Tax disputes are very common in Russia. All large or medium-sized companies have been involved in tax litigation with the authorities at least once, and many companies are involved in tax disputes on a regular basis. For many years now, Russian companies have frequently resorted to litigation to contest tax matters, as the courts have proven to be the most effective venue for resolving tax disputes. Moreover, litigation is generally quite quick, as it usually takes only nine months to a year to pursue a lawsuit through all three judicial instances (and most claims do pass through all three). However, over the last few years, we have seen a number of changes to this trend. Judges have become more conservative and tend to take up a pro-budget position. At the same time, disputes are becoming increasingly complex, resulting in a smaller number of disputes considered by courts and making it more difficult for taxpayers to win in court. Furthermore, owing to the turbulent law enforcement practice in the last two years, it is difficult to predict an outcome of the litigation.
A few years ago, the proliferation of tax-related court cases prompted efforts to shift disputes towards the pre-litigation stage. Since a portion of relatively simple or standard disputes are now being settled in pre-litigation, the courts have started hearing fewer but more complex cases. This trend has been evident for the past five years.
Accordingly, the percentage of cases won by taxpayers has fallen to some extent: prior to 2010, the percentage of cases won was 70 per cent or higher; it currently stands at 15 to 20 per cent. Nevertheless, taxpayers continue to apply to court, seeking the settlement of a dispute and clarification on a matter in dispute.
Most cases arise as the result of a tax audit. Ninety-nine per cent of field tax audits in Russia result in additional tax levies. Recently, many tax audits have resulted in additional levies of under 25 million roubles, and in such cases taxpayers often prefer not to contest the additional amounts assessed. If, however, the amount of additional tax assessed is significant and the taxpayer has solid arguments in its favour, then a formal dispute usually arises.
In terms of litigation costs, the state duty is rather small (in most cases, 3,000 roubles to appeal a case, although sometimes this can rise to as much as 200,000 roubles in property claims). Attorneys' fees are largely dependent on the complexity of the case, the existence of relevant case law, the number of charges in the case and the volume of documents to be examined (in Russian tax disputes, documents play a very important role). Many companies offer support in resolving tax disputes, representing a very broad range in terms of pricing and quality. These include the Big Four firms, international law firms, and large and small local companies.
II COMMENCING DISPUTES
There are a large number of ambiguities and disputed issues in Russian tax law.
Unfortunately, one cannot obtain an advance clearance or ruling in Russia; accordingly, it is not always possible to avert a dispute in ambiguous cases. Taxpayers can request the Ministry of Finance (MinFin) to give clarification on ambiguous pieces of legislation. However, although it provides exemptions from penalties and fines, MinFin clarification letters in response to such requests are non-binding. Furthermore, MinFin can provide clarification on interpreting the law but does not respond to information requests concerning specific taxpayer situations. Nor does it go into detail on how a specific deal or transaction by a taxpayer should be interpreted for tax purposes.
The only exception is the possibility of concluding a pricing agreement. This option became available to taxpayers in Russia in 2012, when new transfer pricing (TP) rules were introduced. The first pricing agreement was concluded in November 2012, and eight such agreements have been concluded to date. Nevertheless, this option has not become workable in practice because of the unwillingness of tax authorities to conclude such agreements.
Given this inability to obtain any kind of binding clarification, taxpayers must complete their tax returns based on their own understanding of the tax law. If a taxpayer makes an error in completing its return and discovers this error itself, it is entitled to file an adjusted return. There is no deadline for filing adjusted tax returns. However, if because of an error a taxpayer becomes entitled to a refund of overpaid tax, such a refund can be made only if a relevant request is filed with the tax authorities within three years of the tax overpayment. The tax authorities verify that taxpayers have a correct understanding of the tax law during tax audits.
Most disputes initiated by taxpayers in Russia originate either from the results of a tax audit or from a taxpayer's request for a refund of certain tax amounts (refund of overpaid or overcharged taxes, value added tax (VAT) refunds). The following should be considered regarding disputes related to tax audit results.
There are three types of tax audit in Russia:
- a desk audit, which is generally a formal review of a tax return conducted within three months of its filing. The tax authorities have only limited rights during this period. As such, disputes resulting from desk audits are rather rare, except for certain categories (e.g., VAT refunds, confirmations of tax benefits and certain other cases);
- a special TP audit, which verifies the accuracy of TP calculations. This type of audit was introduced in 2012 under the new TP legislation. The first TP audits were initiated in summer 2014, but to date just a few decisions have been made in these cases, and no court case has been finished yet; and
- field audits, which are the predominant type of audit. The tax authorities can go back three years preceding the year an audit is initiated. It is a full-scope audit. Since 99 per cent of field tax audits result in additional taxes being charged, disputes are very common. Disputes based on field tax audits are usually the largest and most complex.
If the tax authorities discover errors during any type of audit, they will issue a certificate describing the violations committed by the taxpayer. The taxpayer must then generally file its objections to this certificate within one month (20 business days for special TP audits). Objections are considered by the same tax authority, in the taxpayer's presence; the tax office could conduct additional control measurers (it is optional) and then issues a final resolution on the audit after reviewing all objections.
If the taxpayer disagrees with the final resolution, it can file an administrative appeal to a higher tax authority within one month. This appeal constitutes a mandatory pre-litigation stage. On average, the higher tax authority takes one to two-and-a-half months to review an appeal. In most cases, the higher tax authority upholds the resolution of the lower authority. However, recently a positive trend has emerged of the tax authorities being more objective when hearing appeals and more frequently supporting the taxpayer's position. Once a taxpayer has filed such an administrative appeal with a higher tax authority, it will then have no liability to pay the additionally assessed tax until its appeal has been heard. If the taxpayer fails to file an appeal within the one-month time frame, however, then the tax authority's decision will take effect and the additionally assessed tax may be collected from the taxpayer. However, the taxpayer can still file an appeal with the higher tax authority within one year of the date on which the decision was adopted, to comply with the procedure for a mandatory pre-litigation appeal.
A taxpayer can bring its case to court within three months of obtaining an unfavourable ruling from a higher tax authority. To initiate litigation, a taxpayer files a motion to dismiss the ruling with the court of first instance. The taxpayer may not go to court, however, if the pre-litigation procedure has not been followed.
Another major group of disputes relate to receiving cash funds from the state budget. The most common types are disputes related to refunding or offsetting overpaid tax; refunding or offsetting overcharged tax; and VAT recovery.
