Resolution of the Supreme Arbitration Court on taxation of promotion activities at a retail chain: new issues

Pepeliaev Group advises that the Presidium of the Supreme Arbitration Court of Russia issued Resolution No. 11175/09 further to an application fr om Dirol-Cadbury LLC on 22 December 2009.

The dispute examined by the Supreme Arbitration Court of Russia concerned the following issues:

• Whether a taxpayer may deduct for VAT purposes retrospective discounts granted by a seller to a buyer for the discharge of all the terms of a transaction. The discounts were documented in VAT invoices with negative amounts issued at the end of the quarter as a percentage of the total amount of the delivered products. No adjustments were made to previous VAT invoices for the delivered products. The taxpayer did not change the product unit price in the VAT invoices.

• Whether a taxpayer may deduct (both for profit tax and VAT purposes) expenses relating to merchandising services (the promotion of products on the market), if such services were provided in respect of products, where the title had been transferred to retailers.

After duly examining the case, the Supreme Arbitration Court of Russia drew the following conclusions:

1) “irrespective of how the parties to a distribution agreement establish a system of incentives (by granting a discount that determines a possible reduction in the contractual base price of the product or granting a bonus as additional remuneration or reward paid by the seller to the buyer for the discharge of the terms of the transaction) and irrespective of the procedure for granting discounts and bonuses (remittance to a bank account, offset against an advance payment or reduction in debt), when calculating the tax base, the amount of the proceeds shall be determined with due account of the discounts and, wh ere necessary, adjusted for the tax period when the sale of products (work, services) was booked.”

2) “when incurring expenses on the promotion of the product on the market and filing for deductions on value-added tax, the company being a product manufacturer does not lose its commercial interest in said product even after concluding the supply agreement, as it pursues the goal of increasing total sales. …At the same time, the transfer of title to the product sold by the company does not affect, in the opinion of the Presidium, the nature of the expenses for the purposes of applying Chapter 25 of the Tax Code and the company’s right to file for corresponding tax deductions on value-added tax.”

Overall, the resolution issued in favour of the taxpayer raises a number of questions relating to the ambiguous interpretation of the first conclusion, in particular:

1) Are retrospective discounts and bonuses for the discharge of the terms of transactions with identical categories deductible for tax purposes? Can a company (or should it) adjust the VAT base in connection with this fact by the amount of the discounts and bonuses?

2) Is it possible to apply the conclusion of the Supreme Arbitration Court of Russia on the need to deduct discounts for tax purposes to both the seller and the retailer in terms of an increase in the tax base of the latter?

3) When should the discount be booked - in the current period or in the period when the goods were sold?

For example, the claimant in the dispute – Dirol Cadbury LLC – booked the incentive bonuses as discounts that reduced the price of the sold products as a percentage of total sales for a specific period. According to the tax office, as the unit price of the product was not adjusted, the payment of various awards to buyers has the economic substance of a discount rather than a change in the product price. Dismissing the conclusions of lower-instance courts, which had upheld the position of the tax office, the Supreme Arbitration Court of Russia declared that the discount should be deducted when calculating the tax base, irrespective of whether it reduces the price of each unit or was granted in respect of the whole volume of the products sold over a period specified by the parties in a contract.

At the same time, however, it remains unclear how to qualify incentive payments that were determined by the parties through acts and deeds as bonuses, which did not change the price of the product and were formalised accordingly (in particular, no VAT invoices were issued). This question is particularly relevant for retailers: if bonuses are qualified as payments that in any case affect the price of products, they will reduce the amount of tax deductions filed in respect of the initial product price.

The position of the Supreme Arbitration Court of Russia that the amount of revenues should be determined with due account of discounts when calculating the tax base served as grounds for some retailers to conclude that the discounts and bonuses should be included in the tax base. At the same time, however, such an interpretation of the Supreme Arbitration Court’s position would appear doubtful and is refuted by existing law enforcement practice.

The period when the granted discounts should be booked is also debatable: proceeding from the premise that the Supreme Arbitration Court of Russia invalidated the decision of the tax office with respect to VAT on discounts, the court thereby acknowledged that it was acceptable to issue negative VAT invoices and book them in the period when the discount was granted. Moreover, the Supreme Arbitration Court of Russia simultaneously mentioned that adjustments should be made in the tax period when the sale of the products (work or services) was booked. However, the Supreme Arbitration Court did not establish any clear criteria for the application of different methods of booking discounts.

Since it appears impossible to clearly interpret the conclusions of the Supreme Arbitration Court, it is difficult to forecast how law enforcement practice will evolve.

However, it is already clear today that the conclusions of the Supreme Arbitration Court in the resolution under review on the deductibility of retrospective discounts and bonuses for the discharge of the terms of contracts require further clarification.

Lawyers from Pepeliaev Group are ready to analyse the possible risks for your company relating to the conclusions drawn by the Supreme Arbitration Court in Resolution No. 11175/09 dated 22 December 2009 and to propose ways to mitigate such risks.

For further information, please contact:

in Moscow – Andrey Nikonov, Senior Partner, or Rustem Akhmetshin, Senior Partner, at: (495) 967-0007 or by e-mail: info@pgplaw.ru

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