian Federation (the Russian Tax Code) contains a clear definition of dividends for tax purposes. According to the Russian Tax Code, any income derived by a shareholder (participant) from an entity at the time of the distribution of after-tax profit on shares (participation interest) held by the shareholder (participant) in proportion to participation interests in the charter capital of this entity is recognised as dividends. It can be concluded on this basis that if the financial reporting data of a taxpayer indicate that a loss was incurred in a tax reporting period (in other words, there is no after-tax profit), payments constituting interim dividends within the meaning of civil law are not covered by the definition established for dividends by tax law.

In conclusion, the Letter states that corporate shareholders should include such income in non-sales income that is subject to 20% tax, while individual shareholders should recognise such payments as income that is subject to 13% personal income tax (instead of the 9% personal income tax rate for dividends). Consequently, as a result of this reclassification, shareholders (both legal entities and individuals) may have to pay additional tax (profit tax and personal income tax, respectively), while the entity that paid the interim dividends may be held liable for the illegal non-remittance (incomplete remittance) of amounts of personal income tax to be withheld and paid to the budget.

The clarifications contained in the Letter have been provided for joint stock companies; such arguments might, however, potentially be used by the tax authorities to classify the amounts of net profit distributed between participants in limited liability companies for tax purposes.

Although the arguments set out in the Letter can be contested, it is likely that the tax authorities will be guided by these conclusions when performing tax audits. In this context, organisations deciding to pay interim dividends should assess the tax risk that the amount of paid interim dividends might be reclassified if there is a possibility that the entity could incur a loss based on operating results in the relevant tax reporting period and should also be prepared for a potential dispute with the tax authority. Entities and individuals receiving interim dividends should take similar steps in this case.

For more information, please contact:

Andrey Shpak, Head of Tax,
Goltsblat BLP
Tel: +7 (495) 287 44 44,
Email: info@gblplaw.com

Anton Sitnikov, Partner,
Corporate / M&A,
Goltsblat BLP
Tel: +7 (495) 287 44 44,
Email: info@gblplaw.com

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