On February 16, 2017, the Presidium of the Supreme Court of the Russian Federation approved the Review of Court Practice in the Consideration of Cases Involving the Application of Certain Provisions of Section V.1 and Article 269 of the Tax Code of the Russian Federation (the “Review”). There is no doubt that the Review will significantly influence the future application of the law in issues related to transfer pricing and thin capitalization rules.
Below are the key points of the Review. We will discuss these in greater detail in subsequent articles.
- A corresponding adjustment in relation to controlled transactions with foreign entities may be possible if that possibility is provided for in a relevant double taxation treaty (Preamble to the Review).
- As a general rule, only the Federal Tax Service of Russia is entitled to perform tax audits on pricing (section 1 of the Review).
- There are two cases in which local tax authorities can apply transfer pricing methods and check that prices are consistent with arm’s length prices:
- when that power is explicitly provided for by law (section 2 of the Review);
- when there is a multiple deviation of the actual transaction price from the market (normal) level, which in conjunction with other circumstances indicates a discrepancy between the form and substance of a business transaction (section 3 of the Review).
- Persons may be deemed related if there is a risk that they are acting otherwise than purely in their own interests. Exceptions are set out in the law (article 105.1, clauses 4–5, of the RF Tax Code) (section 4 of the Review).\
- The report of an independent appraiser may be used for tax purposes both in combination with transfer pricing methods (as a source of information) and instead of transfer pricing methods (in a one-off transaction) (section 7 of the Review).
- Recognition of the established practice, now enshrined in the law, that thin capitalization rules apply to loans received by Russian entities from foreign sister companies (section 12 of the Review).
- Thin capitalization rules apply to loans between Russian companies only with respect to the restriction on deductibility interest treated as dividends in line with thin capitalization rules. Further, the borrower is not obliged to additionally withhold tax when paying such interest to the Russian lender, so long as the interest is not a concealed distribution of dividends to the foreign company (section 13 of the Review).
- In cases when interest is reclassified as dividends according to thin capitalization rules, the corresponding loan amount is accounted for as a contribution to capital for purposes of applying the reduced tax rate on dividends under a double taxation treaty (section 14 of the Review).
We also mention two noteworthy elements that changed in comparison with the draft Review distributed in early December 2016:
- the point stating that interest-free loans are examples of non-arm’s length transactions was removed from the Review;
- the final version of the Review kept the lenient interpretation of the penalty for failure to give notice of controlled transactions: 5,000 rubles irrespective of the number of transactions for which information was not provided on time (or incorrectly completed) (section 9 of the Review).
The preparation of a separate review of court practice on transfer pricing and thin capitalization issues attests to the formation of the Supreme Court's position on fundamental aspects of their application, which may encourage the tax authorities to apply them.