Usually, these disputes arise in two instances: the tax authority resolves to deny a refund or offset of tax (resolution to deny VAT recovery); or the tax authority takes no action and does not issue a resolution on refunding or offsetting tax, although it is obliged to refund and offset the relevant tax (refund VAT).
In the first instance, taxpayers can appeal against the tax authority's resolution denying the refund or offset of tax (denying VAT recovery). To appeal against such resolutions, taxpayers must first file with the higher tax authority (within one year of obtaining the resolution), and only then with the court (within three months of obtaining the higher tax authority's resolution).
In the second instance, taxpayers can file a complaint about the tax authorities' inaction with the higher tax authority (within one year; however, there is some uncertainty regarding when exactly the one-year period should begin – in most cases, in practice the period begins from the tax authorities' deadline for adopting a relevant resolution), and only then file with a court (within three months of obtaining the higher tax authority's resolution).
In either case, when filing an appeal with a court, taxpayers often file a second (property) claim: that is, in addition to filing a motion to dismiss a relevant resolution (complaint about inaction), taxpayers also ask the court to obligate the tax authority to adopt a resolution on refunding (offsetting) the tax. Property claims can be filed within three years of the date of tax overpayment or overcharging of tax. The second claim simplifies the subsequent enforcement of the court's decision. Property claims are also filed independently (e.g., when the deadline for filing the first (non-property) claim is missed, or if a taxpayer is seeking to avoid the pre-litigation procedure). Property claims have some procedural specifics; in such situations, courts may take differing approaches to the legality of filing a property claim.
In addition to the disputes described above (based on audit results and to obtain tax amounts from the budget), taxpayers may initiate other disputes. Taxpayers can appeal against other unlawful non-regulatory acts, actions and omissions of the tax authorities (including requests for payments, resolutions to recover, inaction on issuing a resolution). The appeal procedure is on the whole identical to that for appealing a tax audit decision. First, one must file an appeal with the higher tax authority within one year, and then file with a court within three months of the date one receives the higher tax authority's decision.
Another type of dispute involves appealing against regulatory acts. In the case of tax disputes, if the law is ambiguous, taxpayers or the tax authorities can request clarification letters from MinFin, or MinFin can provide clarifications independently. In certain cases, clarification letters are binding on the tax authorities. If such letters violate taxpayers' rights, taxpayers can appeal against them as if they were regulatory acts. In this case, appeals should be filed with the Russian Federation Supreme Court (SC) (the highest judicial instance for civil cases and, since 6 August 2014, for commercial and tax cases as well).
Taxpayers can sometimes purposefully instigate a tax dispute. This could be necessary to test a specific disputable position if the taxpayer is not certain its position is correct, and is seeking to verify its validity in court without waiting for a field tax audit (which could occur after two to three years), and further does not want to assume the risk of liability. To instigate a dispute, the taxpayer files tax returns and purposefully does not claim any tax benefit (expenses, benefits, etc.), and pays the entire tax amount listed in the returns. After a certain period, the taxpayer then files adjusted returns in which it additionally claims the relevant tax benefit (expenses, benefits, etc.) that it did not claim before, and requests a refund of the overpaid tax amount. Since the tax authorities are not eager to refund taxes, they would most probably search for reasons not to refund the tax, issue a resolution to deny the tax refund or simply do nothing.
The taxpayer can appeal against a resolution to deny a refund of overpaid tax or the inaction of the tax authorities. Such a dispute could result in the setting of an interesting judicial precedent that is important for the taxpayer (although Russia is not formally a common law country, the courts do seek to establish uniform judicial practice, and the positions of the highest judicial instances effectively serve as virtual precedents). If the case is won, the taxpayer can then as far as it is possible safely use the relevant tax benefit in future. If the case is lost, the taxpayer can avoid penalties and clarify the law more quickly than if the dispute had only arisen during a field tax audit. However, the tax authorities do not always respond as expected to such an instigation, and may refund overpaid tax without a dispute only to challenge the claimed benefit or expense at a later date during a field tax audit.
All of the above by and large applies for both legal entities and individuals; however, there are some differences:
- legal entities and entrepreneurs litigate in arbitrazh courts, whereas individuals litigate in general jurisdiction courts (see Section III); and
- legal entities and entrepreneurs litigate extensively, and initiate most tax disputes, while individuals litigate much less in disputes, and such disputes are largely initiated by the tax authorities. This is because the tax authorities can levy additional taxes on legal entities and entrepreneurs using the pre-litigation procedure, but on individuals only through litigation. Thus, individuals need not initiate disputes on their own.
The above-mentioned disputes are initiated by taxpayers. Disputes initiated by the tax authorities include disputes concerning the collection of taxes, penalties and fees when they cannot be collected out of court (e.g., from individuals, and when a relevant statute of limitations is missed for legal entities). The tax authorities can also initiate some other types of disputes (e.g., to recover damages caused to the state due to a bank unlawfully debiting a taxpayer's account after receiving a resolution by the tax authorities to suspend transactions, which prevents the tax authorities from collecting arrears, overdue penalties and fines as provided by the Tax Code), but they are infrequent and of a rather specific nature.
III THE COURTS AND TRIBUNALS
As noted in Section II, based on tax audit results, the tax authorities issue a certificate against which taxpayers can appeal. The final audit resolution is issued only after the taxpayer's counterarguments are heard. If a taxpayer has not been given a chance to appeal, or the proper procedure was not been observed when its counterarguments were heard, this constitutes unconditional grounds for revoking the tax authorities' audit resolution.
Once the tax authorities issue their final audit resolution, they cannot amend it in any way that would put the taxpayer at a disadvantage, but may amend it to the taxpayer's advantage (e.g., reduce the amount of additional tax assessed or cancel it altogether).
If a taxpayer disagrees with the resolution, it must appeal to the higher tax authority, which represents the obligatory pre-litigation stage. The same applies to appeals of any other non-regulatory resolutions by the tax authorities, or their actions or omissions. After observing the mandatory pre-litigation procedure, taxpayers can take their cases to court.
Tax disputes between the tax authorities and legal entities and entrepreneurs are heard in arbitrazh courts. The arbitrazh court system consists of three tiers. The first instance tier is usually a court at the level of one of Russia's 85 constituent regions. Appeals against resolutions of a first instance court can be made to the appellate instance (there are 21 appellate courts). Appeals against resolutions of an appellate court can be made to the cassation instance (there are 10 cassation courts). Regular tax disputes go through these three tiers.
