A Russian court found, on 30 June 2011, that a common royalty scheme – which involved a Cyprus company as an intermediary licensing vehicle between a BVI holding company and a Russian operating entity – had no business substance. It concluded that the Cyprus company was interposed merely in order to gain access to unjustified tax benefits.
In Russia, the judicial concept of an "unjustified tax benefit" is similar to a General Anti-Avoidance Rule and is primarily used to challenge purely artificial structures where the only aim is to obtain a tax benefit that is not justified by a sound business purpose.
In case No. А60-32327/2010-С8, the Russian tax authorities assessed, during a tax audit of the years 2006-2008, whether a Russian corporate taxpayer had incorrectly deducted more than RUB470m (USD15m) for a trademark. The payments had been made to a BVI company through a Cypriot sub-license company.
The BVI company had purchased the trademark from a Russian individual, who was a director of the parent company of the taxpayer. Prior to transferring the trademark, the Russian companies had not paid royalties for its use. The BVI company had granted a non-exclusive right to use a trademark to a Cypriot company, which then granted the non-exclusive right to use the trademark to the Russian taxpayer. The initial royalties significantly exceeded the purchase price of the trademark.
The Federal Arbitration Court of the Urals Circuit stated that, in such a case, a thorough investigation must be conducted as to whether or not such a series of transactions has a purpose other than merely tax savings. The findings of the lower courts in the taxpayer's favour had not been so substantiated.
The Court took into account information obtained through Interpol that the beneficial owner of the Cypriot company was a woman cohabiting with the former owner of the trademark, such that it could be deemed to be affiliated. As a result, it dismissed the decisions of the lower courts and remanded the case to the trial-court level for consideration de novo of the issues involved in this dispute.
Sovereign Comment
This case shows once again how vital it is for any such "royalty routing" scheme to be structured correctly. In particular, it shows the importance of demonstrating proper substance and also that the relationship between the owners of the companies must be carefully considered. The Russian tax authorities used data obtained via Interpol to identify the real beneficiaries of the Cyprus company. Sovereign's Cyprus office has considerable experience in establishing structures in this area and it more important than ever that the right questions are asked at the outset in order that the right solution is offered.
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