Russian Tax Brief EY s Russian Tax & Law practice was named a leading Tax firm in Russia in World Tax 2015, an annual guide published by the International Tax Review. In the Issue: The Latest on Tax Benefits: Electronic Commerce Companies Come Under the Tax Authorities Gaze... 2 New Form of Profits Tax Declaration Approved... 4 New CFC Clarifications... 7
Russian Tax Brief 2 The Latest on Tax Benefits: Electronic Commerce Companies Come Under the Tax Authorities Gaze Authors: Anna Ivanova, Lyudmila Zakharova The subject of the legitimacy of tax benefits has been around for some time, and yet, far from waning in importance as the years pass by, it develops and grows more complex as the body of case law expands. As important and complex as the issue is, there is still no single, legislatively defined approach to defining the criteria for judging a tax benefit to be justified or unjustified. But as the case law that is largely responsible for shaping those criteria evolves, the tax authorities are carrying out ever more meticulous audits to establish whether or not tax benefits claimed by taxpayers are linked to actual business activities. Past cases have shown that the tax authorities are able to demonstrate that a tax benefit is unjustified by presenting evidence that it was impossible for the taxpayer s contract partner to have carried out particular operations in view of considerations of time, location, the volume of material resources required and the absence of conditions needed for the achievement of results owing to the unavailability of administrative or technical personnel, fixed assets or production assets. Much attention is also paid to the nature of settlements between a taxpayer and its contract partners and the subsequent fate of funds transferred as payment for goods (work and services) with a view to identifying cases of payments being channelled from one company to another. Transactions involving intermediary companies have always come under close scrutiny from the tax authorities. In analysing such transactions, the tax authorities examine the activities of all the parties involved, combing through the entire chain and assessing the genuineness and economic substance of each transaction. Until recently, the issue of the receipt of unjustified tax benefits, in terms of the involvement in transactions of parties acting in bad faith, mostly affected retail, consumer and industrial companies. Now, however, the tax authorities have set their sights on the young and dynamic sector of electronic commerce. One of the first taxpayers in this sector to be scrutinized by the tax authorities was Yandex. On 30 August 2016, a decision was issued 1 whereby Yandex ( the Company ) was denied the right to deduct costs incurred under contracts with a number of partner service centres (PSCs), which act as intermediaries between the Company and website owners ( partner sites ), in connection with the installation of the Company s advertising software module on those sites. The offset of input VAT was also disallowed for the operations in question. Background The Company concluded contracts with advertisers for advertising to be placed in the Company s search engine and on partner sites forming part of the Company s advertising network. The search for partners and the conclusion of contracts for advertising on partner sites took place according to two models: Conclusion of a contract directly with a site owner and transfer of part of the fee received from advertisers directly to the owners of the partner sites; Conclusion of a contract with a PSC for the provision of services associated with advertising on partner sites, the installation and maintenance of the Company s software module and the attraction of new partner sites ( PSC services ). Where this mechanism was used, a percentage of the fee received by the Company from the advertiser was paid to the PSC, and the PSC had to pay only a part of that fee to the owners of partner sites. During the on-site audit, the Company provided information to the tax authority on companies with which contracts for PSC services had been concluded in the audited period. The tax authority concluded from the information received in the course of the audit and evidence 1 Decision of the Moscow Arbitration Court of 30 August 2015 on Case No. A40-60516/2016.
