On June 11, 2015, Moscow District Arbitration Court handed down
its ruling in the controversial Oriflame case. In the case, the tax
authorities challenged the lawfulness of a Russian organization
deducting VAT and expenses (for profit tax purposes) on royalties
paid to an affiliated foreign company for use of a trademark, trade
name and know-how. According to the judgments, the rights holder (a
Luxembourg tax resident) is a 100% grandparent of the Russian
sublicensee, while payments were made via a Dutch sister company
(formally, the Russian organization concluded a subfranchise
agreement with the Dutch sister company, which in turn had a
franchise agreement with the Luxembourg rights holder).
Sadly, the court of cassation instance did not accept the
arguments by the Russian taxpayer and refused to set aside the
judgments of the first and appeal instances. The court based its
decision against the appeal on the following conclusions:
Affiliation of the rights holder and the Russian
Participation of employees of the Luxembourg rights holder in
management of the Russian organization, supervision of that
organization's activities by the Luxembourg company (including
by introducing common corporate standards, policies and business
procedures), accountability of employees of the Russian
organization to officers of the Luxembourg company. As a result
– the Russian organization was not an independent
The Russian organization resold goods purchased from the
The Russian organization positioned itself commercially
(including before customers) as a division of the Luxembourg
The Dutch sister company's activities were transitory (the
Dutch sister company transferred practically all revenue received
from the Russian organization to the Luxembourg rights
In the opinion of the court, these reasons are sufficient to
ignore the presence of the Dutch sister company in the operational
structure and to treat the Russian organization as conducting
business on behalf and in the interests of the Luxembourg company,
that is, as a dependent agent of the Luxembourg company.
Consequently, the court recognized the Russian organization as a
permanent establishment of the Luxembourg company, and the payment
of royalties to the Dutch sister company as inconsistent with
reasonable business purposes.
Besides changing the treatment of the relations between the
Russian organization and its affiliated foreign structures
(effectively the grounds for tax reconstruction), the court
advanced other arguments for its decision concerning the
subfranchise agreement itself:
The information containing commercial experience transferred to
the Russian organization was publicly available (and therefore does
not qualify as know-how);
Permission to use the trademark was not required, since the
rights thereto were exhausted by putting the goods into the
commercial cycle in the RF.
Finally, in substantiation of the Russian organization's
receipt of an unjustified tax benefit, the court indicated that the
royalties received from the Russian organization were practically
untaxed in either the Netherlands or Luxembourg.
At present we can only speculate as to how the Oriflame case may
affect Russian law enforcement practice, however, it should be
noted that any effect is unlikely to be positive. A significant
portion of the professional community is critical of the
court's approach to applying the doctrine of unjustified tax
benefit in this case, as well as to the interpretation and
application of Russian tax law and international tax treaties
concerning the creation and taxation of permanent establishments of
foreign organizations through so-called dependent agents.
Specialists are also concerned by the way the courts are
essentially diluting the entire notion of permanent establishments
of foreign organizations (the established notions of when a foreign
organization has a permanent establishment and how the tax base is
formed), as well as the increasingly bad habit of courts of
selectively applying OECD guidance on the interpretation of
international tax treaties. All of this undermines the efficacy and
predictability of the Russian tax system.
Time will tell whether these concerns are justified.
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