Pepeliaev Group lawyers win an income tax exemption for banks’ loyalty programmes

Pepeliaev Group has proved before the Presidium of the Russian Supreme Commercial (‘Arbitration’) Court (the “SAC”) that when VIP private customers receive incentives from banks, no taxable income arises. The decision, taken by the SAC on 9 April 2013 in the Citibank case, will safeguard bank loyalty programmes from being subject to additional taxation in future.

The terms and conditions for services provided to the holders of the Citigold and Ultima premium cards for VIP private customers afforded those customers the possibility of using business lounges in airports as long as they maintained an average monthly balance on their accounts in excess of a specified amount. Under a contract between the bank and an airport, the latter would keep a record of the individuals who visited the business lounges and would invoice the bank for payment in relation to services based on the number of visitors . The tax inspectorate, when auditing the bank, concluded that income in kind was generated for the bank’s customers in such a case by way of the bank paying for services on the taxpayers’ behalf (article 211.2(1) of the Russian Tax Code). Therefore the bank should have informed the tax authorities that such income had arisen, and the individuals should have filed personal income tax returns and paid tax at 13% on the value of the services paid for by the bank. 

Acting for Citibank, Pepeliaev Group’s lawyers went to court to challenge the tax inspectorate’s conclusion. The first and second instance courts upheld the bank’s stance, but the Federal Commercial (‘Arbitration’) Court for the North West Circuit, the third instance court, took the side of the tax inspectorate and set aside the lower courts’ rulings. The bank appealed to the SAC to have the case referred to be examined under the supervisory procedure.

The SAC’s panel of judges, in determining whether to refer the case to the Presidium of the SAC, supported the arguments of Pepeliaev Group’s lawyers that since the client obtained the right to visit a business lounge by virtue of there being a specified balance on such client’s accounts, the cost of the business lounge’s services should be regarded as interest on the accounts. In the light of the specific legal provision on the point  (article 214.2 of the Tax Code), taxable income arises when interest is received on accounts only if the total amount of interest is above the standard level set in law (as of 2009, that standard level on rouble accounts is the Russian Central Bank’s refinancing rate plus five percentage points). The Presidium of the SAC agreed with the panel’s stance and set aside the third instance court’s resolution in the tax inspectorate’s favour.

“This resolution could have a significant effect on the development of the banking industry as a whole and the Private Banking sector in particular,” states Igor Marmalidi, a partner in Pepeliaev Group and head of the firm’s banking practice, “since many banks operate similar loyalty programmes.” He considers that when banks implement loyalty programmes involving a condition that set balances be maintained on accounts, it is prudent for such banks to analyse whether or not the benefits they grant to clients count as interest for tax purposes. “It needs to be checked in addition that the total amount of benefits received by the client does not exceed the standard level fixed by article 214.2 of the Tax Code,” believes Sergey Sosnovsky, head of Pepeliaev Group’s tax practice in St Petersburg. 

“When such risks occur, we recommend that thought be given to changing the structure and the terms and conditions of loyalty programmes,” explains Igor Marmalidi. He also considers that, bearing in mind the stance of the SAC, banks would be advised also to analyse any programmes for attracting investments that include a condition for so-called ‘gifts’ to be awarded. In certain circumstances, these may also be regarded as interest for tax purposes.