Taxes in Russia. The Lessons of 2010

Looking back on the year gone by, let me go through the most significant events affecting taxpayers, the business climate and the Russian tax system.

It is encouraging to see that there is more good news than bad.

The main news is probably that one particular bad thing did not happen. The State Duma did not pass the Ministry of Finance’s proposed version of the transfer pricing bill. This gives us some hope that in 2011, lawmakers will come up with a sensible law, rather than a passing vague one which could see businesses required, out of the blue, to pay additional tax.

The beginning of the bygone year was marked by amendments to criminal legislation, which mitigated liability for tax offences and restricted the limits for taking suspects into custody [1]. Most importantly, criminal prosecution for tax offences is subject to such offences being established by a tax authority’s decision that has come into force.

The amendments saw a significant increase in the threshold amounts for large-scale and extremely large-scale tax evasion to constitute a criminal offence. Also, the amendments restored a special provision exempting first-time offenders fr om criminal liability if they have fully paid their tax arrears, fines and default interest. Both individuals and legal entities may now pay outstanding amounts of tax for a legal entity.

Amendments to the Russian Tax Code dealing with tax administration and control [2] and the entry into force of a fast-track procedure for VAT recovery [3] have made relations between businesses and the tax authorities more streamlined and less unpredictable.

For instance, the amendments introduce the active use of electronic workflow management, including the use of electronic VAT invoices, to streamline tax control procedures.

The tax authorities are now required by statute to ensure that tax audit reports are accompanied by third-party evidence of tax offences allegedly committed by the taxpayer. The taxpayer is now entitled to view all files fr om a tax audit before the tax authority takes a decision based on such audit.

The amendments specify situations where outstanding amounts of tax must be written off. Among these are cases where the court finds that the limitation period for tax collection has expired.

Interest is now payable on frozen funds where the tax authority incorrectly decided to freeze taxpayer’s accounts, helping to ensure that such decisions are only taken where justified.

The steps taken by the Russian Government and Ministry of Finance defy unambiguous assessment.

Of considerable importance is the Protocol on the amendments to the Double Taxation Treaty with Cyprus [4], which sets clear guidelines for off-shore business. Once the Protocol is signed and ratified, Cyprus is expected to be removed fr om the Russian Ministry of Finance’s blacklist. Dividends distributed by Cyprus-based companies will then be exempt fr om Russian tax under the strategic participation income exemption provided for in the Russian Tax Code.

However, the preparation of a bill on combatting tax irregularities has made no progress, despite the Russian President’s request to the Ministry of Finance [5]. Courts are still groping with this issue, their practice based on the increasingly outdated Resolution No. 53 of the Plenum of the Russian Supreme Arbitration Court (“VAS RF”) [6].

The Russian Government Resolution [7] introducing a levy to finance compensation to authors drew flak from the business community. Manufacturers or importers of compact discs, computers, cell phones and other equipment now have to pay 1% of their customs value or selling price for the benefit of authors, performers and producers of phonograms intended for private use. Since the money cannot be collected from the end users of musical and other similar products, the government is targeting those who are next in the supply chain. Frankly, it has been a long time since we last saw such a legally uncertain and carelessly drafted regulation paving the way to arbitrary decision-making and uncontrolled spending by private persons of funds compulsorily collected from businesses. It is astonishing to see our leaders create feudal-style institutions and grant income-generating fiefs to their vassals, despite the established principles of a modern tax system already in place for twenty years. It will evidently be a long time before those in power live up to their promises about respect for private property.

And it goes without saying that nobody is happy with the Russian Government’s stubborn refusal to cancel its decision to raise social insurance contributions.

The Russian Constitutional Court issued just one resolution [8], albeit an important one. It agreed that resolutions of the Presidium of VAS RF can set legal precedents, and it also ruled that clarifications by the Presidium of VAS RF may not be used retroactively if unfavourable for taxpayers.

VAS RF, by contrast, was the key newsmaker in tax, its rulings resolving a number important practical issues. More specifically, it allowed losses from writing off debt to be deducted from profit for tax purposes [9]; it ruled that taxpayers must undertake a complete tax restructuring when found to be using a tax evasion scheme [10]; it lim ited taxpayers’ liability for their suppliers’ failure to pay tax [11]; and it lim ited the expenses that only qualify for deduction for VAT purposes within allowable lim its [12].