Russian Tax Brief 3 collected that the tax benefit received by the Company from transactions with three of the five PSCs was unjustified. The Tax Authority s Arguments The tax authority took the view that the tax benefit claimed by the Company in the form of the reduction of the tax base was unjustified owing to the fact that the transactions with the PSCs were non-existent, since there was no evidence of services actually having been provided or expenses incurred. The tax authority s main arguments, which formed the basis for the arbitration court s adverse ruling, were as follows: When questioned, the owners of the partner sites with which the Company claimed to have dealt with through the PSCs denied the existence of any business relationship with the PSCs. Furthermore, in a number of cases the owners of the partner sites asserted that they had contracts and received payment for the installation of the Company s advertising module directly from the Company or from other PSCs which were not suspected of nongenuine activities. In other cases the sites denied having any involvement in the Company s advertising network. The tax authorities discovered (by making an inquiry to the Internet domain name registrar) that the PSCs were not the administrators or owners of the domains included in the list that the Company had provided at the tax authorities request. The possibility that the PSCs had engaged site administrators or owners as subcontractors was also excluded, since there was no evidence of such arrangements. It was proven by analysing bank statements that the PSCs had not transferred funds for the placement of advertising to the site owners. Furthermore, the tax authority found that funds had been transferred on a transit basis. In specific terms, practically all funds received by the PSCs from the Company over the course of one to three banking days had been transferred to other companies accounts in payment for materials, transportation services, railcar supply, agricultural produce, firewood, fabrics and special clothing. Testimony given by the general directors of the PSCs showed that they were unqualified and did not actually carry out duties associated with management of the PSCs; The number of employees of the PSCs ranged from one to nine, and there was no evidence that the employees actually carried out any duties. The PSCs were not present at their legal address and an analysis of bank statements showed that they did not incur any general business expenses. It was unclear what functions the PSCs carried out, since the Company dealt directly with the partner site owners. The Company was in litigation with one of the PSCs over its failure to provide services. It is noteworthy that the tax authority did not challenge the actual operating model involving the use of intermediary PSCs, and it is in this respect that the Yandex case differs from other tax benefit disputes. For instance, in a dispute recently examined by the Supreme Court 2, the tax authority did not contest the genuineness of a transaction, but pointed to the absence of any reasonable need for the company concerned to engage an intermediary to perform its obligations and the bad-faith nature of second- and third-tier partners as grounds for deeming the tax benefit to be unjustified. In the situation involving Yandex, the tax authorities found no fault with the arrangements with the other PSCs, since the Company had provided evidence of the genuineness of those business relationships in the course of the audit. In particular, it was proven that the PSCs had actually had dealings with and paid fees to the Company s partner sites. It should be noted that the court decision contains very limited information on the Company s 2 Determination No. 305-KG16-10399 of the Judicial Panel of the Supreme Court based on consideration of the cassation appeal (representation).
Russian Tax Brief 4 arguments on the case. The decision outlines in detail the position and arguments of the tax authorities, while the Company s arguments are very concise and the court does not make any comments on their validity and/or reasons why they were not accepted. Conclusions The appearance of the first challenges by tax authorities against electronic commerce companies over the receipt of unjustified tax benefits and the first negative case law involving such companies may signal a need for those companies to review their approach to choosing contract partners and structuring relationships with them. Taxpayers need to pay closer attention to proving that transactions are authentic and that tax benefits were obtained in connection with genuine business activities. Particular mention should be made of the thoroughness of the tax authorities approach to questioning employees and requesting information, and the detailed analysis and understanding of the Company s business and the relationships between the parties involved. This included identifying the actual owners of the domains supposedly owned by the intermediaries and assessing the extent to which it was possible for third-tier parties to have provided services. Nonetheless, it appears that the Company is not yet ready to admit defeat in this dispute and has already filed an appeal against the arbitration court s decision. The appeal hearing is scheduled to 22 December 2016. We will monitor further developments in the case. New Form of Profits Tax Declaration Approved Authors: Yulia Timonina, Ekaterina Kuznetsova, Larisa Gorbunova Order No. MMV-7-3/572@ of the Federal Tax Service of 19 October 2016 Concerning Approval of the New Form of a Profits Tax Declaration, the Procedure for Completing it and the Format for Submitting a Tax Declaration for Tax on Profit of Organizations in Electronic Form ( the Order ) was published on 28 October 2016. Beginning with reports for 2016, taxpayers must submit profits tax declarations using the new form ( the Form ). The text of the Order is available on the official portal of legal information. 