From 6 August 2014, the fourth ('second' cassation) and the fifth (supervisory) instance are in the SC, which is now the highest judicial instance for hearing tax disputes (previously it was the Supreme Arbitrazh Court (SAC), which was disbanded on 6 August 2014).
In most cases, to defend its position a corporate taxpayer files a claim with the arbitrazh court of first instance (except for claims contesting regulatory acts issued by state bodies, which are filed directly with the SC). If the tax authorities want to initiate a tax dispute against a legal entity or an entrepreneur, they also file with the arbitrazh court of first instance. The filing is made in the defendant's local court.
The case is considered on its merits by a single judge in the court of first instance. In some Russian constituent regions (e.g., Moscow, St Petersburg), judges specialise in tax litigation. In other constituent regions, there is no tax specialisation (tax specialisation is not mandatory for court judges). Consideration of a dispute starts with a preliminary court hearing. At the preliminary hearing, parties present their key evidence and argue their positions, after which the court starts the main session. A typical case would have one preliminary hearing and two to four main sessions. It takes three to five months for a dispute to progress through the first instance, but this process may take longer (up to a year and even longer) for complicated disputes. Disputes are usually based on an in-depth analysis of documents (evidence), which are the primary evidence (legal proceedings in general are very document-intensive). Examinations of witnesses and experts are not often conducted during court hearings. However, recently such examinations have begun to occur more frequently, reflecting the fact that tax disputes are becoming increasingly complex. The burden of proof in disputes on invalidating non-regulatory acts of the tax authorities lies with the latter (i.e., the tax authorities must prove the validity of their decisions). In practice, however, taxpayers must establish the legitimacy of their position and the illegitimacy of the tax authorities' position. Consideration of a case in the first instance concludes with the issuing of a relevant court decision.
The losing party can appeal against the decision to the appellate court. This must be done within one month of the date the first instance court's decision was issued. If an appeal is filed, the relevant first instance court decision does not take effect until the appellate instance court has ruled on the case. A three-judge panel hears tax disputes at the appellate instance. A dispute is usually considered during a single hearing. Additional evidence cannot generally be presented to the appellate court, except when it could not be presented to the court of first instance. The appellate court considers a case within one to two months after the appeal is filed. Based on the results, a resolution is then issued.
The losing party can appeal against the appellate court decision to the cassation instance. The relevant cassation appeal must be filed within two months of the date that the full appellate resolution is issued. A three-judge panel considers cases at the cassation instance. The cassation court reviews the correctness of the legal provisions applied by the lower courts, but does not check the facts of the case (although in practice, the facts of the case are also sometimes reviewed). The cassation court usually considers a case during a single hearing that takes place within one to two months of the date the cassation appeal was filed. If the claimant complies with the filing deadlines and certain procedures, both the appellate and cassation courts must accept the appeal for review and consider it.
Should the losing party disagree with the court resolutions, it can take its case to the SC (previously the SAC).
The latest amendments to Russian law have established a new two-stage procedure for appealing arbitrazh court rulings to the supreme judicial authority: in the second cassation instance, and in accordance with a supervisory procedure.
Effective August 2014, a cassation appeal to the Judicial Board of the Russian Supreme Court (SC Judicial Board) represents the fourth level for hearing tax disputes.
A cassation appeal may be filed to the SC Judicial Board within two months of the date on which the latest ruling subject to appeal came into force. Such a cassation appeal is considered individually on a preliminary basis by an SC judge, who decides whether to escalate the case to the SC Judicial Board. The SC judge issues a relevant ruling within two months (without a writ of certiorari) or three months (if a writ of certiorari was issued).
Thus, the SC Judicial Board does not consider all appeals filed by taxpayers or the tax authorities of decisions issued by the lower courts. A case is sent for reconsideration only if an SC judge identifies grounds for such a rehearing at the preliminary stage.
If a case goes to the SC Judicial Board for consideration, the Board must consider its merits within two months. Upon considering a cassation appeal, the Board issues a ruling on the case, which comes into force from the date it is issued.
Only a significant breach of substantive or procedural law by arbitrazh courts may serve as grounds for the SC Judicial Board to invalidate the rulings of such courts during a second cassation procedure.
A ruling issued by the SC Judicial Board after considering a second cassation appeal may be appealed within three months in accordance with the supervisory procedure of the SC Presidium.
A supervisory appeal is considered individually by an SC judge within two months (without a writ of certiorari) or three months (if a writ of certiorari was issued). Following that, the judge issues an individual judgement on whether the case should be escalated to the SC Presidium, issuing a relevant ruling. If a case is escalated to the SC Presidium, the latter considers the merits of the supervisory appeal within two months.
Any breach in the uniformity of the courts' application and interpretation of legislative provisions, civil and political rights, and the rights and legitimate interests of the general public and other public interests, may serve as grounds for invalidating previously issued SC Presidium rulings.
Following its consideration of the case, the SC Presidium issues a resolution that comes into force immediately and may not be appealed.
The SC Chair or his or her deputy may, based on an appeal filed by interested parties, make recommendations to the SC Presidium for reconsidering judicial resolutions under the supervisory procedure 'for the purposes of eliminating fundamental breaches of substantive and/or procedural law'. Such appeals may be filed within four months of the date on which the appealed court resolution came into force.
In addition, the SC Chair or his or her deputy may, at their own discretion, invalidate the rulings that decline to escalate a cassation appeal to the SC Judicial Board; decline to escalate a supervisory appeal to the SC Presidium; and reinstate a missed deadline for filing a second cassation appeal.
The number of tax disputes considered by courts as part of a second cassation is negligibly small and accounts for 0.01 per cent of filed appeals. Thus, only a handful of cases are appealed at the second cassation level. Although Russia is not formally a common law country, SC Judicial Board rulings, SC Presidium resolutions and SAC Presidium resolutions effectively serve as judicial precedents. Thus, if the SC Judicial Board, SC Presidium or SAC Presidium have expressed their opinion on a given issue, the lower courts will most likely take a similar position in cases concerning this issue.
Tax disputes with individuals are considered by general jurisdiction courts. Disputes are usually initiated by the tax authorities, since collecting taxes, penalties and fines from individuals is only possible through litigation.
