Уроки российской судебной практики судебных споров об уходе от налогов

Niels Roovers is currently enrolled in the LL.M. program in Dutch, European, and International Taxation at Leiden University in the Netherlands. The author would like to thank Roustam Vakhitov for useful comments and suggestions on earlier drafts of this article.


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During the past year the past year the Russian courts decided a few landmark cases in which the tax authorities successfully challenged aggressive tax planning solutions. This article comments on the Russneft , 1 Bashneft , 2 and MIAN3 cases, in all of which the courts decided in favor of the tax authorities.

The tax authorities managed to prove that tax planning arrangements and structures employed by the three companies resulted in an unjustified tax benefit4 and therefore should be disregarded for tax purposes.

The taxpayers appeared to implement straightforward and aggressive tax planning solutions, which were not regarded as unacceptable when they were implemented. Therefore, many existing tax planning solutions based on similar principles could be affected by the outcome of these cases.

The tax authorities continue to build up knowledge and skills to challenge tax planning arrangements. The purpose of this article is to analyze the court decisions with a focus on the successful reasoning of the tax authorities.


Russneft
 

The deductibility of expenses related to purchase of oil from related oil traders was denied for several years due to the lack of substance behind the traders' operations and the lack of business purpose behind the whole arrangement.

 

Facts of the Case

The oil company Russneft allocated profits from upstream oil production in several trading companies of the group. This was achieved by purchasing crude oil from production units at low prices and selling them to the top holding company for a much higher price. It is not clear whether the trading companies attempted to reduce the effective tax rate on their profits. Shares in one of these trading companies were sold to an offshore purchaser.

The taxpayer directly controlled financial and business activities of the subsidiaries through management agreements with the production units. The employees of the taxpayer were members of supervisory boards and management boards of these production units. Despite this, only 3 percent to 7 percent of the total purchases of crude oil were made directly from the production units.

The
rest of the oil was purchased from the traders at much higher prices. The traders did not have managerial or technical personnel enabling them to operate independently from the taxpayer. The crude oil that the traders purchased from the production units was normally immediately sold to the taxpayer. Subsequently, two of the three traders were liquidated and one sold with undistributed profits to a tax haven resident.

Another tax base erosion method was the interest payment on loans from related parties, which on several occasions appeared to be the same trading companies. In one case, the taxpayer purchased a claim from a related company for cash and immediately borrowed this cash from the related company.

It is not clear whether the taxable profits were reduced at the level of the trading companies, assuming they were Russian residents. The tax authorities challenged both methods.


Decision of the Court

    Excessive Expenses

The tax authorities successfully argued that the taxpayer's business model of purchasing crude

oil from production units through letterbox trading companies did not have any reasonable business purpose except to artificially shift profits to those trading companies.

The
only reason for such a business structure offered by the taxpayer was the practice

of obtaining guarantees from traders to facilitate bank loans. On this point,

the court agreed with the tax authorities that this was not a valid reason for selling and buying oil to and from the traders at significantly different prices.

Consequently, the court denied the deduction of expenses related to purchasing oil from the traders of approximately RUB 3 billion (US $125 million).


    Interest

The court concluded that the main purpose of these loans was to erode the tax base of

the taxpayer. Therefore, the interest deduction on the loans was denied.

To summarize, the court disregarded transactions with related controlled parties having no sound business purpose and those aimed exclusively or primarily at eroding the tax base.

 

Conclusions

The key elements contributing to the defeat of the taxpayer were:

  • full operational control over the activities of other parties involved in executing tax arrangements;
  • inability of the traders to operate on their own (lack of personnel and of capacities); and
  • lack of business purpose behind the arrangements.

 

Through the denial of deductions, the tax authorities, at taxpayer level, taxed the profits that the

tax authorities believed were artificially allocated to other taxpayers, presumably benefiting from

the low effective tax rate.

It is irrelevant whether the traders were Russian residents or not. This suggests that straightforward low substance trading company solutions might not stand before the same challenge by tax authorities.

The company appeared to employ the same tax planning methods as Yukos, where crude oil was sold to related low substance trading companies and later purchased from them at a much higher price. The taxpayer continued applying this tax planning method, which was found by the tax authorities and subsequently by the courts to be abusive and unacceptable as early as 2003.


Bashneft
 

On July 6, 2007, the Moscow Arbitration Court ordered the seizure of the assets obtained through a series of transactions aimed at tax avoidance. This penalty was envisaged by the Russian Civil Code for proceeds obtained in a transaction contrary to the basic principles of public order and morality.

 

Facts of the Case

Shares in several regional refineries were transferred by a holding company to a nonprofit foundation as a charity. The foundation did not realize any profits on contribution. The holding company was liquidated shortly after the transfer. The foundation then established a new holding company and contributed into its share capital the shares of the refineries.

Contribution into charter capital is not a taxable event for purposes of the corporate profits tax. The peculiar feature of this structure is the use of a charity as a top-holding company. Nevertheless, the arrangement was in full compliance with the letter of the law. The liquidated holding company did not pay tax on capital gains realized on the alienation of shares of refineries.

The tax authorities used this as the basis for challenging all the transactions. It maintained that all the transactions were aimed at tax avoidance at the level of the liquidated company and the purpose of the arrangements as a whole was tax evasion.

