Russian Federation: The Aquapark Case, Or Who Can Check Prices In Transactions And How

Last Updated: 16 March 2017
Article by Dzhangar Dzhalchinov

The RF Supreme Court's handing down of the ruling of 1 December 2016 in the Aquapark case marked the end of the first five-year period of applying the transfer pricing rules contemplated by Section V.1 of the RF Tax Code. During this transitional period from Article 40 of the RF Tax Code to Section V.I of the RF Tax Code there were two particularly sensitive questions:

  • are the local tax authorities allowed to check the price?
  • how can the market price be determined for tax purposes?

2016 yielded answers to both of these questions which were developed further in early 2017 in the Review of Court Practice approved by the RF Supreme Court (the "Review"):

  • Generally, they are not entitled to check the price. However, if the transaction price (as the RF Supreme Court put it in 2016 "by many times, materially and markedly" — the Review only expressly mentions the criterion of multiplicity) diverges from some market (normal) price, then that price may be evidence of price manipulations resulting in an unjustified tax benefit.
  • The first stage of development of the "new" transfer pricing rules passed under the sign of universal use of the appraiser's report as key evidence that a transaction price corresponded to the arm's length value. There was scant practice of directly applying transfer pricing methods. At the level of the economic panel of the RF Supreme Court five cases that were based on an appraiser's report were considered (Mitrix Limited, DTs Minayevskiy, Office Realty, Vnukovo-9, and the Aquapark case already mentioned here), and two cases were considered in which the market price was determined using transfer pricing methods ( Aton, Stavgazoborudovaniye).

If the score at the Russian Supreme Court level is "5:2" in favor of the appraisers, the score is even more devastating in the practice of the lower courts, where it was the exception and not the rule to apply or even justify not applying transfer pricing methods.

For the sake of fairness, we will mention two points here:

  • Most cases, including the five listed above, considered by the Russian Supreme Court had to do with real estate, where transactions can be considered one-off transactions (clause 9 of Article 105.7 of the RF Tax Code), and this can be used to justify the validity of using the appraiser's report.
  • All the practice of the first five years was formed either in applying Article 40 of the RF Tax Code or in so-called uncontrolled transactions, in other words transactions in which Russia's Federal Tax Service doesn't have the right to check the price, but the local inspectorates make it look like they are controlling not the price as such, but the calculation of the tax based on the substance and not the form of the transactions. In this context a clearly nonmarket price is one of the criteria of the parties to the transaction getting an unjustified tax benefit from engaging in such transactions.

However, the following is illustrative:

  • Both the tax authorities' choice of challenging primarily one-off transactions (transactions involving real estate, shares/participatory interests, and much less frequently involving intangible assets)
  • and the fact that the tax authorities and the courts, while they have perceived the very possibility of controlling prices in transactions that the law does not treat as controlled transactions, do not however use the tools provided by law, i.e., the transfer pricing methods themselves, to check pricing in controlled transactions.

As a result, a situation is created in which the law and the practice of applying it to controlled and uncontrolled transactions are diverging, where:

  • Transfer pricing methods set forth in the law and based on international approaches are applied to controlled transactions (conventionally transactions of multinational and major Russian companies)
  • The transfer pricing rules established by law are essentially not applied to uncontrolled transactions (conventionally transactions of small and medium-sized Russian companies), and the price in those transactions is determined based on appraisers' reports, cadastral value, and sometimes just common sense.

The Russian Supreme Court attempted to bridge this gap in its Review. We will write about what comes of this in the Top 10 for 2017.

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