To collect taxes from an individual, the tax authorities file an application for a court order with a justice of the peace, who then issues the relevant court order and sends it to the individual's address. The individual can appeal against the court order within 10 days. If the individual fails to make such appeal, the court order is sent to the tax authorities or to a bailiff for execution. If the individual then sends his or her counterarguments to the justice of the peace, the latter must recall the order, and the tax authorities must bring the case to a general jurisdiction court under the ordinary procedure.
The application is filed with a district court. An appeal against the decision of a district court that has not taken effect can be made to the appellate court within one month from the date of the decision. The appeal must be considered. Appeals against district court resolutions are considered by the supreme court of the relevant Russian constituent region. If a losing party disagrees with the appellate court decision, an appeal can be filed with the cassation court within six months from the date of the appellate court decision. A judge refers the appeal to the cassation court only when there are grounds for reviewing the court decision. Appeals are considered by the presidium of the relevant constituent region's supreme court.
If a taxpayer has exhausted all other possible options for defending its rights in a tax dispute, and there are grounds to believe that in considering the dispute legal provisions or interpretations were used that violate general constitutional principles, the taxpayer can bring its case to the Constitutional Court. Such an action would, however, be the exception. Nevertheless, there have been cases where a taxpayer has succeeded in upholding his or her interests only through taking his or her case to the Constitutional Court.
Interpretations of regulations given by the Constitutional Court are generally binding, and must be applied by all state authorities and other participants in legal relationships.
IV PENALTIES AND REMEDIES
Under the Tax Code, in certain cases taxpayers and tax agents may be subject to tax liability. Liability has been established, inter alia, for:
- non-payment of tax in an amount of 20 per cent or 40 per cent in the case of a repeat offence or intentional offence;
- failure to file tax returns as a percentage of the tax amount due that was not paid under the returns;
- failure to submit documents to the tax authorities (200 roubles per document);
- doing business without registering with the tax authorities as a percentage of the income earned from such business activity; and
- failure to perform the responsibilities of a tax agent in an amount of 20 per cent of the amount of tax not withheld.
Penalties can be collected out of court from corporate taxpayers and sole proprietors, but can be collected from individuals only through court proceedings. The statute of limitations is three years after the tax period when the offence took place or from the date of the offence. Once the statute of limitations expires, the taxpayer cannot be held liable for the offence.
The Tax Code provides grounds for taxpayers to be exempted from liability, specifically by following the clarifications of an authorised government body. Taxpayers can request clarifications on tax law from MinFin and in certain cases from the tax authorities. Although such clarifications are not binding, they can exempt the taxpayer from penalties if he or she has complied with their guidelines. Ad hoc clarifications exempt taxpayers from penalties. If clarifications are provided to another taxpayer, but are forwarded by MinFin to the tax authorities and are entered into information databases, they can also serve as grounds for avoiding penalties.
The most widespread penalty is for failure to pay taxes (the penalty amounts to 20 per cent of the additionally charged tax). However, this penalty cannot be applied if the taxpayer overpaid in an amount exceeding the amount of additional tax charged. The overpayment should coincide in time with the failure to pay the tax, and exist until a relevant resolution is issued by the tax authorities. In this case, the budget does not incur any losses, and thus there are no grounds for holding the taxpayer liable. In practice, taxpayers often maintain a certain amount of overpayment to the budget without claiming it back as a means of protecting themselves from penalties.
In addition, the late payment of tax results in additional fees calculated as a percentage of the unpaid tax amount. Officially, this fee is not considered a type of liability. Rather, it is a compensatory payment charged for using the funds.
Fines are very common. Typically, in the case of a violation where the taxpayer is charged additional tax, it will also be charged an additional fee. The taxpayer will also be held liable for non-payment of tax at a rate of 20 per cent of the unpaid amount. Recently, tax authorities have increasingly held taxpayers liable for penalties at the rate of 40 per cent. Compliance with the clarifications of an authorised body or overpayment can provide exemption from additional fines.
If a legal entity is subject to a tax liability, penalties are charged to the entity itself and not to its corporate officers. Corporate officers can be held administratively liable under the Code of Administrative Offences but not under the Tax Code. Penalties have been established for corporate officers for violating filing deadlines, failing to provide information for tax control purposes, failing to meet the deadline for registering with the tax authorities and in certain other cases. Penalty amounts charged to corporate officers for such violations generally range from 100 to 3,000 roubles.
In addition to tax liability, tax evasion can result in criminal liability. Only individuals can be subject to criminal liability; legal entities cannot be held criminally liable. If a legal entity fails to pay taxes, its general director and chief accountant, along with other officers in certain cases, can be held liable.
The minimum unpaid tax amount prompting the application of criminal liability is 5 million roubles for legal entities and 900,000 roubles for individuals. The statute of limitations for such cases is from two to 10 years, depending on the amount of unpaid tax.
The following must be considered. In 2014, the procedure for bringing criminal charges in relation to tax crimes changed. There is now no need to obtain audit materials from the tax authorities to bring such charges; law enforcement agencies may uncover and investigate instances of non-payment of taxes independently. A positive law provision here is that if a taxpayer voluntarily pays the additionally charged tax, the tax authorities are not obligated to refer the case to the relevant bodies for investigating tax offences. Even if a case is opened, the case must be closed if the additional tax is paid and it is the violator's first such offence.
Criminal liability also applies to tax agents for failure to withhold tax, or concealment of funds to be used to pay taxes.
There is no civil liability for non-payment of taxes. Until recently, any tax liability (including payment of additionally assessed taxes, fines and late payment interest, if any) should be borne by a taxpayer (in its own name and by its own funds) but not by any other third parties (i.e., any other companies or individuals). However, in 2017, the tax legislation was amended to allow another person to pay a tax on behalf of a taxpayer. Some amendments were also made to the bankruptcy laws. The revised version stipulates that if a corporate debtor has insufficient assets to pay taxes and repay other debts, the payables can be collected from persons who actually control such a taxpayer and are its beneficiary.
As a result, the number of cases on collection of corporate taxes from other persons has significantly increased at courts.
V TAX CLAIMS
i Recovering overpaid tax
In Russia, companies are entitled to refunds (or offsets against future payments) of overpaid or overcharged tax. Overpaid tax arises because of voluntary erroneous overpayment, while overcharged tax arises because of erroneous compulsory collection. A company is eligible for a tax refund only if it has no arrears for the relevant (or any other) tax. An offset against future payments can be made for this or any other tax of the same type; overpayments of federal taxes can be offset against federal taxes, but not against regional or local taxes.
