Review of practice of consideration by courts of cases involving the application of certain provisions of Section V1 and Article 269 of the Tax Code of the Russian Federation (affirmed by the Presidium of the Supreme Court of 16 February 2017)

Court: Supreme Court

The Review relates to transactions between interdependent entities and cases of thin capitalization. Among the most interesting interpretations are the following:

- repeated deviation of price from the market level may be just one of the signs indicating that there is an unjustified tax benefit in place; in order to prove that the company evaded paying taxes, one should determine other circumstances discrediting a business cause of the transaction – for example, interdependence between parties to the transaction, formation of the organisation in question immediately before the disputed transaction, the use of special forms of settlements and terms for payment, and so on;

- the Review explains what is the correct way the Federal Tax Service should determine the amount of certain taxes which are calculated on the basis of market prices (for example, VAT and profit tax). The Tax Code does not contain special methods of calculating such taxes, but it does not mean that the Tax Service may arbitrarily assess tax liability. It should be guided by the rules of Section 5.1 of the Tax Code. The Supreme Court believes that the rules contained therein are of supplementary nature and do not necessarily apply to transactions of interdependent persons only. Therefore, they are applicable to determining market prices in the context of above-mentioned taxes in the course of both field and internal tax audits;

- controlled debts may occur not only between parent and daughter companies, but also between sister companies. In the latter case the dependence of a Russian taxpayer from a foreign organisation may be indirect – when both firms are controlled by the same parent company;

- if taxpayer failed to defend his position and the interest paid under his loans was requalified as latent dividends, he may nonetheless apply to them a reduced tax rate provided for in a relevant international treaty on the avoidance of double taxation (this is a solution of  a long-felt problem, because in thin capitalization disputes tax authorities failed to fully take into account the real relations of parties and in case of success and judicial requalification of loans as dividends were reluctant to apply the reduced rate for dividends in question);

- the presumption that prices in transactions between interdependent entities are market ones (arm’s length transactions) may be refuted only by the Federal Tax Service and not by inferior tax authorities;

- the right of the court, as provided by Section V1 of the Tax Code, to take into account any circumstances relevant for determining whether the transaction is arm’s length one or not, should not serve as a ground for ignoring the rules, established by a law for the purpose of calculating the amount of taxes in controlled transactions (this point purports to curb the practice of courts to determine the market price without due regard to calculation methods provided for by Article 40 of the Tax Code).  

Subject area:
Economic activities, finances thin capitalization