The tax authorities continue to abide by the principle of “what is not forbidden is allowed”, using contradictory norms of the Russian Tax Code to their advantage.
As a result, there is a surge in tax audits by territorial tax authorities during which they check whether prices charged in transactions are at market level. In doing so, the territorial tax authorities are targeting transactions that are not normally subject to transfer pricing review, as well as those that are normally under the control of the Federal Tax Service of Russia (the “FTS”). Further, Russian representative offices and branches of foreign legal entities have become new targets of transfer pricing control. The scope of transfer pricing control (on which we previously reported) is evidently continuing to expand, not just in the legislative field but also now in the administrative and judicial fields.
The position of the tax authorities
As part of their routine tax control work, territorial tax authorities are keen to check whether prices in transactions between related parties are at market level. They do so despite the fact that under article 105.17 of the Russian Tax Code, the FTS has sole exclusive authority to review the prices of controlled transactions.
While tax inspectorates do not contest the FTS’ exclusive authority in respect of controlled transactions, they do audit prices in transactions between related parties that fall outside the scope of controlled transactions by proving that taxpayers gained an unjustified tax benefit. This approach is consistent with the position of the Ministry of Finance as expressed in its letters dated 26 October 2012 and 8 November 2012.
Above all, domestic transactions are at risk of being audited where the proceeds received by related parties are below the thresholds established by the Russian tax legislation to determine whether a transaction is subject to price control. Based on the developing practice of the tax authorities, the following transactions tend to be of most interest:
- interest-free loans;
- intragroup leases;
- transactions between related parties when there are internal comparable transactions;
- transactions with counterparties, applying special tax regimes;
- transactions between companies and their founders when the latter are individuals.
The position of the courts
As for the courts, they have not yet formed a consistent position as to whether the territorial tax authorities have authority to audit prices in transactions between related parties. While a number of court decisions clearly held that the territorial tax authorities did not have requisite authority (e.g. in Russian: А79-7574/2014, А41-36288/14), in other cases the courts agreed with the position of the tax bodies as to the legality of their review of prices in transactions between related parties in the normal course of tax control (e.g. in Russian: А43-1069/2015, А40-204810/14). Currently there are also several cases in which the cassation courts not only confirmed the authority of the territorial tax authorities to carry out the relevant review, but also agreed with the arguments of the tax authorities, thereby confirming the legality of the additional tax charge imposed (e.g. in Russian: А63-11506/2014, А04-8475/2014).
The emerging case-law is interesting in that, when the courts analyse the position of the parties, they interpret the provisions of the tax legislation erratically, including for instance when:
- the courts review (i) how the parties to the dispute applied transfer pricing methods, or (ii) the preference order the parties applied when they used sources of information on the level of prices in comparable transactions; or
- the courts analyse whether using an appraiser’s report to assess price levels was justified.
This erratic interpretation can then be used by the tax authorities as well as by taxpayers.
Trend to expand the scope of control and application of the transfer pricing rules to branches
The substantial number of decisions on the issue clearly indicates the intention of the tax authorities to expand the scope of transactions in relation to which they will monitor price levels. On its part, the Ministry of Finance recently clarified, in a letter dated 4 August 2015 that the current transfer pricing rules (including in relation to the preparation of notifications and documentation sets on controlled transactions) also apply to the branches and the representative offices of foreign legal entities who are active in Russia.
Based on the emerging court practice, if a tax matter is taken to court, taxpayers are unlikely to be able to rely solely on the argument of the formal inadmissibility of the audit of the conformity of prices with market level by the territorial tax authorities. The same can be said with regard to the argument that prices are presumed to be at market prices unless otherwise proven by the federal tax authority. In order to reduce the associated risks, we recommend taking the following steps in advance of any audit by the tax authorities:
- identifying uncontrolled transactions which are at risk of being reviewed (based on their nature and amount) for their compliance with market level prices;
- where possible, conducting a preliminary check of compliance with market price levels (in particular, this preliminary assessment is possible with internal comparable transactions in respect of intra-group loans, etc.);
- amending existing policies and documentation in relation to controlled transactions to extend the principles of pricing and justification of market price level compliance for similar uncontrolled transactions; and
- developing (when appropriate) a separate internal document that spells out the pricing principles applying to uncontrolled transactions concluded between related parties.