To obtain a refund for overpaid taxes, a company must provide documents confirming that the taxes were actually overpaid. The company must also apply for a refund or offset of the overpaid tax within three years after the overpayment was made. If the three-year deadline to submit an application for a tax refund or offset is missed, the company can no longer claim it.
If the tax authorities fail to offset or refund the overpaid tax on time, the taxpayer can apply to a higher tax authority to invalidate the omission of the lower tax authority, and then to a court to invalidate the omission and compel the tax authorities to refund the overpaid tax amount. If the tax authorities unlawfully deny an offset or refund of overpaid tax, an appeal against such a denial can be made to a higher tax authority and then to a court. A motion filed in court can also contain a property claim for a tax refund. Interest is charged on the overpaid tax.
An overpayment can also arise because of an error during tax itemisation or because of adjusted returns filed by a company for prior periods claiming additional tax benefits. In such cases, the adjusted tax returns can be reviewed during a desk audit or a regular field audit, or a follow-up field audit if the initial audit was performed before the adjusted tax returns were filed.
To recover the overpaid tax, the company must file an application with the tax authorities within one month of the overpaid tax being collected, or with a court within three years of the overpaid tax being collected.
ii Challenging administrative decisions
Appeals of tax authority decisions are very common. In practice, appeals against non-regulatory certificates of the tax authorities can be made both on formal grounds (when the tax authorities fail to comply with procedures, deadlines and formal requirements as stipulated in the Tax Code) and on the merits.
Appeals against some certificates issued by the tax authorities can only be made on formal grounds. For example, if the tax authorities issue a resolution on charging additional tax, and based on this resolution a tax payment notice is generated, an appeal against the notice can be made only on formal grounds (e.g., violation of the deadline for issuing the notice, required information missing in the notice). However, in appealing against the notice, the taxpayer cannot appeal against additional taxes being charged on the merits. To appeal against the grounds for additional tax being charged, the taxpayer must dispute the initial resolution, stating all circumstances that resulted in additional taxes.
When appealing against a tax authority resolution, taxpayers can cite its inconsistency with Russian tax law, international treaties of the Russian Federation and the Constitution.
If any provision of Russian tax law is found to be unconstitutional, it becomes invalid retroactively; in adopting resolutions, the tax authorities cannot apply unconstitutional legal provisions or apply an interpretation of tax law provisions that differs from the Constitutional Court's interpretation.
When appealing against non-regulatory certificates, it is important to remember that the pre-litigation stage is mandatory, and a non-compliant taxpayer loses its right to litigate.
The deadline for appealing against a non-regulatory resolution to a higher tax authority is one year from the date the relevant resolution was issued, and to a court it is three months from the date of the higher tax authority's decision.
Court claims are filed by entities whose rights have been violated.
Appeals against non-regulatory tax authority certificates can be made by the entities that the given certificate concerns (i.e., the entity charged under the certificate with additional liability).
An application for a refund of overpaid tax can be filed by the taxpayer who overpaid the tax. Payment of taxes must be made by the taxpayer independently (using its own funds); no third-party tax payments are allowed. As such, if a company (Company A) makes a tax payment for another company (Company B), Company A incurs excessive tax that it can refund, while Company B would still have taxes due, which it must pay independently.
If a tax agent withheld and paid an excessive tax amount, the application to refund the overpaid tax can be filed by the taxpayer or by the tax agent. If overcharged tax is refunded to the tax agent, it must repay this tax to the taxpayer.
If a company remitted excessive VAT to its contractor, the company can demand the excessive VAT amount from the contractor. For example, Company A provides services to Company B and charges 18 per cent VAT on such services. Company B pays VAT to Company A in full and claims a refund of the VAT paid. The tax authorities audit Company B, and indicate that the services provided were subject to zero per cent tax; thus, Company B should not have paid VAT to Company A. Accordingly, Company B has invalidly claimed VAT as being exempt.
Company B loses its litigated dispute with the tax authorities. The court confirms that Company B could not have exempted VAT, as the services acquired were subject to zero per cent tax, and Company B should not have paid VAT to Company A at the 18 per cent rate. Company B files a claim against Company A for repayment of improper enrichment (excessively paid VAT). The court sustains Company B's claim and orders Company A to repay the excessive VAT amount. In this situation, Company A could submit an adjusted VAT return applying the zero per cent rate to the disputed services (provided the relevant documents are available) and not the 18 per cent rate, and petition the tax authorities for repayment of the overpaid tax.
The main costs that a company incurs in relation to a tax dispute are the state duty, representation and other legal expenses.
The state duty charged in tax disputes is rather low (see Section I), and is paid by the losing party.
The cost of representation and other legal expenses can be substantial, depending on the complexity of the dispute.
The law provides for charging reasonable legal expenses to the losing party in tax disputes. In practice, until recently taxpayers usually did not demand compensation for representation and other expenses. However, recently we have seen a relevant practice beginning to develop; taxpayers have started demanding compensation for legal expenses (including representation expenses) more frequently. In some cases, the courts have ordered the tax authorities to compensate rather large amounts (up to 3 million roubles), but in most cases the courts charge the losing party with negligible expenses, recognising actual expenses as unreasonable and reducing the amounts of actual expenses by five or 10 times (or more). In certain cases, the courts have ordered the losing taxpayer to compensate expenses incurred by the tax authorities (e.g., expenses incurred by the authority's employees in travelling to the litigation venue), but such cases are infrequent.
VII ALTERNATIVE DISPUTE RESOLUTION
The main methods for resolving tax disputes in Russia are appeals to a higher tax authority or litigation. Virtually no other dispute resolution alternatives are used.
It is not possible to obtain a mandatory preliminary clarification or ruling. However, Russia's new Transfer Pricing Law, which took effect in 2012, allows for pricing agreements. During 2013, eight pricing agreements were concluded, and some more took place in the following years. Nevertheless, this tool has not become very popular because there are a lot bureaucratic obstacles to conclude such agreement.
