The Federal Tax Service has published clarifications on the taxation of intra-group services
FAO owners, directors, accountants and tax managers of companies making part of a group
Pepeliaev Group advises that on 6 August 2020 the Russian Federal Tax Service published on its official website the clarifications of individual issues relating to the taxation of intra-group services.
The Letter has been prepared to develop unified approaches to forming the evidentiary base within tax control activities regarding the taxation of expenses on services supplied to Russian companies by related foreign entities. Moreover, taxpayers may report a breach of these Federal Tax Service’s clarifications by tax authorities using the service www.nalog.ru available on the website.
(2) whether there is a duplication of expenses on acquiring identical goods;
(3) what is the economic/commercial value of the services (to be checked by assessing whether independent persons would be ready to acquire such services or perform the relevant work using own resources). It is also checked during an audit for whose benefit the service is provided: whether it is in the interests of the subsidiary (client) or in the interests of shareholders.
2) the volume of the requested documents is required to be commensurate to the volume of services provided according to the principles of expedience, rationality and validity, which stem from the purposes and objectives of the tax control. Such an approach is in line with international standards: the administration of transactions must not be onerous to the extent that it would impede the performance of transactions. Now it is allowed to leave an aspect which is significant for tax purposes unsupported if, for instance, the efforts (costs) required to collect the relevant proof are incompatible with the volume of the services provided;
3) it is necessary to request from the taxpayer and take account of the taxpayer’s clarifications on the aspects that raise questions of the tax authority. If the information missing from the taxpayer’s documents is compensated by clarifications, it is not allowed to refuse the deduction of expenses;
4) it is expressly indicated that the provision of services may include actions and forms of their performance that are not customary for the tax authority:
a) it is allowed to provide day-to-day support on administrative issues and provide services relating to internal control. These facts, therefore, cannot imply that a service has been imposed in the shareholder’s interests;
b) it is also allowed to provide services in the form of an access to such services for a pre-approved fee. The taxpayer may provide documents confirming that a service was expected to be received;
c) it is also possible to supply services that essentially consist of providing a taxpayer with resources that the latter does not possess. With respect to such services no formalised requests are needed for a specific service to be supplied;
5) it is prohibited to draw conclusions that expenses are duplicated based merely on the formal comparison of the names of departments/positions of the taxpayer’s employees without performing a detailed analysis of the functionality, experience and competences of the corresponding departments and employees. At the same time, the functional analysis performed by the taxpayer (comparison of the functions ‘covered’ by an intra-group provider with the functions of an internal department or a specialist in the relevant area of business, etc.) has evidentiary significance;
6) it is required to assess the economic significance of the expenses on purchasing intra-group services proceeding from the intention to gain a positive economic effect from such an acquisition, even if in fact a negative financial result was obtained or the result of the services received was not used in view of objective circumstances of the taxpayer’s activity;
7) it is prohibited to check prices used in controlled transactions involving the supply of intra-group services for conformity with market prices within the scope of field and desk tax audits;
8) it is not allowed to refuse a deduction of expenses only in connection with the price of services being established based on the service provider’s expenses and the standard mark-up used in the particular area. Moreover, the Federal Tax Service directly points out that this pricing mechanism is the usual business practice and the fact of such a pricing model being applied must not be regarded as a redistribution of income and losses between companies of an international group. This reduces to a significant degree the risk of claims being raised on the ground that such a pricing covered an agreement on the distribution of expenses;
9) it is expressly indicated that if services are provided by a shareholder (member) of the taxpayer this cannot automatically indicate that they serve the interests of the shareholder rather than the subsidiary (client).
Even those issues that taxpayers find the most difficult were left without mentioning, including the use of allocation keys when determining the amount of the provider’s expenses relating to the supply of services to a Russian taxpayer. No direct clarifications have been provided to this effect. However, it inspires optimism that the Letter does not contain a prohibition for applying them and refers to the cost-plus pricing method by way of an example.
Upon the whole, the clarifications of the Federal Tax Service may be characterised as favourable for taxpayers, as they take account of the actual practice of the supply of intra-group services within international groups of companies and allow dismissing a number of most frequent claims that local tax authorities raise with respect to this category of expenses when they conduct field tax audits.