Another two resolutions should have a positive impact on the tax authorities’ practices. In its Resolution No. 4903/10 dated 29 September 2010, the Presidium of VAS RF ruled that a tax officer who did not review the tax audit findings [13] could not lawfully sign a decision holding the taxpayer liable for a tax offence. In its Resolution No. 3299/10 dated 12 October 2010, the Presidium of VAS RF ruled that the Budget Code (rather than Article 78 of the Russian Tax Code) must govern the collection, under judicial decisions, of funds from budgets.

At the same time, practitioners have justifiably criticised a number of Supreme Arbitration Court rulings: on the lawfulness of imposing fines on taxpayers for missing the deadline for submitting advance payments calculations of profit tax [14], on calculating taxes based on estimates [15], on court proceedings not being applicable to additional tax being collected wh ere taxpayers’ transactions are classed as being a sham [16].

The Presidium of VAS RF addressed the settlement of tax disputes through administrative proceedings. It ruled that the tax authority does not have to invite taxpayers to appeal hearings [17] and that the taxpayer should not be allowed to claim as a loss expenditure on preparing objections to a tax audit report [18]. These rulings are unfavourable for taxpayers.

On the other hand, the Presidium of VAS RF allowed litigation costs to be claimed from the unsuccessful party when the judgement is enforced [19]. This will not only help companies save on legal costs, but will also give debtors an incentive not to delay enforcement.

By and large, the Supreme Court rulings have made relations between the taxpayers and the tax authorities less unpredictable. Hopefully, this year will also see an end to retroactive application of court interpretations that are unfavourable for taxpayers. This would be the final step in dispelling the negative image of VAS RF, often viewed by companies as a source of unwelcome surprises entailing the recalculation of tax already paid.

What we saw in 2010 was basically an adjustment and fine-tuning of the tax system as a follow-up to many years of tax reform, were it not for various new trends which can only give cause for concern: new tax legislation enacted in the final days of the year, tax rates on the rise, new taxes introduced, and some of the existing ones removed from the scope of the Tax Code. All this could signal the abandonment of the goals of the Russian tax reform that started more than ten years ago.

[1] Federal Law No. 383-FZ dated 29 December 2009.

[2] Federal Law No. 229-FZ dated 27 July 2010.

[3] Federal Law No. 318-FZ dated 17 December 2009.

[4] Protocol of 7 October 2010 on amendments to the 1998 Double Taxation Treaty between Russia and Cyprus.

[5] The Budget Address of the Russian President to the Federal Assembly of 25 May 2009 On budget policies for 2010-2012.

[6] Resolution of the Plenum of VAS RF No. 53 dated 12 October 2006 On the assessment by arbitration courts as to whether the taxpayer enjoys a justified tax advantage.

[7] Russian Government Resolution No. 829 dated 14 October 2010 On compensation for the free reproduction of phonograms and audiovisual materials for private use.

[8] Resolution of the Russian Constitutional Court No. 1-P dated 21 January 2010.

[9] Resolution of the Presidium of VAS RF No. 2833/10 dated 15 July 2010.

[10] Resolution of the Presidium of VAS RF No. 15152/09 dated 16 July 2010.

[11] Resolutions of the Presidium of VAS RF No. 15574/09 dated 9 March 2010 and No. 18162/09 dated 20 April 2010.

[12] Resolution of the Presidium of VAS RF No. 2604/10 dated 6 July 2010.

[13] Resolution of the Presidium of VAS RF No. 4903/10 dated 29 September 2010.

[14] Resolution of the Presidium of VAS RF No. 3299/10 dated 12 October 2010.

[15] Resolution of the Presidium of VAS RF No. 5/10 dated 22 June 2010.

[16] Resolution of the Presidium of VAS RF No. 16064/09 dated 1 June 2010.

[17] Resolution of the Presidium of VAS RF No. 4292/10 dated 22 September 2010.

[18] Resolution of the Presidium of VAS RF No. 3303/10 dated 15 July 2010.

[19] Resolution of the Presidium of VAS RF No. 4735/09 dated 15 July 2010.