Simultaneously with the new Transfer Pricing Law, the concept of a consolidated group of taxpayers was introduced in the Tax Code. Using consolidated groups of taxpayers prevents TP disputes regarding transactions among group members. Accordingly, the agreement establishing a consolidated group of taxpayers can also be viewed as an alternative resolution method for TP disputes. However, the current criteria for establishing consolidated groups of taxpayers are very high (e.g., aggregate assets valued over 300 billion roubles, aggregate annual taxes of over 10 billion roubles), so only a limited number of companies can use this option.
Double taxation treaties between Russia and other countries also allow for a mutual agreement procedure (MAP). In practice, the MAP is not very popular, and is used only rarely. However, because of the new TP rules, we believe this procedure could gain popularity in settling TP disputes, and that support for this procedure will grow.
In addition, in 2015, Tax Code amendments took effect, allowing taxpayers to switch to 'horizontal' tax monitoring. These changes were made following a successful trial run for this regime by several major Russian companies. Under this regime, taxpayers will regularly provide documents to the tax authorities that confirm the lawfulness of identified tax liabilities or give the tax authorities some access to their corporate IT systems. The regime eliminates the need for field tax audits (save for in exceptional cases) and allows the taxpayer to promptly obtain the tax authorities' reasoned opinion on disputed issues. It is also assumed that the new regime will help reduce the number of tax disputes. Taxpayers can switch to the new regime voluntarily if they meet the following conditions: on the date the taxpayer applies to switch to the new regime, tax accrued in the previous year must have exceeded 300 million roubles; income as per accounting records must have exceeded 3 billion roubles; and assets as per accounting records must exceed 3 billion roubles.
Applications to switch to the new regime must have been submitted by 1 July of the preceding year; in other words, based on the text of the law, it follows that the horizontal tax monitoring regime is applied officially starting from 2016.
Other alternative resolution methods for tax disputes (specifically mediation) are also being discussed, but at this time they are not legally available in Russia.
The issue of legal and illegal tax optimisation is quite important in Russia.
Before 2017, this issue was not regulated legislatively, and for a long time the courts approached the legality or illegality of tax structuring as they saw fit, resulting in inconsistent judicial practice, ambiguity and uncertainty. In late 2006, the Plenum of the SAC adopted Resolution No. 53 on an Assessment by the Arbitrazh Courts of the Justification of Taxpayers Receiving Tax Benefits (Resolution).
The Resolution was designed to identify the key criteria for distinguishing justified from unjustified tax benefits. It specifically stipulates the presumption of good faith on the part of taxpayers. Under the Resolution, a tax benefit can be declared unjustified specifically if it is not related to real economic activity, or if the relevant transactions are not accounted for in accordance with their real economic substance, or transactions were recorded that lack any reasonable economic or other basis (business purpose).
Furthermore, receiving tax benefits is not considered to be an independent business purpose. The Resolution notes that the possibility of achieving the same economic result with a lesser tax benefit, obtained by the taxpayer through entering into other transactions either provided for or not prohibited by law, shall not be grounds for recognising the relevant tax benefit as unjustified. The Resolution lists certain criteria that could indicate an unjustified tax benefit (inability to perform certain transactions, transactions with goods that were not produced, etc.) and a range of criteria that, on their own, do not indicate an unjustified tax benefit (interrelationship of participants, agency arrangements, etc.). Another provision of the Resolution is also important: if the taxpayer did not account for transactions in accordance with their real economic substance, the court should determine the scope of the taxpayer's rights and obligations based on the real economic substance of a relevant transaction; that is, establishing that a tax benefit is unjustified and denying the taxpayer's application for this benefit or cost accounting, etc., is insufficient. It is important to establish the real tax obligation of the taxpayer based on actual relationships.
However, in June 2017, Article 54.1 was introduced in the Russian Tax Code to provide for a somewhat different approach to the possibility of reducing the tax base (accounting for expenses on transactions for tax purposes) than that set out in Resolution No. 53. Under this Article, it is important to provide evidence that there are no misstatements about business facts, taxable items to be recorded in tax and/or accounting books or disclosed in tax filings; or that:
- the primary purpose of the transaction (operation) is neither the non-payment (underpayment) nor offset (refund) of the tax amount; and
- the obligation under the transaction was discharged by a person who is a party to the contract or a person to whom the transaction obligation was assigned under contract or law (Article 54.1.2 of the Russian Tax Code).
To date, the court practice on this provision is mixed, with few cases considered. There is no consistency even in terms of the point in time from which it applies:
- to current relations, as it interprets the circumstances related to detection of an unjustified tax benefit in favour of a taxpayer (Resolution of the 13th Arbitrazh Appellate Court No. 13AП-14558/2017 of 13 September 2017 on Case No. A56-28927/2016; Resolutions of the 17th Arbitrazh Appellate Court No. 17AП-11906/2017-AК of 23 October 2017 on Case No. A60-12916/2017, No. 17AП-14023/2017-AК of 23 October 2017 on Case No. A50-9057/2017, No. 17AП-8375/2017-AК of 23 October 2017 on Case No. A50-7683/2017, No. 17AП-13676/2017-AК of 20 October 2017 on Case No. A60-25288/2017 and others); or
- to tax periods after the Article came into force (19 August 2017) (Ruling of the Arbitrazh Court of the Republic of Karelia of 10 October 2017 on Case No. A26-7252/2016).
On the one hand, novelties in the Russian Tax Code in the form of Article 54.1 significantly change the approach to an unjustified tax benefit. On the other hand, they do not rule out the possibility of applying the old approach by courts and tax authorities based on the position set forth in Resolution No. 53.
i Applying Resolution No. 53
In one case,2 a company had a certain number of employees and paid unified social tax on payments made to its employees. A significant number of these employees were dismissed and subsequently hired by several smaller companies.
The company then entered into outsourcing agreements with these smaller companies. Under these agreements, the smaller companies provided employees to the company, which paid for the services provided by the smaller companies. Furthermore, the smaller companies were subject to a special tax regime and did not pay unified social tax. The tax authorities believed that the employees were transferred for the sole purpose of avoiding unified social tax (i.e., there was no business purpose). The actual relationship between the company and the employees did not change (e.g., the employees worked in the same roles, undertaking the same activities), and the smaller companies were created specifically to save on unified social tax (although formally they were independent).
