Actual Income Right In Russia — positive outcome case
In view of the practice of tax administration and tax disputes in Russia recent years, a case which arose in June 2019 is particularly noteworthy. It is no secret that the contemporary mode of implementation of the Russian Tax code’s provisions by the tax authorities (tax inspectorates) has established a consistent trend: practically any aspect of the business activity of a commercial company may lead to an additional tax payment being required. And if income is transferred from Russia to an overseas company, then the chances of such a scenario rise substantially. In this connection, the implementation of the “actual right to income” issue becomes pertinent with respect to income taxed at source in Russia at a lower rate.
With these circumstances in mind, a common way for a Russian company to handle tax issues involves a readiness to uphold one’s own opinion, first by a challenge to the tax audit report which gave rise to the additional tax charge, and then through litigation, which may take a few years. Among a great number of similar tax dispute cases, the decision of the Arbitration Court of Sverdlovsk region of Russia, dated 04.06.2019, on case № А60-14696/2019, for “Advanced Yekaterinbourg LLC” contains interesting details.
According to a tax office audit with respect to sums of income paid to foreign companies for 2017, “Advanced Yekaterinbourg LLC” was held liable to additional tax.
In 2017, this subsidiary company paid dividends to its Cyprus holding (parent) company for 2016 and 3 quarters of 2017. Given this, an amount of tax was withheld at a lower rate of 5%, according to the double tax treaty between Russia and Cyprus, by a payee of dividends who happened to be a tax agent. However, during the tax audit, the tax inspectorate reached the conclusion that the Cyprus company had not been an actual beneficiary of the paid income, on the grounds that its beneficial owner is a natural person non-resident in Cyprus. Consequently the inspectorate concluded that the tax should have been levied at a rate of 15%, and charged additional tax, claiming its payment from the tax agent (“Advanced Yekaterinbourg LLC”).
The tax agent submitted an objection to the tax audit report, stating, among other things, that the inspectorate had not presented any evidence of the absence of commercial activity of the Cyprus company that had received the dividends. After examining the above objection and performing the appropriate tax control measures, the tax inspectorate decided not to impose tax sanctions on the tax agent, according to paragraph 1 of article 109 of the Russian Tax code.
This decision was taken by the tax inspectorate in consideration of the opinion of the Russian Ministry of Finance, stated in its letters dated 28.12.2016, № 03-08-05/78852, and 17.03.2017, № 03-08-05/15450. In particular, it was noted that, even if the tax agent had not collected a set of documents confirming the actual conduct of commercial activity by the Cyprus company on the territory of Cyprus, the tax inspectorate which held the audit had not proved that such activity was not being undertaken by the stated beneficiary. Consequently, the conclusion was reached that the documents presented by a taxpayer do not confirm the actual right of an overseas company to receive the income.
However, the absence of documents confirming non-conduct of commercial activity by the overseas company in Cyprus does not give legal grounds for the additional charge of tax in Russia at a rate of 15% or for the imposition of tax sanctions.
As a result of the tax agent’s presentation of the objection to the tax audit report, his requirements were met by the inspectorate, and this was set out in its final decision.
However this case was transferred to a court. The tax agent filed a lawsuit, claiming the inspectorate’s decision was invalid to the extent of the grounds of non-imposition of tax liability. “Advanced Yekaterinbourg LLC” requested the tax inspectorate to mention a valid defense as legal grounds for such non-imposition of liability – “non-occurrence of tax violation”. The basis of the case is that the above-mentioned paragraph 1 of article 109 of the Russian Tax code contains a number of subparagraphs mentioning the various reasons for exclusion from tax liability. In particular, alongside the above mentioned non-occurrence of tax violation, such situations are mentioned as non-achievement of the age of discretion, or expiration of the term of limitations for tax liability.
In reaching a decision on this case, the court considered the fact that
the reference to the general paragraph 1 of the mentioned article 109 had been removed from the operative part of the inspectorate’s decision at a pre-litigation stage of proceeding with the complaint.
In this way, the court considered the inspectorate’s decision compliant with the legislation in force, and not in violation of the taxpayer’s legally protected interests.
In the current circumstances, the outcome of this case for the taxpayer may be deemed substantially positive. However, in order to bring the company to a “totally bona fide” legal standing, its management and owners had to undertake substantial efforts. Processing the tax audit requires the involvement of a raft of company resources, and of outsourced specialists. Usually, in order to uphold the company’s legal interests successfully, specialists are required who have sufficient expertise in processing tax audits and subsequent appeals against the tax inspectorate’s actions, as well as in court proceedings. And all these resources are to be expended by a company acting bona fide from the beginning, but facing unjustified claims from the tax authorities.
Even if the company conducts its activity without anticipated legal risks, it is prudent to have well-arranged business connections with specialists in processing tax audits and in supporting related tax disputes, in order to get the necessary advice in time, in case of appealing the claims of the tax authorities. The case law and its practical application show that, in the present circumstances, such claims are highly probable for a company conducting commercial activity in Russia.