Letter of the federal tax service on how article 54.1 of the Russian Tax Code should be applied
The Federal Tax Service (the “FTS”) has sent to the tax authorities a letter with detailed recommendations on how article 54.1 of the Russian Tax Code (the “Tax Code”) should be applied[1]. The clarifications of the FTS significantly mitigate administrative and judicial practice by pointing out that the tax authorities should identify the actual amounts of tax liabilities.
It points out that article 54.1 of the Tax Code applies when taxpayers distort information about facts of business operations for the purpose of circumventing the conditions for the application of regulations which determine the rules of taxation and of formally complying with the requirements established by them.
This clarification is also important because tax inspectorates often choose not to apply special regulations against tax evasion and apply the general rule, which is more ambiguous.
They also provide a distinction between situations when the taxpayer (1) acted intentionally (was directly involved in the tax scheme (specific intent) or knew about the supplier's faults (implied intent)) and (2) has not exercised due care (they now use the term “the standard of circumspect behaviour”).
In the first case (if there was intent), the taxpayer may count on a reconstruction of tax consequences (expenses and deductions being booked on the basis of the documents of the actual supplier/service provider) only if the taxpayer itself discloses information about such actual supplier at the stage of the audit (or when objections to the audit report are submitted). The fine for such a violation will be 40%.
In the second case (if the taxpayer has not exercised due care), the taxpayer will receive a right to book the expenses if it proves that they match the market value. VAT may be deducted based on the information about the actual supplier both available to the tax authorities and received with the taxpayer’s help. The fine for such behaviour will be 20% (with a right to appeal to measures that reduce the amount of the liability).
If the actual supplier is unknown, the taxpayer will in any case be refused VAT deductions. However, it will have a right to prove that the amount of costs it has actually incurred matches the market level.
Finally, clause 20 of the Letter contains a provision that if the taxpayer has exercised due commercial care and it did not know and should not have known that the supplier is a “technical” company, then there is no offence and the profit tax and VAT should not be reassessed upwards.
It underscores the need to establish the taxpayer's actual tax liabilities based on the facts to be identified by the tax authority taking into consideration the information and documents available to it and those obtained with the taxpayer’s cooperation, taking account of the imputed income, VAT deductions and taxes paid under special tax regimes.
If a split-up of a business is identified, VAT should be reassessed upwards within the limits of the amounts received from the buyer.
Please note that the Letter is published on the with an option to notify the FTS if the tax authority does not comply with this recommendation.
1 The continuity of legal positions when article 54.1 of the Tax Code is applied
Until now, it has been disputed whether the provisions of article 54.1 of the Tax Code are a “new milestone” in tax and legal relationships or whether it is a regulatory entrenchment of approaches previously developed in practice. Previously, the Russian Ministry of Finance has sent several letters with clarifications that once article 54.1 of the Tax Code is adopted, the previous positions of the Russian Supreme Commercial Court and the Russian Supreme Court (particularly, on the reconstruction of tax consequences) will no longer be applicable. The Letter of the FTS does not uphold this approach. The Letter contains multiple references to legal positions of the Russian Constitutional Court, the Russian Supreme Commercial Court and the Russian Supreme Court. Much of the wording of the Letter of the FTS including the concept of an unjustified tax benefit matches the text of Resolution No. 53 of the Plenum of the Russian Supreme Commercial Court dated 12 October 2006.2 Article 54.1. of the Tax Code applies only when loss is caused to budgets of public bodies as a consequence of taxes not being received
This is a very important clarification which is often overlooked. For example, tax authorities refuse to deduct expenses on intra-group services despite the fact that both companies are good-faith taxpayers (one books the income and the other one books the expenses; therefore the budget suffers no loss). The absence of loss should be identified based on the tax consequences that should arise if there are no abuses and not based on any amounts which could be additionally assessed to the maximum extent possible.3 Correlation between the general and special regulations against tax evasion
Clause 3 of the Letter underscores that in addition to general regulations on combating tax abuses (article 54.1 of the Tax Code), the Tax Code contains special regulations against tax avoidance (rules concerning the actual recipient of income, transfer pricing rules, thin capitalisation rules and so on).It points out that article 54.1 of the Tax Code applies when taxpayers distort information about facts of business operations for the purpose of circumventing the conditions for the application of regulations which determine the rules of taxation and of formally complying with the requirements established by them.
