17 July 2017 Tax Messenger Tax Edition Ruling on Second Transfer Pricing Court Case EY was named a leading transfer pricing company on the Russian market in World Transfer Pricing, 2017 (TPWeek, International Tax Review). The Decision of the Moscow Arbitration Court of 16 June 2017 on Case No. A40-29025/17-75-227 involving Uralkaliy PAO, which was posted on the official website of Russia s federal arbitration courts on 14 July 2017, has become the second court ruling (after the decision on the case involving Neftyanaya Kompaniya Dulisma ZAO 1 ) to be issued on a legal challenge against the results of a specialized price audit carried out by the Federal Tax Service 2. But if the first ruling went against the taxpayer, the outcome in the second case was a resounding victory for the company filing the challenge. 1 Decision of 27 January 2017 on Case No. A40-123426/16-140-1066. More detailed information on the case can be found in our alert. 2 Article 105.17 of the Tax Code.
Facts of the Case According to the Decision, the taxpayer exported potassium chloride to a related company, the Swiss trader Uralkali Trading SA ( UKT ). After carrying out a price audit for the year 2012, the tax authority concluded that the company had set selling prices for its products at an artificially low level. A decision was issued ordering the taxpayer to pay additional profits tax of 980 million roubles and penalties of 3 million roubles. In drawing up documentation for a group of similar transactions, the taxpayer used the transactional net margin method (TNMM). The reasoning given by Uralkaliy PAO in the documentation for not using the comparable uncontrolled prices (CUP) method was that no export supplies were made to independent persons, while domestic transactions involving supplies to the Russian market were not comparable with export transactions for a number of reasons (price regulation by the Federal Anti-monopoly Service, the need for marketing policies and direct contact with customers on the domestic market, varying levels of supply and demand on the potassium chloride market in different countries, the greater logistical component involved in export supplies), in addition to which there were no publicly accessible sources of information on comparable transactions between independent parties. The range of return on sales for 2012 under the TNMM was 1.83% - 5.59%, while UKT s actual profit margin was 1.81%. Since the trader s actual profit margin did not exceed the upper limit of the range, it was concluded in the documentation that the controlled transactions were priced at arm s length. Given this low profit margin, the court rejected as unreasonable the tax authority s contention that the trader had purchased products at an artificially low price and resold them at a large mark-up to end buyers. Notably, the court concluded in its Decision that the taxpayer had provided proper reasoning and supporting documentation for the use of the TNMM. The court also observed that, had the trader used the prices insisted upon by the tax authority in the controlled transactions while keeping the same prices for the resale of products to independent buyers, it would not have been able to cover even direct business costs related to the sale of the products, meaning that UKT would have made a loss. The reasons given by the tax authority for concluding that the taxpayer had acted improperly in applying the TNMM include the following: UKT resells products to related entities (in fact, the court found that only a small proportion of sales (around 10% of the total for 2012) had been made to a related entity, and even if those sales were excluded from the calculation of the trader s return on sales, the figure would still be within arm s length); UKT incurred costs for the maintenance of Uralkali Trading (Gibraltar) (the court pointed out that the trader s margin remained within arm s length after excluding those costs); the taxpayer improperly applied the TNMM to a group of similar transactions 3, whereas it should have calculated the margin for each individual transaction (the court countered that the taxpayer had the right to group transactions for which the following elements coincided: functions performed, method, choice of profit margin indicator and actual margins of comparable companies/transactions. The subject of a transaction is of secondary importance in grouping transactions under the TNMM. The court also stated that it was acceptable to calculate the overall margin for a group of transactions for a calendar year). none of the companies in the sample meet the requirements of the Tax Code, and in particular the comparability criterion (the Federal Tax Service presented reports from the Bureau van Dijk database, but the court asserted that the tax authority had failed to demonstrate that the information 3 The Tax Code does not contain a definition of this term. 2
was relevant to 2012 4 or to attach appropriate reports to the audit report. The court also rejected the references made by the Federal Tax Service to company websites on the grounds that the information in question had not been included in the audit materials). The court ruled that the tax authority had acted improperly in applying the CUP method based on prices quoted by the price reporting agency Argus, since the prices (FOB CIS) used in calculating the arm s-length range were based partly on prices for products produced by the taxpayer itself and Belaruskaliy and exported to independent buyers via a common trading company, Belorusskaya Kaliinaya Kompaniya (BKK), which is a related company of the taxpayer. Given that BKK s price included a trader s margin, transactions involving the resale of the products could not be considered comparable with transactions involving the sale of the products by the manufacturer to the reseller (the tax authority did not make any appropriate adjustment). In other words, the court argued, by using data from the Argus price reporting agency the tax authority had effectively compared the taxpayer s prices in transactions with UKT with that same taxpayer s prices after the addition of another trader s margin (in the case of the resale of products via BKK). Furthermore, the court concluded that the taxpayer s products (various brands of potassium chloride) were not comparable for TNMM purposes with the products for which Argus prices were presented (only two kinds of potassium chloride are identified, grouped together). The court pointed out in this regard that the tax authority had used data published by the Argus price reporting agency without properly reviewing the transactions on which the price quotations were based and without adjusting the conditions of those transactions (including in particular the volume of supplies, the period in which supplies took place and deferred payment terms) in order to ensure the comparability of transaction conditions. For these reasons, the tax authority s decision was invalidated in its entirety. Conclusions for Taxpayers The court expressed support in this case for the taxpayer s choice of pricing method (TNMM) in documentation submitted to the tax authority. The court also identified significant deficiencies in the application of the method chosen by the tax authority. This shows that controlled transaction documentation may be highly useful in helping a taxpayer to defend its position in the event of litigation. Detailed verification of all information in the taxpayer s possession at the time of preparing the document (conducting an economic study) is essential in this regard. It is also extremely important to carry out a thorough review of information contained in sources used (including methods employed by price reporting agencies). Authors: Vladimir Anosov Maxim Maximov Evgenia Veter For additional information please contact the authors of this publication: Evgenia Veter +7 (495) 660 4880 Evgenia.Veter@ru.ey.com Ibragim Khochaev Ibragim.Khochaev@ru.ey.com Maxim Maximov +7 (495) 662 9317 Maxim.Maximov@ru.ey.com 4 It is possible that the information appeared in the database later or related to later periods authors. 3
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