Russian Tax Code Article 54.1: New clarifications from the Federal Tax Service
Legal Update No 840
Bryan Cave Leighton Paisner (Russia) LLP, formerly Goltsblat BLP in Russia, advises that, on 10 March 2021, the Russian FTS sent to lower tax bodies letter No. БВ-4-7/3060@ “On practical application of Russian Tax Code Article 54.1” (the Letter) offering detailed clarifications on how this particular rule of the Russian Tax Code (the RTC) is to be applied.
The recommendations included in the Letter are to be applied by the tax authorities in their tax control measures, so the Letter is of utmost importance to all taxpayers. Here are some of the Letter’s provisions we believe to be most significant.
1. Genuineness of transactions
The Letter attaches primary significance to the reality of transactions: transactions that do not actually take place may not be reported for tax purposes. A transaction found to be real (genuine) is then subject to other tests: whether the obligation was fulfilled by the appropriate person, what the actual economic substance of the transaction was and whether there was any business rationale for it.
2. Appropriate performer test
According to the Letter, this criterion serves to combat use of shell companies (referred to as ‘technical’ in the Letter) that do not conduct any actual business. So when there are no doubts that transactions are real, yet the obligation was not performed by the party required to do so contractually, the taxpayer is not entitled to reduce its fiscal liability on the basis of documents produced on behalf of such party owing to the documentary proof requirement.
Also, in order to preclude purely formal claims, the Letter requires the tax authorities to establish both the fact of an obligation not having been performed by the obligor and the circumstances evidencing that the taxpayer sought to reduce its fiscal liability unlawfully or knew or should have known that its counterparty was a shell company and the obligation was actually performed by another.
3. Tax reconstruction
Unlike prior FTS explanations regarding RTC Article 54.1, the Letter permits tax reconstruction. Not only expenses deductible for profit tax purposes but also VAT offset amounts are to be booked with reference to “real performance parameters” on the basis of documents provided by the actual performer under the transaction. Under the Letter, for reconstruction to be applied, the taxpayer must submit information and documents allowing the actual performer and parameters of the disputed transaction to be established. Otherwise, the tax authority will not permit reconstruction and, consequently, recognition of expenses and the VAT offset.
When a taxpayer acts carelessly and fails to apply so-called commercial diligence yet the actual performer is established, deductible expenses and VAT offsets are recognised on the basis of the financial and business parameters of the actual performer. When the actual performer cannot be identified, no right to offset VAT is granted and expenses are to be determined using the computation method.
If the disputed transactions are performed using the taxpayer’s own resources, the Letter says the tax authority may recognise the relevant expenses and VAT offsets relating to purchase of physical and other resources other than payroll expenses, provided pertinent information is disclosed and documents are submitted.
4. Commercial diligence
The Russian FTS believes the standard of diligent conduct in civil relations expected from a reasonable party in comparable circumstances (i.e., commercial diligence), as shaped by Russian courts, to be equally acceptable for fiscal purposes. In this context, in item 14 of the Letter, the FTS provides examples of criteria to be examined by a diligent taxpayer. Item 15 of the Letter lists defects in diligent conduct that will signal to the tax inspectors that the taxpayer would not have cooperated with such an unreliable counterparty unless there were some tax advantage. The FTS agrees that different levels of diligence would be exercisable in dealing with counterparties in routine purchasing transactions and in strategic deals involving material amounts.
In its Letter, the FTS also reminds taxpayers that they are entitled to recover from the guilty parties any losses caused by insufficient diligence.
5. Intent or carelessness
The Letter determines when a taxpayer’s actions must be recognised as having intent (triggering a fine of 40% of the additional tax charged under Clause 3, Art. 122 of the RTC) and as carelessness (a 20% fine under Clause 1, Art. 122 of the RTC). For instance, intent is identified when a taxpayer deliberately takes part in a tax dodging scheme or knows about such participation. On the other hand, insufficient diligence in selecting a counterparty is recognised as carelessness.
In this context, if the tax audit materials prove that the taxpayer exercised due commercial diligence and did not know (had no possibility of knowing) about its counterparty being a shell company, whereas the obligation was performed by another, there is no offence and the taxpayer may deduct the relevant expenses from its tax base on the basis of the agreement with this counterparty and the pertinent performance documents.
6. Actual economic substance of transactions and the business purpose test
The Russian FTS believes that, when legal classification of transactions appears garbled, the tax authorities must determine the taxpayer’s fiscal duties by establishing true economic substance of the transactions in consideration of their assessment of whether the taxpayer was guided by reasonable economic or other factors and the circumstances evidencing its intention to obtain an economic effect. If a transaction covers up for another, the cover-up transaction is discarded and the tax implications are determined on the basis of the underlying, covered-up transaction.
Any transaction must have a business rationale. When deciding on what the principal objective of a transaction is, the tax authorities “... must assess whether the taxpayer would be willing to enter into the transaction for business reasons only, i.e., in the absence of any tax advantage”. This approach agrees with the commercial diligence standard in selecting a counterparty, as discussed above.
The tax authority also intends to apply the business purpose test to standalone transactions even if, taken together, they are designed to bring about economically justified goals.
The Letter also fixes a number of other provisions essential for law enforcement practice. For instance, the explanation regarding RTC Article 54.1 only being applicable if harm is caused to the Treasury is a paramount guarantee for safeguarding good faith businesses against unjustified claims by the tax authorities.
The Russian FTS was assisted in drawing up the Letter by tax experts and business associations. Bryan Cave Leighton Paisner (Russia) LLP lawyers took an active part in developing suggestions to be included in the Letter.
Given the Letter’s approaches to selecting and checking on contracting parties, it is advisable to revisit, without delay, the relevant corporate policies and procedures and embark on bringing them in line with the latest law enforcement practice and the recommendations made by the Letter.
Should you have any additional questions or need defence during tax control activities or assistance in contesting tax office reports, statements and decisions, Bryan Cave Leighton Paisner (Russia) LLP tax specialists will be happy to provide the necessary legal support.
If you would like to receive our legal alerts and updates highlighting current legal issues relevant to your areas of interest and providing expert commentary by our lawyers, please click on "Sign Up" and fill out the form.