A number of recent tax developments in Ukraine and Russia underline the need for proper planning, documentation and execution of transactions in the light of the tax authorities' increasingly sophisticated and rigorous scrutiny of tax mitigation structures.
Ukraine guidance on tax disputes
Recent guidance issued by the Higher Administrative Court of Ukraine to subordinate courts giving guidance on the application of the Tax Codes in disputes coming before the courts stresses the importance of verifying recorded transactions, and instructs courts to focus on the substance, rather than the form of the transaction. Courts are required to satisfy themselves that the transaction actually took place as claimed and is not merely a "paper-trail". In addition the transaction must have a business purpose. In order to be deductible for tax (and for VAT to be recovered) expenses must be genuinely incurred and properly documented. This is particularly relevant with regard to intra-group transactions such as recharges of administrative and personnel costs, and management, consultancy and licence fees. Care should be taken that there is a logical and defensible basis for such charges, and complete supporting documentation.
The ZAO Stik decision
This decision of the Federal Arbitration Court of the Moscow District gives further confirmation that the Russian tax authorities are becoming more experienced and sophisticated in addressing the issue of whether companies have a permanent establishment in Russia. They have started to examine transactions in detail, with particular attention to the identities of signatories of documents, their location at the time of signing and their role and function in the transaction itself and in the business undertaking it.
The case concerned a Russian company, ZAO Stik, which had borrowed funds from Cyprus companies under loan agreements. The loan agreements were signed on behalf of the lenders by two employees of a Russian company affiliated with the borrower, under powers of attorney. The tax authorities argued that the Cyprus companies were carrying commercial activities in Russia through "dependent agents" (the individuals who signed the loan agreements), and that these activities gave rise to permanent establishments of the Cyprus companies. They claimed additional tax, fines and penalties from ZAO Stik.
In this case the court found that in fact the individuals had merely performed a mechanical function, namely signing the agreements. They were not involved in negotiating the terms of the agreements and did not participate in meetings between the parties. As a result, their activity should be treated as merely supporting and auxiliary, and they were not "dependent agents" of the Cyprus companies. The court therefore ruled that the Cyprus companies had no permanent establishment in Russia.
Although this case ended with a decision in favour of the taxpayers it clearly illustrates the need for detailed planning and consideration at every stage of a transaction, precise implementation of the agreed plan, and comprehensive documentation of every stage of the transaction.
New Russian transfer pricing law
In July 2011 the Russian President formally signed Law 227-FZ, which substantially amends Russia's transfer pricing legislation, bringing it into line with the OECD Transfer Pricing Guidelines. The new law will enter into force on 1 January 2012. Taxpayers will be required to maintain specific transfer pricing documentation (and may be required to produce it to the tax authorities) showing:
- the structure and terms of the transaction, the parties involved and their roles:
- the pricing methodology, including a description of the transfer pricing method adopted, the reason for choosing it and the sources of information used;
- information on other factors that might affect the price (eg competition); and
- information on adjustments to the tax base.
These developments underline the importance of maintaining complete and accurate records in order to achieve tax relief for expenses. It should be borne in mind that, for their part, the Cyprus authorities are prepared to give advance rulings on the tax treatment of proposed transactions.
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