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A promissory note is not always equal to a loan relationship

Law firm Pepeliaev Group advises that the Russian Supreme Court (the “Supreme Court”) has issued a ruling [1] to establish the legal nature of the redemption of a promissory note.

It follows from the facts of the case that as a result of a reorganisation (merger with two Russian companies), a company (the "Company") received promissory notes issued by related foreign companies. The merged companies received the promissory notes on a free-of-charge basis from the majority shareholders [2]. When the Company performed a transaction to acquire trademarks from a foreign entity that was the debtor under the promissory notes, an agreement was concluded that receivables related to the trademarks acquired should be offset against the obligation of the foreign entity to pay the debt under the promissory notes in dispute.

The tax authority concluded that when it offset the counterclaims, the Company did not book the income from the sale of the promissory notes, while there were no expenses involving their acquisition as the members had received the promissory notes free of charge.

The courts of first instance and of appeal did not agree with the tax authority's view, having stated that the promissory notes had been used as a payment instrument and their redemption had been the repayment of a loan and, therefore, it did not generate income for taxation purposes. 

However, the circuit court and the Supreme Court did not agree with the lower courts. Following the lead of the circuit court, the Supreme Court pointed to the redemption of the promissory notes as securities. The reason behind that was the absence of confirmation in the case files of the loan relationships involving the Company and the foreign entity, and that the Company had received the promissory notes free of charge as securities.

The Supreme Court concluded that if a third party’s promissory note was transferred during a set-off procedure with the taxpayer receiving such promissory note under the transaction as a piece of property (security), income (including from the redemption of the par value of the promissory note) and the expense (the acquisition price of the promissory note) should be recorded in tax accounts.


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In this case, the Supreme Court has drawn a line in the classification of the legal nature of a promissory note as an instrument of a loan relationship and a security. If a taxpayer receives a promissory note by lending the money to the maker of the promissory note, the principal amount under such promissory note will be the repayment of the loan and will not generate an income. If the promissory note was received and transferred on any other grounds, the tax consequences will be determined based on the rules for redeeming a promissory note as a security.

The legal position of the Supreme Court may be applied to the redemption of promissory notes which were received free of charge from a member, and to other situations:
  • to an original promisee who transfers a promissory note to a third party;
  • to a new promisee who has received the promissory note from a previous promisee.
The tax accounting will then be based not on the rules for repaying a loan but on recognising all the amounts received as income. A promisee, however, may deduct the expenses of acquiring the promissory note (if these are confirmed).

If a promisee who did not issue a loan is a foreign entity all instalments under a promissory note must be properly classified, including the amount of the loan issued to the maker of the promissory note and the acquisition price of the promissory note by the foreign entity.

Tax authorities adopt a conservative stance regarding the tax agent being able to deduct the expenses of a recipient of income. Therefore, tax agents may be required to thoroughly justify the lawfulness of their actions in deducting the tax in a certain amount.


What to think about and what to do

Companies that use promissory notes in their business relationships are advised to reconsider their approach to the taxation of promissory notes and to assess the risks of their repayment which has already taken place or is anticipated.

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[1] Ruling No. 305-ES19-9969 of the Supreme Court's Judicial Board for Economic Disputes dated 30 September 2019 in case No. А40-24375/2017
[2] Article 251(1)(11) of the Russian Tax Code

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