The Supreme Arbitrazh Court is due to decide a case involving international home improvement retailer Leroy Merlin, which has challenged a decision of the tax authorities in relation to value added tax (VAT) on trade bonuses.

The issue is that suppliers which sold goods to Leroy Merlin paid bonuses for placing their goods in Leroy Merlin's stores, as well as bonuses to incentivise Leroy Merlin to sell the goods more quickly (and thus buy more goods from the suppliers). These bonuses had the effect of reducing the amounts that Leroy Merlin paid for the goods, which meant a reduction in the VAT base.

The tax authorities argued that bonuses for the placement of goods and to stimulate sales and turnover should not be regarded as reducing the VAT base because they are paid in respect of separate services from the trading network (ie, acquiring and selling the suppliers' goods). The suppliers had no choice but to pay such bonuses, which were covered in the terms of their agreement with Leroy Merlin; the retailer would conclude an agreement only on these terms. In effect, the bonuses were paid to secure an opportunity to sell goods through Leroy Merlin's trading network.

The Supreme Arbitrazh Court previously ruled on the question of trade bonuses in Dirol Cadbury in 2009. In that case the court found that such bonuses are normal practice in the retail sector and are closely connected with the main business purpose (ie, selling more goods and achieving greater profits). The court's conclusion was based on Article 166(4) of the Tax Code, which states that prices for VAT purposes must be determined with reference to all changes or adjustments, including bonuses, discounts and premiums. However, the court's approach could be about to change.

If the court agrees with the tax authorities' position that such bonuses are payments for separate services, retailers could face serious problems and an increase in their tax burden. On this analysis, such payments would not reduce the VAT base and would count towards a separate VAT base for such services. Moreover, the effects of such court rulings can be applied retrospectively. If the Supreme Arbitrazh Court rules against the retailer, the tax authorities will be able to charge VAT on such separate services and will not deduct the sum of bonuses from the general VAT base. They will be able to apply this analysis to tax periods up to three years previously.

For further information on this topic please contact Andrey Tereschenko or Ivan Zelenin at Pepeliaev Group by telephone (+7 495 967 0007), fax (+7 495 967 0008) or email ([email protected] or [email protected]).