What used to be a means of mitigating risks may now enhance them. The evidentiary base that used to be ‘tailored’ to fit the format conventional for the tax authority was often at variance with the actual procedure of the supply of services, because the ‘conventional’ format did not take account of the specifics of relationships between parties to transactions. By permitting the options that used to be risky the Letter allows documenting the actual events and purposes behind them. The measures that have been taken earlier to ‘camouflage’ these events and purposes may only do harm now.
On the other hand, the defence files may be completed with additional proof executed in permitted formats (clarifications, memos, reports etc.) for protecting the most vulnerable aspects.
The clarifications sent to the tax authority pertaining to control procedures in progress, the objections filed and complaints escalated to a higher-level tax authority may be supported by additional documents based on the new clarifications of the Federal Tax Service.
Pepeliaev Group advises that on 6 August 2020 the Russian Federal Tax Service published on its official website the clarifications of individual issues relating to the taxation of intra-group services.
The Letter has been prepared to develop unified approaches to forming the evidentiary base within tax control activities regarding the taxation of expenses on services supplied to Russian companies by related foreign entities. Moreover, taxpayers may report a breach of these Federal Tax Service’s clarifications by tax authorities using the service www.nalog.ru available on the website.
The purpose of the Letter is to develop uniform approaches to expenses on the services provided by related foreign companies. Yet, the same approaches are still applicable to similar transactions involving the supply of services within Russian holding companies and the services that Russian taxpayers supply to foreign companies of the same group.
The Federal Tax Service confirmed the current algorithm of an audit suggesting that it must be consistently checked:
(1) whether the services are real, in other words, whether the services existed and were provided;(2) whether there is a duplication of expenses on acquiring identical goods;
(3) what is the economic/commercial value of the services (to be checked by assessing whether independent persons would be ready to acquire such services or perform the relevant work using own resources). It is also checked during an audit for whose benefit the service is provided: whether it is in the interests of the subsidiary (client) or in the interests of shareholders.
The following provisions may turn out to be useful for the taxpayer:
1) it is prohibited to apply a formal approach to assess documents supporting the supply of services and their feasibility, and there are no restrictions with respect to the list of such documents. The list is an open one and it is not limited by the examples set by the Federal Tax Service. The examples themselves include e-mail correspondence, telephone call details, minutes of meetings, internal memos and reports, printouts from the taxpayer’s electronic systems, printouts of the electronic calendar, screen shots;2) the volume of the requested documents is required to be commensurate to the volume of services provided according to the principles of expedience, rationality and validity, which stem from the purposes and objectives of the tax control. Such an approach is in line with international standards: the administration of transactions must not be onerous to the extent that it would impede the performance of transactions. Now it is allowed to leave an aspect which is significant for tax purposes unsupported if, for instance, the efforts (costs) required to collect the relevant proof are incompatible with the volume of the services provided;
3) it is necessary to request from the taxpayer and take account of the taxpayer’s clarifications on the aspects that raise questions of the tax authority. If the information missing from the taxpayer’s documents is compensated by clarifications, it is not allowed to refuse the deduction of expenses;
4) it is expressly indicated that the provision of services may include actions and forms of their performance that are not customary for the tax authority:
a) it is allowed to provide day-to-day support on administrative issues and provide services relating to internal control. These facts, therefore, cannot imply that a service has been imposed in the shareholder’s interests;
b) it is also allowed to provide services in the form of an access to such services for a pre-approved fee. The taxpayer may provide documents confirming that a service was expected to be received;
c) it is also possible to supply services that essentially consist of providing a taxpayer with resources that the latter does not possess. With respect to such services no formalised requests are needed for a specific service to be supplied;
5) it is prohibited to draw conclusions that expenses are duplicated based merely on the formal comparison of the names of departments/positions of the taxpayer’s employees without performing a detailed analysis of the functionality, experience and competences of the corresponding departments and employees. At the same time, the functional analysis performed by the taxpayer (comparison of the functions ‘covered’ by an intra-group provider with the functions of an internal department or a specialist in the relevant area of business, etc.) has evidentiary significance;
6) it is required to assess the economic significance of the expenses on purchasing intra-group services proceeding from the intention to gain a positive economic effect from such an acquisition, even if in fact a negative financial result was obtained or the result of the services received was not used in view of objective circumstances of the taxpayer’s activity;
7) it is prohibited to check prices used in controlled transactions involving the supply of intra-group services for conformity with market prices within the scope of field and desk tax audits;
8) it is not allowed to refuse a deduction of expenses only in connection with the price of services being established based on the service provider’s expenses and the standard mark-up used in the particular area. Moreover, the Federal Tax Service directly points out that this pricing mechanism is the usual business practice and the fact of such a pricing model being applied must not be regarded as a redistribution of income and losses between companies of an international group. This reduces to a significant degree the risk of claims being raised on the ground that such a pricing covered an agreement on the distribution of expenses;
9) it is expressly indicated that if services are provided by a shareholder (member) of the taxpayer this cannot automatically indicate that they serve the interests of the shareholder rather than the subsidiary (client).