Based on SAC Presidium Resolution No. 1229/09,3 the SAC upheld the tax authorities' position. However, the SAC also noted that, when charging additional unified social tax to this company, the authorities should check whether it is entitled to any tax benefits, and to charge additional tax in accordance with the Tax Code taking such benefits into account.
ii Application of the internal Russian thin capitalisation rules
It follows from a literal interpretation of the Tax Code that if a loan is received from a foreign group sister company, the internal Russian thin capitalisation rules are not applicable, and interest can be deducted in full. In the case at hand,4 a loan was received by a Russian company from a foreign group sister company and the relevant loan interest was fully deducted. However, the tax authorities established that, de facto, the loan was provided by the foreign parent company, while the group sister company was used solely for technical purposes to transfer funds. Accordingly, the tax authorities applied the thin capitalisation rules to the Russian company and charged additional tax. The courts of three instances upheld the position of the tax authorities, and the SAC refused to retry the case. Interestingly, in this case, while neither the tax authority nor the court cited Resolution No. 53 on unjustified tax benefits, they still applied its concepts.
In general practice, if the tax authorities cite unjustified tax benefits (lack of business purpose, real relationship or substance) when charging additional tax, such cases are usually the most complex, and the courts examine the facts of the case and the evidence much more closely.
iii Challenge resale of Russian assets5
The shares of the taxpayer were sold abroad and then bought back two years later at more than five times the original sale price. The tax authorities concluded that the profit received by the foreign resellers should be subject to withholding tax in Russia.
Thus, in 2010, the company sold the shares it held in the capital of a Russian coal mining company for 177 million roubles abroad. In 2012, it bought back the same shares, but at an increased price of 1.19 billion roubles. Mutual settlements for both transactions were formalised in October 2012. The income received by the foreign resellers was approximately 1.01 billion roubles.
The tax authorities stated that the companies involved in the transaction for the share buyback were related to a major Russian group that also includes the company.
They also drew the court's attention to the fact that the foreign buyer of the shares finalised the settlements for the 2010 transaction with the company only in October 2012, using the funds it had received from the company only a few days earlier following the buyback of the disputed shares. These circumstances raised doubts about the paid-for basis of the first transaction for a sale of the shares abroad and provided grounds to recategorise it as a distribution of property to a foreign company. The tax authorities stated that the difference between the price of the original sale and the share buyback, amounting to 1.01 billion roubles, received by the foreign companies that resold the shares constituted income from Russian sources and was subject to taxation at 20 per cent. The court backed the tax authorities and stated that the company's arguments regarding the paid-for basis of the two transactions (for the original sale of the shares and their subsequent buyback) were unsubstantiated. The court concluded that the taxpayer recognised the disputed transactions in a manner inconsistent with their actual economic substance.
IX DOUBLE TAXATION TREATIES
Russia has concluded double taxation treaties (DTTs) with many countries. Moreover, some treaties have recently been amended to provide additional regulations, specifically regarding information exchange and assistance in tax collection efforts. The Tax Code directly stipulates that international treaties take precedence over domestic law.
Russia is not a member of the Organisation for Economic Co-operation and Development (OECD), and the latter's comments on applying the Model Treaty are not mandatory or legally binding. Nevertheless, in recent years the courts have started taking these comments into consideration. However, no uniform position on their status and applicability has been developed. In addition, there are no similar domestic comments. The relevant authority for most treaties is MinFin; accordingly, it comments on their applicability.
In recent years, the most interesting treaty-related cases have concerned the application of thin capitalisation rules, identifying the beneficial owner and the creation of a permanent establishment (PE).
By way of example,6 in a dispute concerning the thin capitalisation rules, a Swiss company held a 20 per cent stake in the charter capital of a Russian company. The Russian company received a loan from the foreign company exceeding its own capital by more than three times. Under domestic Russian thin capitalisation rules, in this situation the total amount of the loan interest cannot be used to calculate profits tax in full. The interest exceeding the maximum must be requalified as a dividend and is subject to the relevant tax. However, the Russian company deducted the loan interest in full. Furthermore, the company proceeded from the fact that Russia's DTT with Switzerland contains a non-discrimination clause. According to the Russian company, this clause allows accounting for loan interest in full, because if the loan were granted by the Russian company the interest would be accounted for in full. Accordingly, the provisions of the domestic Russian thin capitalisation rules contain discriminatory conditions and cannot be applied because they contravene the Russian–Swiss DTT.
For several years, the courts upheld this approach. However, in 2011, the SAC reconsidered the position developed by the lower courts in one such case,7 indicating that in that case the domestic Russian thin capitalisation rules were applicable, while the non-discrimination clause did not apply. Specifically, the SAC cited OECD comments on the Model Treaty.
Another interesting issue is the identification of beneficial owners to apply DTTs. In one case,8 a Russian company obtained a loan from its Cypriot parent company, and under the relevant agreement was paying interest on the loan. On the basis of the Russian–Cypriot DTT, tax was not withheld in Russia when the interest was paid. The tax authorities believed that the Cypriot company was not the beneficial owner of the loan interest, as it had itself obtained a similar loan from a company registered in the British Virgin Islands (BVI). Interest from the Russian company was paid to BVI, and in some cases the interest was paid directly by the Russian company to BVI. The first instance and appellate courts upheld the taxpayer's position.9 They cited the DTT with Cyprus, which does not require the recipient to necessarily have the actual right to the interest (to be the beneficial owner). The tax authorities have decided not to appeal against the courts' decisions further.
The tax authorities have also raised the issue of PEs. They closely examine the operations of non-taxable PEs working in Russia regarding their compliance with the definition of a non-taxable PE. Thus, the authorities look closely at whether business activities are preparatory or auxiliary in nature, or both, or constitute the company's core activity. In these disputes, evidence (including witness testimony) is very important.
More disputes involving the tax authorities concerning the application of DTTs are expected in the future.
In addition, significant changes introduced to the Tax Code by the 'de-offshorisation' law should not be overlooked. These changes pertain to three major areas: controlled foreign corporation rules, tax residency rules for legal entities and the concept of beneficial ownership. Relevant disputes are likely to arise in the three-year period following this new legislation, which took effect in 2015.
X AREAS OF FOCUS
The changes ushered in by the de-offshorisation law, which took effect in 2015, are currently the hottest topic in the tax field. While we fully expect to see relevant disputes, they are unlikely to arise before 2019.
