Last year, for the first time the courts gave a legal evaluation to the deductibility of interest on debt obligations arising due to a company's participation in a cash pooling system, which is understood to be a system for managing available cash on the bank accounts of companies controlled by major multifunctional holdings that have an extensive network of branches, structural subdivisions or subsidiaries.
In particular, in April 2016 the Arbitration Court of Chelyabinsk Region recognized economically justified a system of revolving loans existing under cash pooling agreements concluded between Gazprom Neft LLC, its subsidiaries and credit organizations (the Gazprom Neft Chelyabinsk LLC case, No. А76-15351/2015).
It follows from that judicial act that the tax authority's claims to Gazprom Neft Chelyabinsk LLC (the "Company"), which is a wholly-owned subsidiary of Gazprom Neft OJSC (the "Parent Company"), consisted in the fact that, in the tax authority's opinion, the Company's actions were not economically justified in issuing the Parent Company short-term loans at a lower interest rate than the rates at which the Company itself paid interest on loans raised from the Parent Company in the same periods.
When considering the case, the court established that the Company's issuance of short-term loans to the Parent Company was done as part of a cash pooling system providing for the accumulation on the Parent Company's accounts of cash funds from subsidiaries, including the Company, and redistributing those funds as needed among all subsidiaries using the revolving loan arrangements. The court shared the Company's position that the cash pooling system makes it possible to reduce substantially expenses associated with raising short-term loans from credit organizations offering higher interest rates, allows to effectively control cash flows within the group of companies, and to minimize the group's credit risks related to raising bank loans. The court also took into account that the use of the cash pooling mechanism was specifically set forth in the Gazprom Neft group's treasury policy.
At the same time, the Company demonstrated to the court that it raised debts from the Parent Company on long-term financing principles and this was intended to achieve investment objectives, namely, for the Company to acquire a chain of filling stations and tank farms. Among other things, the Company was able to prove that:
- profit earned by the Company in the ordinary course of business was insufficient to achieve these capital investment objectives;
- raising the long-term loan and spending it on investments resulted in an increase in the Company's key production and financial performance indicators, growth in the number of its employees, increase in the Company's revenue and, as a consequence, in the amount of taxes paid by the Company;
- the loans granted by the Company as part of the cash pooling system, and the loans granted to the Company in order to solve investment objectives differed considerably in terms of their purposes (targeted financing of a long-term investment program and short-term placement of available cash) and repayment periods, which made it impossible to directly compare the interest rates on those categories of loans.
As a result, despite the difference in interest rates, the court recognized that the Company had lawfully deducted interest expenses on the loans granted by the Parent Company in full, thereby indirectly confirming the possibility of using the cash pooling system in a Russian tax regulation context.
When the tax authority appealed this judicial act in the court of appeal the higher court did not see grounds to reverse the decision of the court of first instance and allow the appeal (Ruling No. 18AP-7177/2016 of the 18th Commercial Court of Appeals of 4 July 2016), and the tax authority decided not to file a cassation appeal.
In noting the importance of this judicial act for the development of the practice of cash pooling in Russia, one should nevertheless bear in mind that in this decision the court relied on a quite extensive body of evidence showing that there was real economic substance and transparency in the transactions. One may suppose that without such evidence the court's conclusions on whether the deductibility of the disputed interest was legitimate could have been fundamentally different.
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