 

Decision of the Court

Because the tax authorities believed tax evasion is contrary to the basic principles of public order and morality, it claimed that the whole amount of transferred assets received under the arrangement should be confiscated. The court agreed with this reasoning and ordered the confiscation of shares of refineries.

 

Conclusions

The outcome of the case leads to several conclusions:

  • Straightforward nonpayment of tax by liquidating a company with tax debts may involve disastrous consequences, as with any other form of tax evasion.
  • The tax authorities may successfully apply the step transaction approach and analyze various transactions not on a stand-alone basis, but in the context of other transactions and arrangements. Therefore, the viability of the tax structure must be evaluated from the point of the overall effect and not only on a stand-alone basis. Further, one questionable transaction may invalidate a whole set of arrangements. In Bashneft, tax liabilities effectively followed the assets. The importance of due diligence regarding tax risks in mergers and acquisitions cannot be overestimated.
MIAN
 


The MIAN  case shows the tax authorities' increasing attention to the real estate sector.

 

Facts of the Case


The taxpayer is a real estate developer. To minimize its tax liabilities, it used the following solution.

While selling some apartments, MIAN did not receive cash from customers directly. Instead, it offered the customers the opportunity to enter into investment agreements and to pay with promissory notes of a related party. The related party received cash and invested in development projects, becoming the legal owner of the apartments.

The promissory notes were sold to individuals at par value, but accepted by the taxpayer with a significant discount. When apartments were ready for sale, investment agreements were terminated and individuals were granted a claim against the legal owners of the apartments, which were fully controlled subsidiaries.

This resulted in lower revenues at the taxpayer level. The difference between the market price of apartments and reduced revenues was allocated to companies issuing promissory notes. It is not clear whether any technique was used to reduce the effective tax burden at the level of the company issuing the promissory notes.

The tax authorities challenged this arrangement on the basis of several considerations.

First, the companies involved were clearly related. The promissory note companies were either established or managed by the director or a financial director of MIAN. Individuals buying the apartments testified that they were referred to the company selling promissory notes by MIAN. MIAN advertised apartments for sale on its Web site. Employees of MIAN negotiated contracts on behalf of related entities.

On at least one occasion MIAN provided its subsidiary a local currency loan bearing 0.1 percent interest, while the arm's-length interest rate was 15 percent.

There was no business purpose behind organizing such a complicated sales procedure except for artificially reallocating revenues between several companies.

Decision of the Court

The court regarded the entire nominal value of the accepted promissory notes as the taxpayer's income.

Effectively, this resulted in taxation of income of the group at the taxpayer level. The result is somewhat similar to the outcome in Russneft.

Conclusions

As in Russneft, the lack of substance and business purpose behind the establishment and operations of related entities led to reallocation of profits from these related entities to the top company of the group. It was irrelevant whether these related entities were Russian residents.

It is interesting to note that a loan with 0.1 percent annual interest rate was taken as a sign of an artificial arrangement.


Summary
 


The tax authorities are becoming more successful in challenging straightforward aggressive tax planning arrangements. The weak elements of all the arrangements analyzed above are the inadequate evaluation of risks of the structure and poor implementation of the arrangements.

Full operational control over the related parties, artificial arrangements, and obvious contradiction between legal form and actual substance of the arrangements were the major contributing elements to the defeat of the taxpayers.

The tax authorities did not challenge particular transactions, but rather reattributed profits for substantial time periods from one person to another. In effect, this appears to be quasi-CFC legislation emerging from case law. In some cases, as Bashneft demonstrates, the penalty may be as harsh as full confiscation of the assets involved in the tax planning.

Although the cases do not involve foreign affiliates yet, there is no reason to believe the outcome would be different should the affiliated entities be located in low-tax jurisdictions.

On December 14, 2007, at the annual conference of the Russian Chamber of Tax Consultants, Sergey Razgulin of the Ministry of Finance announced the Ministry's plans to introduce CFC legislation and the place of effective management test as tax residence criteria in 2008.

Considering this, more tax planning structures will become vulnerable to challenges from the tax authorities.

The major lesson is that what was regarded as legal for many years is becoming less safe. Ongoing audits of tax solutions, risk evaluation, and management are necessary for a successful operation in the current Russian tax environment.


FOOTNOTES
 


1 Ruling of the Federal Arbitration Court of Moscow Region of February 1, 2008, No. KA-A40/13549-07.

2 Decision of the Moscow Arbitration Court of July 6, 2007, No. A40-78279/06-62-220.

3 Ruling of the Moscow Arbitration Court of Appeal of October 19, 2007, No. 09AP-11923/07-AK.

4 The concept introduced by the ruling of the High Arbitration Court of October 12, 2006. For more details, see Richard Lewis, "Russia's Courts Focus on Tax Evasion, Not Politics," Tax Notes Int'l, Nov. 26, 2007, p. 843, Doc 2007-24098 [PDF], or 2007 WTD 231-6 2007 WTD 231-6: Viewpoint.

Статья написана - May 2, 2008

 

Читать статью в оригинале:    Lessons From Recent Russian Antiavoidance Cases

 


 

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