The deoffshorization and counteracting tax evasion have definitely become an international trend for the recent years. The Russian Federation does not stand apart. The stages of implementation of the national plan against offshores, the influence of this strategy on the formation of judicial practice, the recent tendencies in solving traditional tax disputes and the risks the companies should be aware of when participating in international transactions were discussed with the Attorney and the Managing Partner of Freytak and Sons. Law office – Nikolay Konstantinovich Freytak.
Ed.: Nikolay Konstantinovich, in the last two years the use of conduit companies has become an extremely topical subject. From your point of view: does it mean solely a struggle with the use of offshore schemes or can you see some excesses in this practice?
N.K.:Obviously, more and more often the legitimacy of use by the Russian tax agents the preferential tax rates, withheld at the source, is subjected to doubt. I sincerely hope that the development of law enforcement practice on this issue will follow the right direction and the concept of beneficiary owner will not become a new alternative to refill the budget and will not be used against bona fide taxpayers – those, who legally use the tax incentives provided by the agreements on avoidance of double taxation.
Ed.:In which way the international practice on disputes with conduit companies is forming?
N.K.:It should be mentioned that the OECD elaborated a Report on conduit companies as far back as 1986. The document contains the principal statements, which determine a fictitious nature of the activities of conduit companies, as well as a number of ways for identifying the final recipient of income. The provisions of this Report served the basis of the doctrine of beneficiary owner of many foreign countries.
For instance, in the USA tax doctrine there is a special anti-conduit rule, or, as it is called, the beneficiary owner rule, according to which a reduced tax rate withholding at the source does not apply, if the formal recipient of income is not its factual recipient, namely does not have the right to dispose of income at his sole discretion and transfers the income received to the third person (is a transit link – a conduit).
In foreign practice there is a widely spread concept of treaty shopping – company’s establishment in the country with the most favorable regime of international taxation in the absence of a reasonable economic objective. The treaty shopping doctrine was applied in several high-profile cases on challenging the tax incentives for transactions involving technical (transit) companies. Thus, in Prevost Car case the Canadian court revealed four criteria, in accordance with which a person can be considered as a factual recipient of income: possession, use, control and risk. These criteria do not loose their relevance for today.
In the decision on Indofood case the English Court of Appeal ruled that the transit company could not be considered as a final recipient of income, since it had been transferring the received income to shareholders and did not carry out any other activity, besides having the right to receive income.
Ed.:What kind of recommendations can you provide for taxpayers whose shareholders/counterparties are foreign companies?
N.K.:For avoiding the risks when conducting cross-border transactions the Russian companies should obtain from their foreign counterparties the proof of their factual presence in the country – party to the Agreement on avoidance of double taxation with the Russian Federation.
Markers that demonstrate the real nature of activities of the intermediate company can be: an independence in determining the economic fate of the received income; an absence of obligation of its transfer in full amount in favor of a third person; the existence of company’s other types of activities and other incomes, different from those obtained under contracts with the Russian party; a company’s independence of incurring entrepreneurial risks.
Ed.:At the end of 2016 – the beginning of 2017 the Judicial Panel on Economic Disputes of the Supreme Court of the Russian Federation issued two rulings in favor of taxpayers (“Centreregionugol” and “SITI” cases) concerning the disputes, where the alleged failure to exercise due diligence when choosing a contractor served as the basis for additional charges. Nikolay Konstantinovich, from your point of view, can we talk about the emergence of a positively new vector for taxpayers?
N.K.:As we know, the tax authorities can add taxes in case, when the taxpayer’s counterpart of the first, second or even third level is recognized doubtful. A bona fide taxpayer, who is not insured from the emergence of such a supplier in the chain of its counterparts, is trying to challenge this practice. However, for the recent times the courts consistently take the position of tax authorities. Those who do not defend the budget interests are deprived of their robes or forced to resign. I suppose, that the objectives of the two proceedings against the judges of Moscow Arbitration Court, initiated last autumn, have been fully achieved. Those wishing to listen to the taxpayers will remain in even larger minority.
