Under these conditions, the large number of tax disputes in the country is no surprise. But as Mikhail Orlov, partner, and Anton Zykov, senior lawyer, of KPMG in Russia explain, the situation seems to be easing due to new programs and approaches that improve collaboration and transparency between the tax authorities and taxpayers.
MO: For tax audits and assessments, there are three levels of appeal: the first two levels involve appeals to the superior revenue authority and then an optional appeal to the Federal Tax Service headquarters. The third level is tax litigation through Russia’s commercial courts, which were established 17 years ago in a revamp of the post-Soviet judicial system.
Transfer pricing disputes are dealt with through a separate process. Under new regulations that took effect at the beginning of 2012, all transfer pricing audits are conducted by auditors with the federal tax services headquarters. If the dispute cannot be resolved at this level, tax litigation is the only further option.
AZ: In all cases, the deadlines for filing objections are extremely tight. For example, claims to appeal tax audits to the superior revenue authority must be filed 10 working days from receipt of the reassessment and appeals to the Federal Tax Service must be filed within three months after the revenue authority’s decision comes into force. Court proceedings can take from four to nine months but up to two years for more complex cases. It should be noted that the courts have begun ordering the revenue authority to pay litigation costs to taxpayers who win their disputes.
MO: Because many tax disputes stem from differences in interpretation as to how the tax law applies to particular facts, it may be to a taxpayer’s advantage to proactively identify and clear up potential misunderstandings at the audit stage. In many cases, you can avoid tax disputes before they develop by filing written explanations during the audit, setting out your interpretation of how the tax law applies to a particular set of facts. You can also apply to the Russian Federation’s Ministry of Finance for clarification of the law, which offers protection from penalties even if the revenue authorities and the courts disagree with the Ministry and do not decide the issue in your favor.
Even if the revenue authorities issue a reassessment, they may be willing to accept a taxpayer’s arguments, as long as the arguments are well researched and documented. And if the senior revenue authority upholds the reassessment, the Federal Tax Service can still reverse the decision. Appeals to the Federal Tax Service can be particularly effective for cases that hinge on interpretations of tax law.
As a result of this more open approach, more tax disputes are being settled at the tax authority level.
MO: The biggest issue presently is related to the denial of VAT and corporate tax on payments to so-called “fly-by-night companies”—vendors that collect taxes on invoices but fail to remit them to the government. In these cases, the revenue authorities can target the buyer and deny their related deductions. Revenue authorities’ investigations may include cross-checks and depositions. The revenue authority may also interact with police or collaborate with customs or other enforcement bodies. However, the revenue authorities cannot rely on evidence obtained from the police in making their determinations.
AZ: A good approach in these cases is to “know your vendor”. You should also keep a record of your dealings with these businesses by preserving communications, emails and other supporting documents.
MO: This has definitely emerged as a top audit issue in Russia. The tax authorities have developed the skills and knowledge to analyze complex international tax structures. Like many other tax authorities around the world, they are challenging “conduit companies” based in treaty-favored jurisdictions on the basis that they lack commercial substance, denying treaty exemptions and assessing withholding taxes at the statutory 15 percent rate. Though the “conduit company” concept is not a feature of Russian tax law, the courts recognize the concept as defined by the Organisation for Economic Cooperation and Development.
AZ: In addition to determining the arrangements are legally sound and well documented, companies should be aware of the extent of the tax authorities’ ability to collect evidence, including through the sharing of information with tax authorities in other countries. As we noted earlier, applying to the Ministry of Finance for clarification is also worth considering to guard against penalties. Companies should also take care that their arrangements will not run afoul of the Russian general anti-avoidance rule (GAAR).
AZ: The GAAR, which can operate to deny “unjustified tax benefits”, is not part of Russian tax law. Rather, it stems from Resolution #53 of the Presidium of the Supreme Commercial Court of the Russian Federation, which is binding on lower courts and widely applied by the tax authorities. Factors that can indicate unjustified tax benefits include:
- practical impossibility of business operations, as evidenced by lack of time, location or material resources
- lack of staff in vendor companies
- lack of business substance
- operations with goods that were not produced.
Where the GAAR is concerned, the taxpayer is not guilty until the tax authorities prove otherwise.
MO: For one thing, we can expect to see more audit activity and disputes in the area of transfer pricing, as the headquarters audit division now responsible for these audits increases its specialized knowledge and capabilities and settles into this new role.
At the same time, taxpayers have a number of reasons to expect things to change for the better.
- The Russian tax authority has now concluded a series of advance pricing agreements, which should ease the process for achieving certainty over the treatment of transfer prices on audit for taxpayers pursuing APAs in the future.
- The tax authority has also entered into its first advanced information interaction agreements with taxpayers, introducing a form of horizontal monitoring that promotes more cooperative, transparent relationships between corporate taxpayers and tax inspectors.
- The Federal Tax Service has declassified its tax audit procedures, providing transparency over what characteristics (e.g., effective tax rate benchmarks, higher risk industries) will be more likely to attract audit scrutiny.
AZ: Despite these positive developments, companies should keep in mind that the skills and knowledge of Russia’s tax auditors and lawyers are increasing, and they are becoming more sophisticated in their audit and enforcement approach. Further, Russian courts tend to transfer the burden of proof to the taxpayer in some cases. As in any jurisdiction, taking a comprehensive, proactive approach to your company’s tax obligations and planning will help determine that you are well equipped to face any tax dispute scenario and help improve your chance of a favorable outcome.
Mikhail has been a partner of KPMG Russia’s Tax and Legal Services since 2010. Mikhail’s background includes helping to draft the foundation of Russian tax law as the Head of the Taxation Policy Department with the Russian Ministry of Economic Development and Trade along with many years representing Russian and multinational clients in various tax disputes, including administrative appeals and litigation.
Mikhail is currently the Chairman of the Tax Law Expert Council of the Budget and Tax Committee of the Russian State Duma (Parliament), and keeps an active role in drafting tax legislation. In addition, Mikhail currently lectures at the National Research University Higher School of Economics and regularly participates as a speaker in events organized by KPMG and external industry seminars.
Mikhail holds a specialization degree in law and a PhD in Law from Moscow State Law Academy.
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Anton has been a lawyer at KPMG Russia’s Tax and Legal Services since 2008. Anton’s background includes a broad level of experience in tax law and different industry sectors, with focus on tax disputes, advisory in indirect taxes, GAAR and tax planning. He has 10 years experience in litigating against tax, currency control and other state authorities.
Anton is an advokat (member of the Russian Bar Association) and holds a specialization degree in law from Voronezh State University.
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