The Russian Supreme Arbitration Court has supported the computation method for determining profit tax when the documents of the taxpayer’s counterparty are not accurate

Pepeliaev Group advises that Resolution No. 2341/12 of the Supreme Arbitration Court dated 3 July 2012 has been handed down.  It clarifies the application of article 31(1)(7) of the Russian Tax Code for the calculation of profit tax with ‘problematical suppliers’.

Facts of the case

OAO Kamsky Concrete Products and Structures Plant (the “taxpayer”) appealed a decision of the Federal Tax Service’s Republic of Udmurtia Inter-district Tax Inspectorate No. 3 (the “Inspectorate”) to the state commercial (arbitration) court. Under the Inspectorate’s decision, an additional RUB 43,294,043 of profit tax and RUB 34,890,794 of value added tax were assessed, along with the corresponding late payment interest and tax fines. This related to business transactions with limited liability company UPK-Metal (the “supplier”).

The Inspectorate did not challenge the fact that the Plant undertook genuine business transactions involving goods being acquired in volumes that were secured by the demand for raw materials to manufacture ready products (95.9% in 2006, and 87% in 2007), as well as the lengthy nature of а business connections with UPK-Metal (in the period in dispute, that company was the sole supplier of the products in dispute to the Plant). Nevertheless, the Inspectorate treated expenses on purchasing the supplier’s goods as economically unjustified, citing the ground that the source documents supporting such transactions were not accurate.

The courts of three levels rejected the taxpayer’s claims. Agreeing with the Inspectorate’s conclusions, the courts based their conclusions on the facts established during a tax audit, which evidenced that the supplier could not have been conducting business activity and, as a result, the information in the documents supplied was inaccurate. The inaccuracies included the counterparty being registered at an address where there were bulk registrations; the lack of its own or leased fixed assets, transport and staff in the period in dispute; the fact that its managers in the period in dispute stated that there was no business relationship with the Plant; and the fact that they did not know about the company’s activity. These factors meant that the court viewed the plant as being at fault for not exercising the proper degree of care when selecting the counterparty in question.

Arguments of the Russian Supreme Arbitration Court

1. Under article 247(1) of the Russian Tax Code, the item that is taxable for corporate profit tax purposes is the profit generated by the taxpayer. Further, the profit is treated as income received reduced by the amount of expenses incurred, which is determined in accordance with chapter 25 of the Code. In this case, the taxpayer actually incurred expenses on acquiring raw materials (cement); the goods manufactured from the raw materials (concrete products) were sold, and the proceeds taken into account for tax purposes.

Pepeliaev Group’s comments: Since the tax authority is not adjusting the amount of revenue, then in this situation the failure to take account of the taxpayer’s expenses violates article 247(1) of the Tax Code, since the tax is actually calculated based not on profit but on revenue.

2. The Plenum of the Russian Supreme Arbitration Court, in clause 7 of its resolution No. 53 dated 12 October 2006 On the assessment by arbitration courts of whether a taxpayer’s receipt of a tax benefit is justified stated if the court, on the basis of an assessment of evidence supplied by a tax authority and a taxpayer, concludes that the taxpayer has, for tax purposes, accounted for transactions other than in accordance with their actual economic substance, the court shall determine the extent of the taxpayer’s rights and obligations based on the genuine economic content of the relevant transactions.

Pepeliaev Group’s comments: In the case in question, the courts did not perform this obligation, which resulted in an outcome that did not correctly establish the taxpayer’s tax obligations. The court violated the requirement of article 3(3) of the Tax Code that there must be economic grounds for tax.

3. Under the provisions of article 31(1)(7) of the Code, it is possible for the provisions cited to be implemented when the tax authority is determining the expenses actually incurred by the taxpayer. Article 31(1)(7) gives tax authorities a right to determine the amounts of taxes that are payable by taxpayers into the Russian federal budgetary system using the computation method based on information they have about a taxpayer and data about other similar taxpayers.

Pepeliaev Group’s comments: In this case, the SAC has interpreted article 31(1)(7) of the Tax Code in the same way as the Russian Constitutional Court did in its rulings No. 441-O and 301-O dated, respectively, 4 December 2003 and 5 July 2005, i.e. as a rule guaranteeing a taxpayer’s rights not to pay tax in an unlawful and unjustified amount. The court took account of the applicants argument that a taxpayer which had lost documents relating to a contentious transaction should not benefit from applying this guarantee ahead of a taxpayer which had retained such documents in good faith. 

General conclusions

In the event of the tax authority establishing that documents supplied by a taxpayer are inaccurate, its assumptions are that there is, in the taxpayers actions, an intention to obtain an unjustified tax benefits, or that it has not shown sufficient care in selecting its counterparty. The actual amount of the estimated tax benefit or expenses incurred should be determined taking into account article 31(1)(7) of the Code.

In the SAC’s view, a tax authority should apply this provision not only if a taxpayer fails to provide for a tax audit source accounting documents that confirm the business transactions in has consummated, as stated more than once by the Presidium of the Russian Supreme Arbitration Court (resolutions No. 1621/11 and No. 16282/11 dated, respectively, 19 July 2011 and 10 April 2012). It should also do so in other situations, when an inspectorate’s argument that documents are inaccurate results in a significant part of material expenses being excluded from the body of the taxpayer’s expenses, such that the true extent of tax obligations in relation to profit tax being distorted.

What to think about, and what to do

However, the SAC indicated that the taxpayer bears the obligation to provide documentary substantiation of a right to a tax deduction of amounts of value added tax when goods, work or services are acquired. Further to this, the right to use the computation method is excluded when amounts of tax deductions are determined (see also resolutions of the SAC No. 8686/07, No. 6961/10 and No. 14473/10, dated, respectively, 30 October 2007, 9 November 2010 and 9 March 2011).

A question arises: why have arbitration courts, including the SAC, not applied in the case in question the legal position developed in the OAO Muromsky Strelochny Zavod case (see resolution No. 18162/09 of the Presidium of the SAC dated 20 April 2010)?

It seems that they would have been prevented from doing so by the fact that the supplier in that instance was the main (primary) supplier for the taxpayer. According to the logic of clause 10 of resolution No. 53 of the Plenum of the SAC, this allowed the tax authorities and courts to regard its tax benefit as unjustified (both for VAT and profit tax).
In this sense, resolution No. 2341/12 of the Presidium of the SAC dated 3 July 2012 seems progressive, providing additional protection for taxpayers’ rights.

For further information, please contact:

in Moscow – Anton Nikiforov, Partner, at: (495) 967-0007 or by e-mail; Konstantin Sasov, Senior Associate, at: (495) 967-0007 or by e-mail

in St Petersburg - Sergey Sosnovsky, Head of Tax Practice (St. Petersburg), at (812) 640-60-10 or by e-mail