As for the two above-mentioned rulings, it is hardly possible to talk about the positive trend for business. They are based at the general principles, established once by the Supreme Arbitration Court of the Russian Federation. In fact, the Judicial Panel once again corrected the errors of the lower courts by annulling the decisions of cassation instance, that revaluated the evidence, and upheld the decisions of lower courts, that confirm the reality of the taxpayer’s business operations and the exercise of due diligence in choosing his counterparties.
Generally, practically every tax dispute inevitably comes to in one form or another not to the issues of law, but to questions of fact, so that the success of a particular legal case depends on the court’s internal conviction formed in the process of examining the case.
If we talk about the concept of unjustified tax benefit in the form, in which the Russian courts apply it, the question of maintaining the balance of public and private interests inevitably raises. In the situation, when the law enforcer does not solve the most important problem – the taxpayer’s responsibility for the counterparty, one cannot speak about its compliance. Neither the tax authorities, nor the courts establish who is the ultimate beneficiary of this most unjustified tax benefit. Under such circumstances, it turns out that there are some preferences for the State: it adds taxes to the taxpayer, who has not been lucky with the counterparty, and does not charge them from that same unscrupulous counterparty.
Ed.:Has the number of cases related to the recovery of tax debts from the associate company increased?
N.K.:The cases involving the application of the sub.2 of the paragraph 2 of the Article 45 of the Tax Code of the Russian Federation continue to appear, and the judicial practice on them develops exclusively in favor of the budget. The tax authorities do not refer only to the direct signs of dependence expressly provided by law, but also to a set of indirect characteristics.
In the case of company “Interos” the tax authority considered the firms as associate on the basis of a set of indirect characteristics in the absence of common members, managers and other grounds on which they could be assigned to one group of persons. The Judicial Panel of the Supreme Court of the Russian Federation supported the inspection in that dispute, having proposed to take into consideration not only subjective, but also objective dependence, that is, those most indirect signs not listed in the law. Also the Panel proposed to consider the renegotiation of contracts with suppliers and customers, which essentially led to the transfer of rights to receive income from the activity of the taxpayer, as a form of transfer of property (property rights).
Despite the fact, that it will be necessary to consider whether the conditions and circumstances of the transfer of business differed from those that ordinarily exist in the interaction of mutually independent members, the present approach to selling current business can be applied to bona fide taxpayers. This is explained by the fact that the criteria for determining the so-called ordinary circumstances of the transfer of business are not defined, but the situation when the business is alienated to an independent buyer, the same counterparties are retained and the same employees continue working constitutes a usual business practices, especially for specific industries, and they do not necessarily indicate the presence of some unscrupulous schemes.
Ed.:In January, the Commission on the legislative activity of the Government of the Russian Federation approved a bill that gives tax authorities the right to request from auditors documents received during the auditing of their clients. We would like to know your opinion on this initiative.
N.K.:The adoption of a bill providing access to the Russian tax authorities for information that constitutes an audit secret is essentially the implementation of one of the seventeen points of the Plan, developed in February 2014 by the Russian Ministry of Finance and known as the national plan to counter offshore companies.
The lawmaker notes, that the bill has been prepared pursuant to the OECD recommendations in the framework of negotiations on Russia’s accession to the OECD. The OECD Report on Transparency and Exchange of Information for Tax Purposes with respect to Russia provided a list of recommendations for improving legislation regulating the exchange of information for tax purposes. In particular, the recommendations concerned the ensuring of access for tax purposes for the authorized bodies of foreign states to information classified as «audit secret». If we consider the text of the bill more closely, we will see that the first place is given to the submission of information on the requests of the Russian tax authorities, while the retrieval of information on the requests of the authorized body of a foreign state goes to the background.
Perhaps we can say that the executive power was able to successfully take advantage of the current state of affairs, ensuring even wider access to information on taxpayers.
