On 6 August 2020, the Russian Federal Tax Service published Letter No. SHU-4-13/12599@ "On certain issues regarding taxation of intra-group services" (the "Letter") addressed to local tax authorities. The Letter sets out key principles to guide tax audits of intercompany services acquired by Russian entities from foreign group companies:
Factual proof and non-duplication of intra-group services
The Letter recommends that local tax authorities conduct a comprehensive review of the documents provided by Russian taxpayers. The list of documents establishing factual proof of the services is not exhaustive. Taxpayers are permitted to provide documents drawn up in accordance with Russian law or according to customary business practices in a foreign jurisdiction if the services have been provided by a foreign entity.
Before reaching a conclusion regarding possible duplication of services, the tax authorities are to review whether or not services may be differentiated in terms of value added or other factors. A mere similarity in the way services are described is not proof of duplication. The Federal Tax Service also instructs tax authorities not to use a formalistic approach when requesting and analyzing documents related to intra-group services. Instead, they are to act reasonably and refrain from requesting documents that are not related to the intra-group services under review.
Economic and commercial value of intra-group services for the subsidiary's business
The Federal Tax Service recommends the principles set out in BEPS Actions 8-10 "Aligning Transfer Pricing Outcomes with Value Creation", i.e. whether or not the Russian subsidiary could have used identical or similar services of an unrelated party in the normal course of events. At the same time, the tax authorities are not to prohibit deducting expenses related to intragroup services if the taxpayer intended to use these services for commercially gainful activities, but for objective reasons failed to do so.
"Shareholder activity" not tax deductible
According to the Letter, "shareholder activity" is not seen as a service benefiting a Russian subsidiary. Therefore, the cost of these services may not be tax deductible in Russia.
"Shareholder activity" means activities related to corporate governance, particularly providing information on a shareholder's activities, activities related to participation in profit distribution, participation in the shareholders' general meeting, etc. Shareholder activity is performed solely due to membership in a multinational group; a Russian subsidiary would not have to pay an unrelated party for similar activities. At the same time, the fact that a shareholder provides services is not in itself sufficient evidence to conclude that these services constitute shareholder activity.
Cost of services
The Letter states that the price formation mechanism and/or principles may be different for intra-group services in comparison with third-party services. Therefore, when analyzing intragroup services, tax authorities are instructed to review whether the pricing methodology is transparent and uniformly applied across the entire group. The Federal Tax Service also notes that a "cost plus" method is consistent with common business practices and, in and of itself, is not indicative of an unjustified tax practice aimed at shifting profits. Further, taxpayers may use transfer pricing documentation or its sections, besides providing an explanation of pricing mechanism, to clarify the price formation.
The Letter seems to encourage tax inspectors to review the pricing mechanism in intra-group transactions. On the other hand, if services are priced on a cost-plus basis, the tax-payer is not required to support the cost deduction by giving the tax authority an account of the service provider's costs.
Regrettably, certain key issues are not addressed in the Letter, particularly how shared services may be priced if several subsidiaries benefit from these services, and what allocation keys could be acceptable. Nevertheless, we believe that the Letter is a sign that the Russian tax administration is shifting towards the OECD approach to taxation of inter-company services and abandoning its traditional formalistic approach to tax control.
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