A case on the application of the 32% rate and profit tax legislation of 1994 by contractors under the Sakhalin-II PSA

Pepeliaev Group advises that on 21 June 2010 a panel of judges of the RF Supreme Arbitration Court issued Ruling No. VAS-1674/10 stating that the case should be referred to the Presidium, and specified that the contractors of Sakhalin Energy Investment Company Ltd. working under a production sharing agreement for the development of the Piltun-Astokhskoye and the Lunskoye oil and gas fields (hereinafter – the “Sakhalin II PSA”), dated 22 June 1994, are not obliged to apply the 32% rate and legislation effective on 1 January 1994 (as stipulated in the PSA) when calculating their profit.

The subject matter of the dispute was the assessment of profit tax by a contractor of Sakhalin Energy Investment Ltd. within the scope of the Sakhalin-II PSA. The contractor calculated profit tax according to chapter 25 of the Russian Tax Code at the rate of 24%. The profit generated within the scope of the PSA was not separated by the contractor for profit tax purposes. The tax inspectorate pointed out that under the Sakhalin-II PSA the contractor was to calculate the tax at the rate of 32% envisaged by the Law on Profit Tax (as per 1 January 1994) and levied additional tax after calculating the profit. The courts upheld the tax inspectorate’s position that the tax should be calculated at the rate of 32%.

When referring the case to the Presidium of the RF Supreme Arbitration Court, the panel of judges presented arguments in favour of both the old and effective profit tax legislation. They suggested, in fact, that the Presidium define the judicial practice on this issue. Previously, the Supreme Arbitration Court judges saw no grounds for referring similar cases to the Presidium. They used to uphold the tax inspectorate and ruled to apply the 32% tax rate under the old legislation.

The arguments presented in the aforementioned Ruling of the Supreme Arbitration Court in favour of the 24% rate (i.e., the effective legislation) require a thorough analysis, since they may affect the profit tax and transport tax incentives as well as other benefits which are currently enjoyed by contractors and subcontractors of the Sakhalin-II PSA, meaning that the lawfulness of these incentives might be reconsidered. Moreover, a number of contractors and subcontractors under the Sakhalin-II PSA have already recalculated their profit tax obligations in accordance with the 1994 legislation: some of them paid additional tax voluntarily, the others applied for recovery of overpaid tax, e.g., on grounds of capital investment benefits (sub-clause a, clause 1, article 7 of the Law).
At this time the established court practice confirms the right of contractors and subcontractors to apply the aforementioned benefits. At the same time, the rationale (legal position) presented in the Ruling is based on the fact that the PSA provisions may solely be applied with regard to investors.

On the one hand, this will boost the tax risks relating to the application by contractors and subcontractors of the above incentives and other benefits envisaged by the Sakhalin-II PSA and the 1994 legislation. On the other hand, this may allow companies that have already paid profit tax to file for a recovery or offset of this tax by presenting adjusted tax returns.

in Moscow – Andrey Nikonov, Senior Partner, at: (495) 967-0007 or by a.nikonov@pgplaw.ru; Rustem Akhmetshin, Senior Partner, at: (495) 967-0007 or by r.ahmetshin@pgplaw.ru; Pavel Kondukov, Leadig associate, at: (495) 967-0007 or by p.kondukov@pgplaw.ru

in St Petersburg - Sergey Sosnovsky, Head of Tax Practice (St. Petersburg), at (812) 333-07-17 or by s.sosnovsky@pgplaw.ru