POSITIVE CHANGES IN COURT PRACTICE ON TAX DISPUTES

Pepeliaev Group advises that the legal position formulated by the Russian Supreme Arbitration Court when issuing Resolution No. 15574/09 dated 9 March 2010 may improve the situation of taxpayers in respect of the practice of interpreting and applying legislation on expenses arising in relations with suppliers that submitted invalid documents.

The Presidium of the Russian Supreme Arbitration Court (the Court) posted on its official website Resolution No. 15574/09 of the Presidium of the Russian Supreme Arbitration Court dated 9 March 2010 on the case of OAO Leasing Company of Small Business on deducting expenses in relations with a supplier that provided invalid documents. The Court ruled in favour of the taxpayer on this case.

Facts of the case and the Court’s conclusions

In this case, the tax authority and subsequently the courts of three instances stated that a contract under which the taxpayer purchased property could not have been concluded and performed by the supplier, as the supplier no longer existed as a legal entity on the date indicated in the contract as its conclusion date. Consequently, the taxpayer submitted invalid documents received fr om the supplier to substantiate the deductible expenses decreasing its taxable profit and unlawfully deducted the relevant expenses.

Although the courts found no facts that attested to the buyer’s negligence, they held that this fact had no legal significance for the recognition of expenses and calculation of taxes, but could be relevant for the collection of a fine (the fine was cut approximately 10 times during the court proceedings).

The Presidium of the Court concluded that the tax office had failed to refute the body of indirect evidence that attested to business transactions performed by the taxpayer for a consideration (in this case including evidence of the resale of purchased property). The tax office failed to prove that said transactions had not actually been performed. Consequently, the conclusion that there was no supporting documentation to confirm that the contested expenses had been incurred under the transaction with a certain entity does not lead to the unconditional refusal to allow the deduction of such expenses for profit tax purposes.

The conclusion on the unlawful deduction of expenses incurred under actual business transactions runs counter to articles 41 and 247 of the Russian Tax Code defining an item subject to profit tax as income reduced by the expenses incurred (as an economic benefit) and sub-clause 7, clause 1, article 31 of the Tax Code stipulating that if accounting is kept in violation of the established procedure, which makes it impossible to assess taxes, the tax authorities may assess the taxes using the imputed method.

Indeed, the invalidity of the documents received from the supplier may be interpreted as grounds for the tax authority to apply indirect sources of information, including, in particular, evidence of purchased property, its payment by the taxpayer and resale to a third party.

On the other hand, the tax authority may disallow the deduction of expenses if the buyer knew or should have known, based on the terms and circumstances of the conclusion or performance of the contract, about the unreliability of the submitted documents or about the supplier’s default on its tax obligations, which, by virtue of the legal position specified in clause 10 of Resolution No. 53 of the Plenum of the Russian Supreme Arbitration Court dated 12 October 2006, could constitute grounds for disallowing the deduction of incurred expenses for tax purposes as a type of tax benefit.

The tax authority, however, did not submit relevant evidence in the case concerned, wh ereas the taxpayer, on the contrary, explained the circumstances of the conclusion and performance of the transaction, including the grounds for choosing the suppler (the supplier of the taxpayer, which is a leasing company, was selected by the leaseholder). In this case, the taxpayer took data from the Unified State Register of Legal Entities, which did not contain any information about the termination of the supplier’s activity.

The Presidium of the Court, taking into account the fact that the courts found no negligence on behalf of the taxpayer, invalidated the decision of the tax authority in a respective part, without referring the case for a new hearing.

Commentary

The Resolution concerned does not contain a reference to the mandatory nature of this legal position for similar cases. Yet, it is highly likely that this legal position will be applied by courts in future and may change practice, which is predominantly negative for taxpayers at present, especially after Resolution No. 9299/08 on the case of OOO Kestroy-1 dated 11 November 2009 and Resolution No. 7588/08 on the case of entrepreneur A.A. Yakubovsky dated 18 November 2008 adopted by the Presidium of the Court. No precedent clause in the Resolution under consideration means that similar cases may not be reviewed on the basis of newly discovered circumstances, with due account of Resolution No. 1-P of the Russian Constitutional Court dated 21 January 2010.

In our opinion, the reference to the Unified State Register of Legal Entities mentioned in the Resolution concerned should be interpreted as necessary only within the scope of a specific case (purchase of a leasing item, with due account of the volume of business carried out by the leasing company), rather than in all other cases.

Similarly, it is not necessary to substantiate the choice of supplier in all cases. For example, such substantiation is generally not attributable to the circumstances of a purchase if the purchase was made for business purposes, but pursuant to a procedure identical to purchases in the retail or public services sector.

In our opinion, the question as to the actions that should be taken in each separate case within the scope of due care should be resolved in accordance with standard business practice and the circumstances of the business of a specific entity and be stipulated in internal standards.

It should be noted here that based on a literal interpretation of the Resolution, negligence in respect of flaws in documents constitutes independent grounds for the tax authority to disallow the deductibility of expenses, even if it has not been established that the tax obligation in the supply chain had not been fulfilled. At the same time, however, there are grounds for treating such circumstances in their integrity: negligence in respect of flaws in documents leads to a decision to disallow the deductibility of expenses as long as it is connected with the non-fulfillment of tax obligations in the supply chain.

Anticipated consequences and further actions

We will monitor further development of court practice on the recognition of expenses and deductions for tax purposes in respect of relations with suppliers that submitted invalid documents. For example, the legal positions expressed in the Resolution under consideration may be developed in supervisory proceedings No. VAS-18162/09 on the case of OAO Muromsky Track Switching Plant, which consider the same question, but in connection with value-added tax. This case was referred by a Ruling of the Court dated 12 March 2010 to the Presidium of the Court, with the review scheduled for 20 April 2010.

Pepeliaev Group experts are ready to help companies adjust legal requirements provided by court practice on due care for tax purposes (the due diligence of suppliers) in accordance with their specific business practices.

For further information, please contact:

in Moscow – Ivan Khamenushko, Senior Partner, at: (495) 967-0007 or by i.khamenushko@pgplaw.ru; Peter Popov, Senior Associate, at: (495) 967-0007 or by p.popov@pgplaw.ru

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