Russian Federation: Development Of Court Practice In Tax Disputes Related To Grant Financing Of A Russian Company

Last Updated: 1 August 2016
Article by Dzhangar Dzhalchinov

On 22 July 2016 the Commercial Court of Samara Region delivered a decision in case No. А55-11332/2016.

In that case, the court considered a dispute between SMARTS JSC and the Samara Region Interdistrict Federal Tax Service of Russia Inspectorate for major shareholders that was connected with accusations that SMARTS JSC had received an unjustified tax benefit without intending to engage in actual economic activity.

The taxpayer received grant financing from its foreign subsidiary and treated the financing that had been received as not subject to profit tax (the exemption under Article 251(1)(11) of the RF Tax Code was used).

The tax authority established that several years before the grant financing was received from the foreign subsidiary, the taxpayer had transferred its shares in Russian companies to that foreign company as a contribution to charter capital. Later, the foreign company sold those shares to a third party and transferred part of the funds received from sale of the shares to the taxpayer as grant financing.

The tax authority considered all of these facts together and found that:

  • the foreign subsidiary had been created by the taxpayer as an artificial entity and was intended solely for channeling transactions for sale of the shares held by the taxpayer, thereby concealing income from sale of the shares from taxation in Russia;
  • the grant financing received by the taxpayer from its foreign subsidiary was essentially a transfer to it of part of the income from sale of the subsidiaries' shares.

The taxpayer managed to prove in court that it had not received an unjustified tax benefit. Furthermore, the taxpayer proved that there were three purposes of creating a foreign company and contributing the subsidiaries' shares to its charter capital:

  • to protect subsidiaries' shares from the possibility of illegal seizure;
  • to ensure the possibility of raising bank financing with a suretyship of the foreign company;
  • to ensure that it was possible to sell the subsidiaries' shares to those buyers who require as a mandatory condition of the transaction that the sale be performed according to the provisions of foreign law with the involvement of a "foreign element" in the transaction.

The taxpayer's successful defense of its position in court does not cancel out the fact that the tax authorities pay a lot of attention to grant financing amounts received by taxpayers, considering them together with other facts of business life. And, if the tax authorities discover that the taxpayer has transferred any assets to foreign companies of the group, the risk of claims being brought that the taxpayer has received an unjustified tax benefit is multiplied. The taxpayer will need to prove that it has a business purpose for each of its transactions.

We recommend reevaluating tax risks having to do with the receipt of grant financing from foreign companies of a group, especially in situations associated with disposal of assets in favor of such foreign companies.

Based on their considerable relevant experience of advising and representing in court, the lawyers of Dentons' Tax practice are prepared to analyze tax risks related to Russian companies receiving untaxed income from foreign companies of a group, and to devise approaches and recommendations to confirming the business purpose of the operations, enabling the client to considerably mitigate any risks.

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