Recover VAT from a bad faith counterparty? Possibly!

28.06.2017

Goltsblat BLP would like to update you on the latest developments concerning recovery of VAT deemed non-deductible by the tax authority as damages from counterparties.

On 5 June 2017, the Arbitrazh (Commercial) Court for the North-Caucasus Circuit (the Court) ruled on Trade House RIF v. Agrobusiness1. The Court upheld recovery from the counterparty of damages arising from false material representations (article 431.2 of the Russian Civil Code).

The courts found VAT recovery against the counterparty to be lawful, taking note of the following:

  • The tax authority confirmed that the VAT could not be deducted;
  • The tax authority’s denial of refund stemmed from the defendant’s relations with its counterparty and artificial document flow;
  • The contract made the counterparty (defendant) liable for false representations and warranties;
  • This contractual liability did not depend on court appeals against tax authority decisions;
  • The defendant had the right to submit sufficient and reliable documents proving its relations with the counterparty and refuting the tax officers’ conclusions, yet it failed to do so;
  • Although tax deductions are covered by tax rather than civil laws, they could be treated as a special tool for reimbursement of corporate expenses.

This Court ruling is an important development in recovery from counterparties of VAT deemed non-deductible by the tax authority, as courts used to deny recovery of VAT as damages.

Importantly, this case differs in that it addresses contractual liability for misrepresentations (clause 1, article 431.2 of the Russian Civil Code) and not “conventional” recovery of such damages under articles 15 and 393 of the Civil Code.

Bad-faith counterparty disputes are the most common type of tax dispute. VAT refunds are a particular risk, since unlawful refunds might be treated as fraud (article 159 of the Russian Criminal Code). Today's surge in criminal cases filed by law enforcement agencies over VAT refunds and bad-faith counterparties is further testament that these are cause for concern even for good-faith businesses.

We believe that the courts’ interpretation of Civil Code article 431.2 can be disputed in the above case. With this in mind, inclusion in the contract of counterparty tax discipline clauses should be carefully reviewed from both the tax and civil law perspectives. Also, you might want to take the above cassation court ruling into account when building your tax and criminal defence tactics.

1Case No. А53-22858/2016

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