Changes in tax control of transfer pricing

On 8 July 2011 the Russian State Duma adopted in the third reading the law On amending certain legislative items of the Russian Federation in connection with improving the pricing rules for tax purposes.

The following amendments have been made to tax law concerning transfer pricing with regard to transactions between related parties:

1. The list of grounds for treating the parties as related has been considerably extended. The courts will still be able to treat the companies as related based on grounds not envisaged in the law. At the same time, the threshold participation interest in another company which triggers companies being treated as related has been increased to the amount of a blocking stake (more than 25%).

2. The list of controlled transactions has been amended. The following transactions will be controlled:

• transactions between related parties
• foreign trade transactions with goods traded on international stock exchanges
• transactions where the status of a party to the transaction or the subject of the transaction allows for tax optimisation.

Domestic transactions between related parties will be controlled if income fr om such transactions exceeds RUB 1 billion. During the transition period, domestic transactions will be controlled if proceeds fr om these transactions exceed RUB 3 billion (in 2012) and RUB 2 billion (in 2013).

3. The amended law sets out the principles for the controlling authority to use the sources of information required to monitor that transaction prices are in line with market prices. The amended law also provides a list of sources of information on transactions.

The law forbids the use of information that constitutes tax secret or the access to which is lim ited by law. Information sources must be public.

4. The amended law extends the list of methods for determining for tax purposes whether income from controlled transactions is in line with the market level. The methods of comparable profitability and distribution of profit have been added.

5. The amended law introduces a procedure for the taxpayer to draft and submit documents confirming that prices applied in the controlled transaction are in line with the market level. These documents should be submitted at the request of the tax authority not earlier that 1 July of the year following the year when the controlled transaction took place. According to the amended law, taxpayers will have to report controlled transactions to the tax authority.

6. The federal tax authority will perform a tax audit of controlled transactions. The audit will be performed in the office of the controlling authority within 6 months.

7. The amended law allows the tax return of the other party to the controlled transaction to be adjusted to mirror the first party’s return. Such adjustment is only possible if the tax authority issues a decision to assess additional taxes to its counterparty. Then the other party will need to adjust its tax return based on request from the tax authority, without amending its tax registers or source documents.

8. Major taxpayers will be allowed to conclude fixed-term pricing agreements wh ere they will set out the procedure for calculating prices and applying pricing methods. A groundless refusal of the tax authority to conclude such an agreement may be challenged in court.

The law enters into effect on 1 January 2012.

Please also be advised that the Federal Tax Service has established the Transfer Pricing and International Cooperation Department headed by Dmitry Volvach (former head of the Pskov Region Administration of the Federal Tax Service). The Department will, among other things, analyse international experience of tax administration and share its own experience with foreign colleagues.

Once in force, the new procedure for controlling transfer pricing will significantly affect relations between taxpayers and tax authorities with regard to taxation of controlled transactions. The new law is a very complicated and self-contradictory legal document. Hence, taxpayers and legal advisors have a lot of questions on how it should be applied.

For further information, please contact:

in Moscow – Rustem Ahmetshin, Senior Partner, at: (495) 967-0007 or by r.ahmetshin@pgplaw.ru; Valentina Akimova, Partner, at: +7 (495) 967-0007 or by v.akimova@pgplaw.ru

in St Petersburg - Sergey Sosnovsky, Head of Tax Practice (St. Petersburg), at (812) 640-60-10 or by s.sosnovsky@pgplaw.ru