3 EY previously issued an alert 4 on the main changes to the Form based on a draft version of the Order ( the Draft ). In this article we will focus on modifications that have been made compared with the previous version of the Form. Significant changes include the following: Computation of the Amount of Profit of Controlled Foreign Companies Profits of controlled foreign companies (CFCs) are to be declared using the newly added Sheet 09 Computation of Tax on Profit of a Controlled Foreign Organization ( Sheet 09 ), which enables compliance with CFC profit taxation requirements. The final version of Sheet 09 consists of the following sections: Section А: Details of a Controlled Foreign Company ( Section A of Sheet 09 ); Section B1: Computation of the Amount of Tax on Profit of a Controlled Foreign Company on the Basis of Financial Statement Data ( Section B1 of Sheet 09 ); Section B2: Computation of the Amount of Tax on Profit of a Controlled Foreign Company According to the Rules Established by Chapter 25 of the Tax Code for Taxpayers Which are Russian Organizations ( Section B2 of Sheet 09 ); Section B3: Computation of Profit (Losses) of a Controlled Foreign Company from Transactions Involving Securities Not Circulated on the Organized Market and Derivative Financial Instruments Not Circulated on the Organized Market ( Section B3 of Sheet 09 ). This section is to be completed only by taxpayers 3 http://publication.pravo.gov.ru/document/view/000120161 0280001?index=0&rangeSize=1 4 Tax alert of 10 October 2016 Publication/vwLUAssets/EY-Tax-Alert-10- October-2016-Eng/$File/EY-Tax-Alert-10-October-2016- Eng.pdf
Russian Tax Brief 5 that calculate CFC profits according to the rules established by Chapter 25 of the Tax Code for taxpayers that are Russian companies; Appendix No. 1 to Sheet 09: Computation of the Amount of a Loss or Portion of a Loss That Reduces the Tax Base for Profits Tax for a Controlled Foreign Company ( Appendix No. 1 to Sheet 09 ). In the tax alert issued on 10 October, EY pointed out a number of deficiencies in the Form. Most of these have been addressed in the current version of the Form. In particular: One of the key changes is the modification of the titles of Sheet 09 sections and appendices they no longer contain the qualification controlled foreign company which is a foreign organization which was used in the previous version of the Form. This eliminates the question regarding the treatment of profits of CFCs that are unincorporated foreign structures. Sheet 09 is to be used in this case also. Sheet 09 now contains a field in which to indicate the organizational form of an unincorporated foreign structure, the state (territory) in which it is tax-resident, the share in profits of the CFC and the grounds on which the CFC s profits are exempt from taxation. In addition, the Procedure for Completing the Form contains a provision to the effect that, for those CFCs whose profits are exempt from taxation, there is no need to complete the remaining sections and appendices of Sheet 09. Adjustments to CFC profits that apply in the case of calculation based on financial statement data are now entered as two amounts in lines 020 and 030 of Section B1 of Sheet 09. To be entered in line 020 are adjustments under clause 3 of Article 309.1 of the Tax Code (revaluation of participating interests, securities and derivatives, reserves, etc.). To be entered in line 030 are the positive/negative result from the revaluation of participating interests, securities and derivatives when they are sold (clause 3.1 of Article 309.1), the result of adjusting transaction prices (clause 9 of Article 309.1) and income/expenses from the sale of securities in the event of the liquidation of a CFC (clause 10 of Article 309.1). Sections B1 and B2 of Sheet 09 now contain separate lines for entering amounts used in the computation of CFC profit with account taken of the ownership share of the controlling person (and other controlling persons, if applicable) and for entering amounts of taxes calculated in accordance with the legislation of foreign states and/or Russia and amounts of taxes paid by a CFC s permanent establishment in Russia; Sections B1 and B2 of Sheet 09 have had lines 090 and 130 inserted in them respectively in which to enter the average exchange rate for the purpose of calculating CFC profits in roubles. There is still a lack of clarity regarding the procedure for calculating prior year losses that are deductible from a CFC s current tax base, whether the calculation is made on the basis of financial statement data or according to the rules of Chapter 25 of the Tax Code. The Form does not contain separate lines in which to make calculations, but only lines to show the total amounts of prior year losses for each period. This may be an indirect indication that adjustments under clause 3 of Article 309.1 (revaluation of participating interests, securities and derivatives, reserves, etc.) need not be made when calculating prior year losses based on financial statement data. Clauses 3 and 3.1 of Article 309.1 (adjustments) apply to legal relations that arose on or after 1 January 2015 5, which further supports the view that no adjustments should be made to prior year losses which arose prior to 1 January 2015. There are as yet no official clarifications on this issue. 5 As amended by Federal Law No. 32-FZ of 15 February 2016 Concerning the Introduction of Amendments to Parts One and Two of the Tax Code of the Russian Federation and to the Federal Law Concerning the Introduction of Amendments to Parts One and Two of the Tax Code of the Russian Federation (Regarding the Taxation of Profit of Controlled Foreign Companies and Income of Foreign Organizations).