If we compare the legislative norms of the OECD member-countries on issues of providing an access to tax authorities for information constituting an audit or professional secret, the Financial Law of Great Britain in 2008 contains provisions that auditors, as well as tax advisers, are not obliged to respond to requests from tax authorities in relation to the provision of information (documents) received and formed by the auditor or tax during execution of professional task. The German Tax Code provides that auditors have the right to refuse to submit to the tax authorities information and documents received by them in the course of executing their professional activities, since such information constitutes a professional secret. Under the laws of Italy, an access to confidential information of the auditor is possible only on the basis of an official request of the General Prosecutor’s Office, if there are grounds for the tax authorities to believe that the taxpayer has committed a tax offense.
Undoubtedly, this innovation will significantly reduce the degree of business confidence in their professional advisors.
Ed.:Nikolay Konstantinovich, how can you evaluate the work of the tax authorities? Whether we can speak of a substantial increase of their professional level of training?
N.K.:In general, we can admit that the implementation of international mechanisms for eradicating the aggressive tax planning is proceeding successfully. Tax authorities, certainly, occupy one of the key roles in this process.
In recent years, the tax authorities have significantly enlarged their tools for making claims against taxpayers, especially regarding the transactions between associate companies, one of which is of foreign origin. The tax authorities take an active part in the international exchange of tax information, attract leading national experts, send inquiries to foreign competent authorities, which in its totality contributes to the formation of a convincing position shared by the arbitration courts.
The “Ekvant” case presents a vivid example in this respect: the Russian tax authority sent inquiries to the tax authorities of several foreign countries (Ireland, Germany, Sweden, Norway, Denmark, Hungary, Ukraine and Kazakhstan), where the organizations belonging to the international group of companies were situated. Thus, in the scope of a single case, a multilateral information exchange was carried out, thanks to which the tax authorities were able to form an impressive evidential base.
Ed.:At the end of our interview I would like to recall the bill passed by the State Duma in the first reading aimed at solving the problem of tax abuses. Last time (interview in the newspaper «Ezh-Jurist», No. 2, January 2016 - ed.) you expressed concerns that the proposed amendments could well negatively affect the interests of bona fide taxpayers. Has anything changed in the text of the bill since then?
N.K.:At the meeting of the Expert Council on Tax Legislation under the State Duma Committee on Budget and Taxes on February 10, 2017, a discussion of this bill took place. The parliamentarians once again stressed that the bill is primarily aimed at protecting taxpayers who are properly performing duties on paying taxes. Meanwhile, it can be seen from the document proposed for discussion that the previous version has changed with regard to the wording of the new version of the Article 54 of the Tax Code of the Russian Federation.
It is proposed to directly fix the right of the tax authorities at their own discretion to establish the business purpose of any facts of economic life and on the basis of this determine the amounts of taxes and fees payable by taxpayers to the budget, without taking into account the transactions, the main purpose of which, according to the inspection, is non-payment or incomplete payment and (or) offset (refund) of tax amounts.
That is, it is not even about the requalification of transactions, which the inspectors are dealing with for a long time, but in general about the exclusion of the entire operation for tax purposes. If the operation was real, but not accounted for in accordance with its actual economic meaning, then it is necessary to determine the scope of the rights and duties of the taxpayer based on the true economic content of the relevant operation. This was mentioned in the Decree of the Plenum of the Supreme Arbitration Court of the Russian Federation of 12.10.2006 No. 53. In this regard, this is not the very possibility of re-qualifying the transactions or their exclusion for taxation purposes that makes us concerned, but the fact that this may affect the transactions concluded long before the adoption of the relevant amendments. That is, in fact, we are talking about giving a retroactive effect to the law, aggravating the taxpayer’s position.
Ed.: Nikolay Konstantinovich, thank you for participating in the discussion.
Interviewed by Nadezhda Yashina, Victoria Eremchenko, Moscow