We believe that the following provisions are ambiguous and may be interpreted differently by local tax authorities:
- it is mentioned that a taxpayer is allowed to justify the need to perform transactions (operations) in a form of its choice and the need to involve foreign companies of the international group in processes and transactions (operations). Unfortunately, in practice the rights granted to taxpayers often end up becoming their obligations;
- the Letter specifies that it is required to ensure conformity of the submitted source documents with the accounting standards of the relevant state and the absence of contradictions to the general principles of issuing source documents applied under any accounting standards;
- it is left for local tax authorities to decide how to assess the mechanism and principle of forming the price, and the availability of a transparent methodology of the pricing of services “for the purposes of determining whether a service has been supplied”. The inspectorate is allowed to use transfer pricing documentation for raising claims and the taxpayer is allowed to use the same for contesting the claims.
Even those issues that taxpayers find the most difficult were left without mentioning, including the use of allocation keys when determining the amount of the provider’s expenses relating to the supply of services to a Russian taxpayer. No direct clarifications have been provided to this effect. However, it inspires optimism that the Letter does not contain a prohibition for applying them and refers to the cost-plus pricing method by way of an example.
Upon the whole, the clarifications of the Federal Tax Service may be characterised as favourable for taxpayers, as they take account of the actual practice of the supply of intra-group services within international groups of companies and allow dismissing a number of most frequent claims that local tax authorities raise with respect to this category of expenses when they conduct field tax audits.
What to think about and what to do
The Letter requires a revision of contracts, source documents and saved operating documents (deliverables, etc.) that are collected in defence files. These sets of documents used to be adjusted with regard to favourable and unfavourable precedents, experience of past audits and audits of other taxpayers. Yet, the provisions of the Letter extend beyond this toolkit.What used to be a means of mitigating risks may now enhance them. The evidentiary base that used to be ‘tailored’ to fit the format conventional for the tax authority was often at variance with the actual procedure of the supply of services, because the ‘conventional’ format did not take account of the specifics of relationships between parties to transactions. By permitting the options that used to be risky the Letter allows documenting the actual events and purposes behind them. The measures that have been taken earlier to ‘camouflage’ these events and purposes may only do harm now.
On the other hand, the defence files may be completed with additional proof executed in permitted formats (clarifications, memos, reports etc.) for protecting the most vulnerable aspects.
The clarifications sent to the tax authority pertaining to control procedures in progress, the objections filed and complaints escalated to a higher-level tax authority may be supported by additional documents based on the new clarifications of the Federal Tax Service.
Help from your adviser
Pepeliaev Group's team has a vast experience in supporting pre-audit activities and tax audits during which the inspectorates check whether the deduction of expenses on purchasing intra-group services was justified. We will be happy to assist you with:
- revising the prepared defence files in terms of their conformity with the new instructions of the Federal Tax Service and assisting with adjustments to these files;
- preparing a set of documents to support the supply of intra-group services taking account of the new requirements;
- preparing additions to previously filed objections, statements, complaints, lawsuits or clarifications bearing in mind the requirements of the Letter we comment on;
- identifying intra-group benefits received from other companies of the group that are not supported by documents, assessing the relevant risks and assisting with elaborating a way to mitigate or eliminate them;
- providing support in negotiations with the head office and advising on how to choose the benefits (services) on which the expenses may be deducted in Russia at an acceptable level of risk, and on how to choose the form of their supply, confirmation and pricing;
- assisting with the choice of a model of actual intra-group relationships and transactions that allows simultaneously preventing a refusal of the deduction of expenses abroad on account of the link with operations in Russia and a refusal of the deduction of expenses in Russia due to the absence of such link or for other reasons;
- adjusting the transfer pricing documents to ensure compliance with the requirements of this Letter;
- mitigating the risk of administrative and criminal liability for foreign currency offences stemming from the refusal of the deduction of expenses on intra-group services, as well as adjusting the measures previously taken to mitigate such risks, taking account of the requirements set out in the Letter.