For the attention of heads and employees of banks’ legal divisions and premium services departments

Pepeliaev Group advises that on 9 April 2013 the Presidium of the Russian Supreme Commercial (‘Arbitration’) Court issued a ruling concerning the case of Citibank. In the ruling, the Court resolved the issue of taxable income arising when VIP clients receive bonuses from banks.

Facts of the case

According to the terms and conditions of Citigold banking services for VIP clients (individuals), those clients who maintain on their accounts an average monthly balance of RUB 1.3 million have the right to take advantage of the services provided by airport business lounges free of charge.

To ensure that it could provide this privilege, the bank entered into an agreement with an airport. The airport kept track of the individuals who visited the business lounges and invoiced the bank for the services provided by those business lounges based on the number of visitors and the cost of each visit as stipulated by the contract.

During its audit, the tax authority concluded that in the above circumstances the bank’s clients derived income in kind in the form of the bank paying for the services on behalf of its clients and for the benefit of the taxpayers (article 211(2)(1) of the Russian Tax Code). This means that the bank should have informed the tax authorities of such income arising and the individuals should have filed their Personal Income Tax returns and paid 13% tax on the cost of the services paid for by the bank.

Pepeliaev Group’s lawyers appealed against the conclusion of the tax authority in court. The first and second instance courts upheld the bank’s position but the Federal Commercial (‘Arbitration’) Court for the North-Western District (the court of third instance) took the side of the tax authority and invalidated the decisions of the lower courts.

PG comment

If such a position had been supported by judicial practice that would mean that the client, when receiving any additional services from the bank under its loyalty programme without any direct payment, obtains income that should be declared in a Personal Income Tax return and taxed. Obviously, that would be detrimental to developing the premium banking services sector.

The bank addressed the Supreme Commercial (‘Arbitration’) Court claiming a supervisory review of the case.

On 9 April 2013, the Presidium of the Supreme Commercial (‘Arbitration’) Court satisfied the bank’s claim and overturned the resolution of the third-instance court.

PG comment

The full text of the resolution is as yet unavailable. However, we can assume that the Court has upheld the arguments of Pepeliaev Group’s lawyers who represented Citibank in that case: since the client’s right to visit the airport’s business lounge is conditional on there being a certain balance on the client’s account, the cost of the services provided by the business lounge should be considered as interest on the accounts for taxation purposes. Pursuant to a special provision of law (article 214.2 of the Russian Tax Code), when interest on the accounts is received, taxable income is only derived if the overall amount of interest exceeds the statutory threshold (since 2009 the threshold for Ruble accounts has been equal to the refinancing rate set by the Central Bank of Russia increased by 5 percent).

The resolution will have a significant impact on the developing banking industry in general and, particularly, on Private Banking.

To think about

Those banks who implement loyalty programmes requiring the client to maintain a certain balance on their accounts should analyse whether the benefits granted to the clients represent interest for taxation purposes.

If the benefits may be treated as interest it is also necessary to check whether the overall amount of the benefits received by the client may exceed the threshold set by article 214.2 of the Tax Code. When such risks occur, we recommend that it be considered whether to change the structure and terms and conditions of the programme.

In addition, we recommend analysing the programme of raising investments against so-called “gifts”, taking into account the stance of the Supreme Commercial (‘Arbitration’) Court. Under certain circumstances, such “gifts” may also be regarded as interest for taxation purposes.