Furthermore, during audits the following issues arise most frequently.
i Subject over form
The tax authorities have recently started to focus greater attention on this concept and on relatively new related issues, such as determining the beneficial owner, share deal versus asset deal, transitional payments and back-to-back payments. This trend is likely to continue.
ii Economic justification of expenses
The economic justification of expenses is a mandatory criterion used to account for any costs when calculating profits tax. Since companies' expenses decrease the profits tax base, the tax authorities have tended to pay special attention to this issue, particularly for the following:
- a company that is just launching its business activity, and therefore incurs overall losses;
- a company that incurs losses as the result of a specific transaction; and
- a company whose expenses are suspected of being economically advantageous or beneficial to third parties (other groups, companies, individuals or counterparties) rather than the taxpayer itself.
iii Cross-company charges and cost-sharing agreements
During audits, the tax authorities pay particular attention to the legality of deducting the costs incurred to pay for management and other services provided to group companies. The essential questions raised by the tax authorities are:
- the real nature of the services provided; the tax authorities check which services were provided and their scope. They ask for the relevant agreement and primary documents (invoices, certificates), as well as for detailed reports on services provided and tangible evidence (communications, presentations, draft documents, marketing materials, etc.);
- expense redundancy; the tax authorities check whether it was necessary to engage a third party to obtain the disputed services, or whether the company could have obtained the same results on its own. The tax authorities also check whether the company that paid for the services was the same entity that was actually in need of them; and
- the service fee; the tax authorities check the pricing and its conformity with the scope of services. Accordingly, if the list of services remains the same each year but the service fee increases substantially, there is a high likelihood that the tax authorities will challenge the company's position. If under the old TP rules it was difficult for the tax authorities to confirm the actual market value of such services, the new rules provide more grounds for the tax authorities to verify pricing accuracy.
On such matters, the courts generally uphold the taxpayers' position if the latter provide sufficient evidence that the services were actually rendered and of their relevance to the taxpayers' business. However, recently cases have emerged where the courts have dismissed taxpayers' claims because they could not justify substantial price changes and the scope of services. In future, the tax authorities' interest in this issue will remain high.
iv Accounting for loan interest
The tax authorities pay particular attention to the validity of accounting for loan interest. Most relevant disputes concern domestic thin capitalisation rules (see specific examples in Sections VIII and IX), interest-free loans and the calculation of arm's-length interest.
v Bad-faith suppliers
In the normal course of business, companies interact with numerous suppliers and face the risk of dealing with a 'bad-faith supplier'. This could lead to increased taxes for the buyer, although the impact may vary depending upon the tax authorities' claims. Under the best-case scenario, the buyer would have to settle the dispute with the tax authorities. Under the worst-case scenario, the buyer would have to pay additionally charged taxes, late payment interest and fines should the tax authorities judge the supplier, or relationships with the supplier, as non-existent or artificial.
As a result, ensuring the 'good faith' of a supplier before entering into any commercial relationships is of particular importance for a company. The main indicators of a supplier's bad faith are failure to pay taxes, failure to submit tax returns and the lack of any capital assets or employees.
Even though in most cases the arbitrazh courts have tended to favour taxpayers, there may be situations in which it is difficult to defend the taxpayer's position.
vi Beneficial ownership
The tax authorities have recently started to pay particular attention to determining the beneficial owners of passive income from Russia. This heightened interest on the part of the tax authorities may be the result of the latest confirmation of their right to collect withholding income tax from tax agents, which are also Russian legal entities.10
When applying reduced rates of withholding tax (as determined by a DTT), a taxpayer must be sure that the recipient of the income is their beneficial owner.
If the taxpayer fails to prove this, then it will be charged with additional assessed tax, a fine and penalties. Recent court practice has shown that companies are often unable to confirm beneficial ownership of income.11
In recent years, the courts have issued a number of decisions on the abuse of double tax treaties (DTT), some in favour of the tax authorities and others in favour of taxpayers. For example, there are two court cases on the question of applying the reduced tax rate under the Russia–Cyprus DTT and, in particular, on the question of identifying the beneficial owner of income.
The first case concerns a dividend payment of 300 million roubles on which the taxpayer was assessed to be liable to an additional tax of 30 million roubles as well as penalties and fines in the amount of about 5.5 million roubles and 750,000 roubles respectively, because a Cypriot company involved in the deal was not deemed a beneficial owner of the income.12
In the second case, the court examined the assessment of the 5 per cent reduced rate on dividend income under the Russia–Cyprus DTT, but the dispute was different. The court applied a literal interpretation of the tax treaty's provisions and ruled that compliance with the formal DTT requirements was sufficient grounds for applying the reduced tax rate.13
As Russia has no statutory framework that could ensure the strict regulation of provisions regarding the concept of beneficial ownership, court practice serves as the key tool that taxpayers can use to obtain information on the criteria for compliance with the respective definitions set by the Russian Tax Code and DTT. This trend will likely continue.
XI OUTLOOK AND CONCLUSIONS
Generally, there are two main trends regarding tax disputes in Russia. The first is the growing complexity of tax disputes, in which the tax authorities are raising increasingly complicated issues (e.g., beneficial ownership, thin capitalisation, TP). During audits, the tax authorities are questioning witnesses and performing expert examinations more frequently, and information exchange with foreign jurisdictions is improving. In this context, it is harder for taxpayers to win a dispute on the one hand, while on the other, the general number of cases has fallen substantially as there are fewer standard, straightforward cases.
The second trend concerns the shift of disputes away from litigation to the pre-litigation stage. Administrative procedures for adjudicating disputes are becoming more efficient. Interest in alternative resolution methods for tax disputes (advance pricing agreements, MAP, horizontal monitoring) is also growing. This trend is extremely beneficial for taxpayers, and will continue in future. However, certain efforts must be made towards this end, including legislative amendments. Currently, litigation remains the most effective avenue for resolving a tax dispute.
1 Yana Proskurina is a former partner and Maria Mikhaylova is a director at PwC Legal.
2 Case No. A81-2855/07.
3 Dated 30 June 2009.
4 Case No. A40-1164/11-99-7.
5 Case No. A40-10532/17-140-122.
6 Case No. A81-2855/07.
7 Dated 30 June 2009.
8 Case No. A40-1164/11-99-7.
9 Case No. A40-10532/17-140-122.
10 Resolution of Plenum SAC # 57 dated 30 July 2013.
11 Case No. A40-11909/12, Case No. A40-12815/15.
12 Decision No. 15AП-17143/2016 of 13 March 2017.
13 Case No. A76-20508/2016.