This clarification is also important because tax inspectorates often choose not to apply special regulations against tax evasion and apply the general rule, which is more ambiguous.
4 The reconstruction of tax consequences when information is distorted about facts of business operations
With respect to prohibiting distortions of information concerning facts of business operations (or any combination of such facts) and concerning taxable items (article 54.1(1) of the Tax Code), the FTS states in section VI of the Letter that “the proper legal classification of operations should be established based on their genuine economic content”. This is an important clarification of article 54.1(1) of the Tax Code, the text of which does not contain a provision to this effect.5 Tax consequences in the case of a “technical” supplier (article 54.1(2)(2) of the Tax Code)
A significant part of the Letter of the FTS is devoted to clarifying the procedure for the application of article 54.1(2)(2) of the Tax Code (sections II-IV of the Letter). They explain that this clause of the Code applies to situations when a “technical” company that is unable to perform its civil law obligations is deliberately included in the chain of suppliers.They also provide a distinction between situations when the taxpayer (1) acted intentionally (was directly involved in the tax scheme (specific intent) or knew about the supplier's faults (implied intent)) and (2) has not exercised due care (they now use the term “the standard of circumspect behaviour”).
In the first case (if there was intent), the taxpayer may count on a reconstruction of tax consequences (expenses and deductions being booked on the basis of the documents of the actual supplier/service provider) only if the taxpayer itself discloses information about such actual supplier at the stage of the audit (or when objections to the audit report are submitted). The fine for such a violation will be 40%.
In the second case (if the taxpayer has not exercised due care), the taxpayer will receive a right to book the expenses if it proves that they match the market value. VAT may be deducted based on the information about the actual supplier both available to the tax authorities and received with the taxpayer’s help. The fine for such behaviour will be 20% (with a right to appeal to measures that reduce the amount of the liability).
If the actual supplier is unknown, the taxpayer will in any case be refused VAT deductions. However, it will have a right to prove that the amount of costs it has actually incurred matches the market level.
Finally, clause 20 of the Letter contains a provision that if the taxpayer has exercised due commercial care and it did not know and should not have known that the supplier is a “technical” company, then there is no offence and the profit tax and VAT should not be reassessed upwards.
6 Tax reconstruction when a split-up of a business is identified
Section VIII of the Letter points out that a reconstruction of tax obligations is necessary when a “split-up of a business” scheme is identified.
It underscores the need to establish the taxpayer's actual tax liabilities based on the facts to be identified by the tax authority taking into consideration the information and documents available to it and those obtained with the taxpayer’s cooperation, taking account of the imputed income, VAT deductions and taxes paid under special tax regimes.
If a split-up of a business is identified, VAT should be reassessed upwards within the limits of the amounts received from the buyer.
What to think about and what to do
If you are in a dispute with the tax inspectorate where article 54.1 of the Tax Code is applied, now is the perfect time to refer to the new Letter of the FTS to avoid an additional tax assessment or to reduce the additional taxes significantly.Please note that the Letter is published on the with an option to notify the FTS if the tax authority does not comply with this recommendation.
Help from your adviser
Pepeliaev Group's lawyers can help you develop a legal position to protect your company's interests in a tax dispute and to reassess tax risks of different business operations taking into account the provisions of the new Letter of the FTS.[1] Letter No. BV-4-7/3060@ @ of the Russian Federal Tax Service dated 10 March 2021 “On the practice of the application of article 54.1 of the Russian Tax Code”.