Corporate restructuring tax risks

01.03.2017

Legal Update No. 592

Goltsblat BLP advises that the arbitration decision database now includes a new tax dispute-related decision of great importance for business. On 13 February 2017, the Vladimir Region Commercial Court passed a decision on case No. А11-6203/2016 ("Decision") involving Mondelez Rus LLC ("the Company"). It upheld the tax authority’s legal position, providing a detailed analysis of the international restructuring of the Group's assets at the level of its Russian businesses.

Higher courts may invalidate a court decision for violating existing law enforcement practice or uphold it, this potentially creating serious tax risks for corporate business restructuring.

In 2011, the Company acquired a 100% interest in Dirol Cadbury LLC from Cadbury Russia Two Limited (UK) for RUB 12.8 bn. At the time, both the purchaser and the seller belonged to the same group of companies. In payment under the transaction, the Company delivered two interest-bearing credit notes for the specified amount to the foreign seller. During 2011-2012, the Company booked the interest (RUB 2.4 bn) as costs and did not deduct the tax from interest payments in compliance with the relevant clauses of the international treaty between Russia and the UK. The tax authority refused to allow deduction of the interest and recognised payments relating to the credit notes and interest as “concealed” distribution of dividends.

The first instance court supported the tax authority's position on the following grounds:

  • On the transaction date, Dirol Cadbury LLC, the Company and the seller of the interest belonged to the same group of companies. Since acquisition of the interest was part of a global restructuring programme, the Company lacked free will in concluding the transaction to purchase Dirol Cadbury LLC.
  • The terms and conditions of the transactions were not in line with good business practices (there was no agreement between the parties on the credit repayment term, conditions of granting the credit or repayment security). Independent companies may not conclude a transaction on such terms and conditions.
  • Cadbury Russia Two Limited (the Seller of the interest):

(1) was incorporated shortly before the transaction;
(2) appeared to be a shell company;
(3) performed no activities following the transaction;
(4) transferred all the funds received from the Company to intermediate owners as dividends;
(5) paid no tax owing to exemptions effective in the UK.

  • The Company actually obtained control over Dirol Cadbury LLC before the transaction was completed: appointed a new General Director, transferred Company employees, closed several bank accounts and changed some goods supply models.
  • The Company's 2010 corporate social report specified the Dirol Cadbury assets as belonging to the Company.
  • The Company's accumulated retained profits were comparable to the amounts transferred to the foreign seller under the credit notes.

The court dismissed the expert opinions of the St Petersburg State University and Ernst & Young LLP (UK) submitted by the Company to the effect that the integration mechanism applied ("purchase followed by a merger") was standard business practice. Moreover, the court asserted that the true purpose of the transaction was for the Company to transfer its business profits to its parent company Kraft Foods Inc (USA).

We believe that the judicial conclusions on the case were unsubstantiated because they violate a number of basic judicial practice concepts:

  • The tax authority unlawfully assessed the transaction in terms of its reasonableness, rationality, effectiveness and results (Resolutions of the Presidium of the RF Supreme Commercial Court No. 11542/07 dated 26 February 2008, No. 14616/07 dated 18 March 2008 and No. 8867/10 dated 28 October 2010). The courts specified that "the tax authority’s powers do not include imputing profits to taxpayers relying on its own understanding of how taxpayers might achieve economic benefit at a lower cost".
  • Achievement of the same economic result accompanied by the taxpayer obtaining a lower tax benefit through other operations provided for or not prohibited by law does not constitute grounds for a tax benefit to be deemed unjustified (Resolution of the Presidium of the RF Supreme Commercial Court No. 53 of 12 October 2006).  

Relying on their wealth of experience in supporting clients on tax aspects of corporate restructurings and transactions involving sale and purchase of businesses, the tax experts of Goltsblat BLP are ready to provide a preliminary assessment of a seller's or purchaser's tax risks during the planning of transactions, to suggest ways to minimise tax risks and to assist taxpayers during tax audits.

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