The Russian Supreme Arbitration Court will resolve the issue of whether taxpayers may treat as deductible VAT paid as part of the expenditure on the repair of general infrastructure facilities that are in state ownership

Pepeliaev Group advises that, on 25 October 2011, the Presidium of the Russian Supreme Arbitration Court (the “SAC”) will resolve the issue of whether taxpayers may treat as deductible VAT paid as part of the expenditure on the repair of infrastructure facilities that are in general use and that are not owned by the taxpayer but are required for it to carry out its economic activity (the SAC’s Ruling No.  VAS-3844/11 dated 14 July 2011 – the OOO Tulacement case).

When constructing a cement factory, the taxpayer established that the most effective way of taking cement out of the factory, once the factory had been commissioned, would be to use a general use roadway owned by a constituent entity of the Russian Federation.

The road was unfit for cement to be transported by special vehicles (cement trucks). Consequently, the taxpayer, by its own initiative and at its own expense, undertook the repair of the road by concluding with third parties contracts for the design and execution of the repairs.

The taxpayer deducted the VAT it paid to the companies which had undertaken the design and repair work, and the tax authority challenged whether such deduction was legitimate.

In the dispute that arose, the first instance state commercial (‘arbitration’) court, the appeal court and the cassation court sided with the tax authority. The courts cited as the reasons for this stance the fact that the taxpayer did not own the road; there was no contractual relationship between the taxpayer and the duly authorised body of the constituent federal entity, meaning that the repair of the road was not aimed at carrying out transactions that would be taxable; and the taxpayer could have used other roads to transport the cement.

The SAC’s Panel of Judges considered it necessary to refer the matter to the Presidium of the SAC under the supervisory procedure.

The reasoning behind the Panel of Judges’ referral to the Presidium of the SAC by was that, in judicial decisions adopted by arbitration courts in the court circuits of several constituent federal entities, the courts had considered it possible to deduct amounts of VAT paid by taxpayers to contractors when repair and construction work had been carried out in relation to public highways because the work was connected with the construction of manufacturing facilities or with the taxpayer undertaking its activity.

As the Panel of Judges indicated in its ruling, the fact that public highways repaired using a taxpayers funds are not its own assets does not prevent amounts of VAT from being treated as deductible as long as the expenses incurred are in the nature of production, incurred for the propose of producing goods, the sale of which is VATable and does not contravene the rules of articles 171 and 172 of the Russian Tax Code.

The Panel also noted that the arbitration courts have held that a taxpayer is justified in deducting such expenses for profit tax purposes.

Main conclusions

The Presidium of the SAC’s examination of the case which is in favour of the taxpayer, could significantly influence the case law for hearing disputes on the right of organisations to reduce the profit tax base and treat the relevant amounts as deductible when they incur expenses in repairing transport and other general infrastructure facilities which are not owned by the taxpayer but which, objectively, are necessary to it for it to perform its business activity effectively. A similar approach could be extended to construction in cases when facilities that have been constructed are transferred to operating organisations or state authorities.

The conclusions that the Presidium of the SAC adopts in its resolution further to its hearing of this case could be especially topical for organisations undertaking manufacturing activity and extracting minerals in places that are difficult to access, when such organisations are therefore compelled to use their own funds to maintain state or municipally owned general infrastructure facilities in working order.

For further information, please contact:

in Moscow – Denis Schekin, Senior Partner, at: (495) 967-0007 or by e-mail;  Egor Lysenko, Senior Associate, at: (495) 967-0007 or by e.lysenko@pgplaw.ru; Kirill Rubalsky, Associate, at: (495) 967-0007 or by k.rubalskiy@pgplaw.ru

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