“Counter-reform” of the VAT Law: New draft law from the Russian Ministry of Finance

Pepeliaev Group advises that the Russian Ministry of Finance has published on its official website a draft law  proposing to introduce, fr om 2011, a series of amendments into the VAT calculation regime, concerning settlement differences, the recovery of tax when property is lost, discounting and other issues affecting the position of companies.

We draw your attention to the main provisions of the planned value added tax amendments and offer a preliminary evaluation of some of them by Pepeliaev Group’s experts.

Location where different types of services are rendered

It is proposed that the place where auditing services are performed will be defined as the place where the buyer of the services carries on its activity.

The rules are amended for determining the place of rendering services in cases where carriage is being performed or where air vessels, sea vessels and inland waterway vessels are put into temporary use. Internal transportation within Russia will be recognised as the provision of a service in Russia even if performed by foreign carriers.   Putting sea vessels into use to catch marine life or for conducting scientific research abroad will not be considered to be the provision of services in Russia.

It is clarified that work or services may be regarded as auxiliary in nature, if they are performed by the same person who performed the original works or services.

Supporting documents where a zero rate is applied

It is proposed to remove from the list of documents confirming that a zero rate may validly be applied a bank statement confirming receipt of proceeds from a buyer or customer together with supporting documents.

Pepeliaev Group commentary

The “tax incentives” of returning export currency proceeds to Russia are being abolished. In fact, the obligation to present such documents, as the Russian Constitutional Court clarified in its Resolution No. 20-P dated 23 December 2009, ensures compliance with the requirements to return foreign currency proceeds to Russia contained in article 19 of Federal Law No. 173-FZ “On foreign currency regulation and control” dated 10 December 2003. At the same time, these provisions contain their own penalty for breach (clause 4 of article 15.25 of the Russian Code of Administrative Offences), in connection with which similar provisions in tax law are not strictly necessary for the purposes of confirming operations liable to tax at a zero rate.

Taxation of discounts

A procedure is envisaged for the updating of the cost of deliveries in the event of a “downwards change to the price (tariff)”, i.e. a reduction of the price. This procedure envisages the buyer submitting an invoice for the reduction of the price to the seller (a supplier cannot himself submit a negative invoice). The reduction is reflected by the supplier in the period in which it receives the negative invoice (i.e. not in the delivery period and not even in the period during which the basis for reducing the price actually arises) and as a part of its tax deductions (the updating of the proceeds is not contemplated to avoid there being a negative quantity of proceeds when deliveries are stopped in the period of receipt of the negative invoice).  The buyer restores the corresponding part of the deduction.

Pepeliaev Group commentary

Such a procedure generally corresponds to the practice for resolving similar issues in the European Union , but it must be noted the reduction of the price in its business and legal nature is closer to the concept of proceeds than to deductions. In the European Union, the reduction of the price was related to deductions by liberally interpreting an EU Directive on the level of court practice, and therefore there is no barrier to providing in legislation specifically for proceeds to be reduced (even down to a negative amount, if there are no new deliveries in the current period).

At the same time, the draft law does not clarify the issue of whether the buyer and supplier may provide for incentives from buyer to seller that do not reduce the price of delivery or whether any incentives from buyers to sellers (apart from standard gifts) are in essence a reduction of the price (in the light of the uncertainty of a number of expressions in Resolution No. 11175/09 dated 22 December 2009 of the Presidium of the Russian Supreme Arbitration Court).

Settlement Difference

The draft law proposes explicitly excluding the updating of the cost of deliveries by the settlement difference when the tax base is calculated.

Pepeliaev Group commentary

In its Resolution No. 9181/08 dated 17 February 2009 the Presidium of the Russian Supreme Arbitration Court relied on clause 4 of article 166 of the Russian Tax Code and proceeded from the concept that VAT (from an economic point of view) accrues on the actual economic benefit received in cash form. The Presidium thus laid down the legal position that settlement differences correct the cost of deliveries in the period in which those settlement differences occur.  Such an approach ensures compliance with clause 3 of art. 3 of the Russian Tax Code, which provides that chargeable taxes cannot be arbitrary and must have an economic basis.