Russian Tax Brief 6 Section B2 of Sheet 09 still contains lines for entering adjustments to CFC profits that apply only in the case of calculation based on financial statement data (lines 060-070 of Section B2 of Sheet 09). The adjustments in question do not apply when CFC profits are calculated according to the rules of Chapter 25. In the approved Form, CFC profits and tax calculated on CFC profits are not consolidated with the general computation of the tax base and the amount of profits tax due on Sheet 02. Nor does the Form provide for the tax base for a CFC to be entered in the Non-sale income line. According to clause 5.7 of the Procedure for Completing the Form, however, the total amount of calculated profits tax entered in line 190 of Sheet 02 includes, inter alia, the amounts in line 200 of Section B1 of Sheet 09, 240 of Section B2 of Sheet 09 and 160 of Section B3 of Sheet 09. The first two values are taxes deductible from tax on CFC profits (not tax calculated on CFC profits). As for the third value, it should be pointed out that Section B3 of Sheet 09 does not contain a line 160, and further clarification is needed from the Federal Tax Service in this regard. At the same time, Sections B1 and B2 contain all the necessary lines and allow for CFC profits and the relevant amount of tax to be properly calculated. We should emphasise that the information on CFCs that is provided in Sheet 09 must correspond to the information previously given in the CFC notification. A profits tax declaration containing information on CFC profits must be accompanied by the financial statements of the CFCs concerned (or, if these are not available, other documents) for the relevant period, together with an auditor s opinion if available. All of these documents must be translated into Russian. Reflection of Amounts of Independent (Symmetrical, Reverse) Adjustments As noted in the alert of 10 October, amounts of independent adjustments are to be entered in the newly added Sheet 08 Income and Expenses of a Taxpayer Which Has Made an Independent (Symmetrical, Reverse) Adjustment. The final version of Sheet 08 has undergone a number of changes compared to the Draft: Sheet 08 now consists of one Section Adjustment of the Tax Base for Transactions. It is no longer divided into Section A and Section B for adjustments relating to non-financial transactions and adjustments relating to securities and derivatives transactions, as in the Draft. However, the actual line-by-line breakdown of adjustments is the same as in the Draft; Line 100, in which tax calculated as the product of adjustment amounts in absolute terms was to be entered according to the Draft, has now been excluded, thus eliminating questions raised about how it would be applied; It may be inferred from the provisions of the final version of the Procedure for Completing the Form that Sheet 08 is completed for reference purposes, and amounts in that Sheet are not totalled with amounts in Sheet 02. Presumably, therefore, amounts of income and expenses are to be entered in Sheet 02 with adjustments already made. The Federal Tax Service is expected to issue relevant clarifications in the near future. Other Changes Most of the changes included in the Draft are reflected in the final version of the Form. There are also some changes that were not in the Draft: New lines have been inserted in Sheet 02 Computation of Tax, namely line 350 Amount of capital investments made for the purposes of the execution of an investment project and line 351 Difference between the amount of tax calculated at the 20% rate and the amount of tax calculated using lower tax rates. These lines are completed for reference purposes and are needed in order to check the application of lower tax rates by companies involved in regional investment projects in accordance with subsection 2 of clause 3 of Article 284.3;
