Taxation of Incentive Payments and the New Trade Law

Expenses on the payment of remuneration stipulated in art. 9 (4) of the Law should be recorded by the supplier as non-sale expenses according to art. 265 (1) (19.1) of the Russian Tax Code (the “RTC”). The buyer (retail network) should record the remuneration obtained as non-sale income according to art. 250 (1) of the RTC.

Even if the actually paid remuneration exceeds 10% of the price of the purchased foodstuffs, the taxation of expenses will remain unchanged, including taxation of amounts in excess of the maximum remuneration stipulated by the Law. The supplier shall be entitled to deduct the whole amount of expenses actually incurred, if the nature of such expenses is in compliance with art. 252 (1) of the RTC. When calculating the profit tax, a taxpayer is entitled to deduct any expenses that are economically justified (substantiated), confirmed by supporting documents and aimed at generating income. Since the remuneration is paid by the supplier as an incentive for the buyer to purchase more goods, such expenses are economically justified and directly linked to the generation of income.

The statement that even in excess of the maximum remuneration stipulated by art. 5 (4) of the Law the taxpayer does not forfeit its right to reduce the taxable income by the whole amount of remuneration is based on the fact that the terms of taxation, including those that restrict the taxpayers’ rights, may only be established by tax legislation.

By virtue of art. 1 (1) of the RTC the Law in question is not a tax law. This means that any restrictions imposed by the Law or any breach thereof does not entail any tax implications, unless the same are explicitly stipulated by tax laws. At present, the RTC does not stipulate any such implications.

This approach is upheld by state arbitration case law (Resolutions No. KA-А41/5145-09 of 11 June 2009, No. KA-А40/5494-08 of 23 June 2008, No. KA-А40/2403-09 of 6 April 2009 of the Federal Arbitration Court for the Moscow Circuit).

In the current commercial practice, parties to supply contracts often stipulate a remuneration (premium, bonus) or discount for the discharge of certain contractual terms. Nevertheless, neither civil, nor tax legislation defines or formulates the difference between the remunerations (premiums, bonuses) and discounts, while practice has established the legal differences between those two types of incentive. A discount is granted for the performance of certain contractual terms and involves a change (reduction) in the price of goods, whereas a remuneration (premium, bonus) is also paid for the fulfillment of certain terms and conditions of a contract, but does not affect the price of goods (does not change the price).

Such a difference directly affects implications of the sale of goods fr om the VAT perspective.

According to art. 154, 166, and 168 of the RTC, the VAT base is determined as the value of goods sold. According to art. 162 of the RTC, the tax base comprises the income relating to payment received for the goods.

Taxpayers believe that the VAT base should be adjusted for both the supplier (reduced) and buyer (increased) only if a discount is granted and it follows explicitly from the terms of the contract that such a discount reduces the price of the goods. In this case, it is irrelevant when the discount was granted, at the time of the sale or after the execution of certain contractual terms. If the remuneration (premium, bonus) is paid and it follows directly from the contract that the parties did not intend to change the price of goods, then the VAT base should not be adjusted by any of the parties to the transaction.

Taxpayers often have disputes with tax authorities to this effect.

We believe that the norms set forth in cl. 4 of this article, wh ereby the remuneration is included in the price of the contract, but not in the price of the goods, could contribute to the resolution of such disputes. From the tax perspective, this means that the settlements relating to the payment of remuneration (premium, bonus) are attributable to settlements under the contract, but not settlements for the goods sold, consequently, they do not affect the VAT base which is formed by the value of the goods sold.

The taxpayer is entitled to use this norm of the Law invoking art. 11 (1) of the RTC stating that institutes, notions and terms of civil, family and other areas of Russian legislation referred to in the RTC are used in the same meaning as in those areas of legislation, unless the RTC stipulates otherwise.

We believe that the norm contemplated in art. 9 (4) of the Law may, to a certain extent, clarify the discussion which took place after the Russian Supreme Arbitration Court (the “Russian SAC”) had issued Resolution No. 11175/09 of 22 December 2009 on the case of Dirol-Cadbury LLC. The court concluded that “irrespective of how the parties to a distribution agreement establish a system of incentives (by the granting of a discount that determines a possible reduction in the base price of the product indicated in the contract or the granting of a bonus as additional remuneration or reward payable by the seller to the buyer for the discharge of the transaction terms) and also 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”.

To date, law enforcement practice has developed a clear understanding that the tax implications for VAT purposes depend on the agreement between contracting parties as to how the incentives should affect the price of the goods:
- Discounts are payments reduce the price of goods irrespectively of when they are granted. Consequently, they reduce the VAT base.
- Remuneration, premiums and bonuses do not reduce the price of the goods and constitute additional incentives which are not related to settlements for goods sold.

Some specialists believe that by making such a statement, the Russian SAC have equaled discounts, premiums and bonuses for VAT purposes.

We are of a different opinion. A literal interpretation of this wording allows us to conclude that the Russian SAC acknowledges the right of the parties to a supply contract to use different ways of remunerating their buyers for the discharge of specific contractual terms — through a system of discounts or through a system of remuneration (premiums, bonuses).

Still, irrespectively of the type of incentive agreed for buyers in the contract, “the amount of the proceeds shall be determined with due regard to the discounts”.

In other words, the bonuses, additional incentives and premiums are not deducted for VAT purposes during the calculation of the tax base and proceeds from the sale of goods, notwithstanding the fact that they are also a sort of incentive payable to the buyer for the execution of specific contractual terms.

To justify its position the Russian SAC refers to the norms of the RTC prescribing how the tax base should be formed with due account of all settlements for the goods and changes that may reduce or increase the tax base or, in other words, the price of goods. However, the Russian SAC does not refer to the rules of law saying that the tax base should include all of the taxpayer’s income and expenses under the contract, rather than just the settlements relating to payment of the price of goods.

The new law may clarify the issue. As noted before, according to art. 9 (4) of the Law a remuneration payable to the buyer for the discharge of the purchase volume terms affects the price of the contract, but not the price of goods.

The Law entered into force quite recently. This does not mean, however, that the “price of goods” and “price of contract” have only been distinguished since its enforcement. This norm of the Law only fixes the general understanding formed in practice that these notions are different and the “price of contract” is a broader concept than the “price of goods”.

For tax purposes, this means that the VAT base should only include and be adjusted with regard to the value of the goods sold, which is based on the price agreed by the parties with account of all adjustments to this price envisaged by the contract. Other settlements between the parties that affect the price of the contract, but not the price of goods, are not taken into account for the calculation or adjustment of the tax base.

In other words, remuneration (premiums, bonuses) for the execution of specific contractual terms that does not change the price of goods will not affect the VAT base of the supplier or the buyer. Such a conclusion is in line with the established state arbitration practice.