If the draft law is adopted, then taxation in accordance with agreements, in relation to which the payment obligation is expressed to be in roubles in an amount equivalent to a specified sum in foreign currency or in nominal monetary units, will not take account of changes in exchange rates between currencies. This breaches the very principle of tax having an economic basis (clause 3 of art. 3 of the Russian Tax Code) and the practical ability to pay tax (clause 1 of art. 3 of the Tax Code).

Recovery of tax when property is lost

Another instance of a highly contentious new proposal is the idea to allow reinstatement of lawfully deducted tax when “goods, including fixed assets, disappear as a consequence of depreciation and actual wear and tear; when stock taking shows that goods have been stolen or there is a shortage and also in other cases which do not constitute operations involving their sale with the exception of … natural disasters and emergency situations”.
It is also proposed to make the procedure for reinstatement of tax more precise in a case wh ere fixed assets are improved and the taxpayer begins to use them in a non-VATable activity (a detailed calculation of the reinstated tax is demonstrated).

Pepeliaev Group commentary

As a general rule, the basis for the reinstatement of tax is a change in the designation of the use of property, a material part of whose value is transferred over to a non-VATable activity. Therefore each of the instances contemplated by the draft law requires an independent basis.

When property becomes obsolete or suffers from wear and tear no transfer of this property can take place, whether to a non-VATable activity or otherwise.

Cases of theft, including that revealed in a stock take, cause loss to the taxpayer and therefore also does not indicate that property has been transferred to a non-VATable activity of the taxpayer. The need to pay VAT on stolen property does not correspond to the principles of the taxpayer’s ability to pay tax (clause 1 of art.3 of the Russian Tax Code) and of an economic basis for the payment of tax (clause 3 of art.3 of the Tax Code). From an economic point of view, there is no material difference between theft and the instances of “natural disasters and emergency situations” which do not entail reinstatement of tax. If a particular taxpayer covertly sells or consumes its property while pretending that it has been stolen, then such actions are a matter for the criminal law and should have no effect on the VAT calculation procedure.

Finally, “other instances which are not sales operations”, mentioned in the draft law, are not sufficiently defined, breaching the principle of certainty in tax legislation (clause 6 of art. 3 of the Russian Tax Code), in what appears to be an attempt to circumvent the court practice relating to the principle of an economic basis for tax.  Such court practice evaluated a whole range of operations, in particular the transfer of property into trust management or into a special partnership (see Resolutions No. 2196/10 and No. 2809/10 of the Presidium of the Russian Supreme Arbitration Court dated respectively 22 June 2010 and 15 July 2010) and classed them as dependent operations which could be aimed at accomplishing VATable operations, meaning that the taxpayer retains a right to a deduction.

Conclusions and recommendations

Several of the amendments the draft law proposes to chapter 21 of the Tax Code “Value added tax” are envisaged by the “Basic directions of tax policy for 2011 and the planning period 2012 and 2013” approved by the Russian Government. Others were produced by the financial agency reacting to precedent decisions of the arbitration courts and represent a way of serving fiscal interests by surmounting that court practice.
In breaching the principle of an economic basis for tax, the amendments concerning settlement differences and reinstatement of tax on the lost property result in an inadequate and excessive imposition of added value, worsening the economic situation of many companies.   If these amendments are adopted, then the possibility of numerous disputes going right up to the Russian Constitutional Court cannot be excluded.

Taking account of the above, we recommend that companies lobby their business associations and trade bodies to prepare and send a consolidated professional opinion to the Russian Ministry of Finance, the Russian Government and the State Duma.  This should give the business community’s views on the issues at hand and its suggestions for revisions to the draft law.

[1] http://www.minfin.ru/common/img/uploaded/library/2010/08/Zakonchistyyvosstanovlenie.doc

[2] Decision of the European Court of Justice in case no. C-317/94, Elida Gibbs, dated 24 October 1996: http://eur-lex.europa.eu/smartapi/cgi/sga_doc?smartapi!celexplus!prod!CELEXnumdoc&lg=en&numdoc=61994J0317

For further information, please contact:

in Moscow – Ivan Khamenushko, Senior Partner, at: (495) 967-0007 or by i.khamenushko@pgplaw.ru; Vladimir Boriskin, Lead Associate, at: (495) 967-0007 or by v.boriskin@pgplaw.ru; Peter Popov, Senior Associate, at: (495) 967-0007 or by e-mail

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