Russian Tax Brief 7 Lines 131-135 of Appendix No. 2 to Sheet 02, used to enter information on depreciation amounts and methods for fixed assets and intangible assets, have now been restored after they were removed in the initial Draft. The wording of the line description has changed in lines 060 and 061 of Appendix No. 6b to Sheet 02 Income and Expenses of Members of a Consolidated Group of Taxpayers Which Have Calculated a Consolidated Tax Base for the Group as a Whole. Conclusions The Form approved by the Order has been substantially modified compared with the previous version: there are changes in wording, lines have been added where necessary and areas of uncertainty have been addressed. However, there are still some issues, particularly in regard to the calculation of CFC profits, that require clarification from the Federal Tax Service. We hope that clarifications will be issued in the near future. The Order enters into force on 28 December 2016. New CFC Clarifications Authors: Oksana Yaroschuk, Viktoria Missar, Vsevolod Bude The time for submitting controlled foreign company (CFC) reports in Russia is drawing ever closer, but there are still certain issues regarding the procedure for calculating CFC profit that remain unresolved. This article looks at a few of the explanatory letters recently issued by the Finance Ministry on the subject of the application of the CFC rules. The Procedure for Determining CFC Profit for the Purposes of Applying the Exemption Based on the Profit Threshold CFC profit must be taken into account by a controlling person if the profit amount exceeds a specified threshold (50 million roubles for 2015). The Code does not clarify whether distributed dividends should be deducted from CFC profit for the purposes of comparison with the threshold value. The Finance Ministry has issued at least two letters (No. 03-03-06/42552 of 20 July 2016 and No. 03-12-11/62523 of 26 October 2016) in which it is stated that a CFC s profit should be reduced by dividends paid by that CFC for the purpose of comparison with the threshold value. Translation of Profits Tax Calculated on CFC Profit in Foreign Currency into Roubles Taxes calculated on CFC profit in accordance with the laws of foreign states and/or Russia may be credited when calculating tax on CFC profit in Russia. If the tax in question was calculated in foreign currency, it must be translated into roubles in order for it to be credited. However, the Code does not specify what exchange rate should be used for that purpose. In Letter No. 03-12-11/62523 of 26 October 2016, the Finance Ministry clarifies that CFC profit that is to be credited must be translated into roubles using the official exchange rate set by the Bank of Russia on the date on which tax is paid. Definition of International Carriage for the Purposes of Classifying Income as Active When Applying the Exemption for Active Foreign Companies For the purposes of applying the CFC profits tax exemption for active foreign companies, income of a CFC from the leasing or subleasing of ships, combined (river-sea) vessels, aircraft and/or means of transport and containers used in international carriage is not deemed to be income from passive activities. International carriage includes any transport that takes place other than solely between points outside Russia. The use of this definition of international carriage in relation to foreign companies classed as CFCs is not directly provided for in the Tax Code and has not gone unquestioned. In Letter No. 03-12-11/2/58819 of 10 October 2016, the Finance Ministry clarified that, for the purposes of applying the CFC rules, international carriage must be defined relative to the jurisdiction of a CFC. This means that international carriage should be taken to mean transport operations in which either the departure point or the destination of the goods concerned is situated outside the country of which the CFC is a resident.
Russian Tax Brief 8 Application of the New CFC Rules Which Enter into Force from 1 January 2017 A new version of clause 3 of Article 25.15 of the Tax Code enters into force from 1 January 2017, according to which, where the participating interest of a controlling person in a CFC differs from that person s share in the CFC s profit, the CFC s profit must be taken into account by the controlling person to an extent corresponding to that person s share of the CFC s profit. The Finance Ministry has issued explanations 6 to the effect that the new CFC rules apply to the determination of CFC profit for taxation purposes in relation to financial periods starting in 2017. In 2015 and 2016, therefore, profit of a CFC should be recognised by a controlling person in line with its participating interest in the CFC, even if it differs from that person s share of the CFC s profit. 6 Ministry of Finance Letters No. 03-12-12/2/64332 and No. 03-12-12/2/64335 of 2.
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