How to manage a Russian tax dispute
Almost all tax audits in Russia result in some kind of adjustment by the authorities, meaning that disputes with the tax authorities come with the territory for companies operating in Russia.
International Tax Review speaks with three leading tax lawyers and advisers in the country – Ruslan Vasutin of DLA Piper, Evgeny Timofeev of Goltsblat BLP and Roustam Vakhitov of International Tax Associates – to find out how taxpayers can best cope with challenges from Russia’s tax authorities.
International Tax Review (ITR): What advice would you give to taxpayers about how they can avoid getting into a dispute with the Russian tax authorities?
Ruslan Vasutin (RV)(pictured left): Taxpayers need to carefully look at the documents requested by the tax authorities as part of the tax audit. By checking whether the auditors are focusing on specific documents, you can already understand which direction they are interested in taking and this helps to prioritise things.
Taxpayers must understand which areas they will be aggressive in defending and in which areas they can exercise a relaxed approach.
Taxpayers need to anticipate the tax authorities’ thinking and reasoning and try to answer some of their specific questions in more detail than is typical to help the authorities understand that whatever the decision is about a specific tax affair – be it a specific tax deduction or a VAT claim – there was a very thorough, well thought-out process on the part of the company before making the decision.
As part of the litigation risk mitigation strategy, I think that obtaining advance rulings from the Ministry of Finance is a very good thing for taxpayers to do. In the last two or three years, we have obtained dozens of advance rulings for our clients on complex tax issues and as practice shows, the tax authorities have not decided to appeal any of the Ministry of Finance’s rulings.
Evgeny Timofeev (ET): There is virtually no way to avoid tax disputes. This applies no matter what you do and whether you follow the Ministry of Finance informal recommendations or not.
My advice to taxpayers would be to think in the first place about how to win the unavoidable dispute and pay more attention to case law rather than to administrative positions of the tax authorities.
Roustam Vakhitov (RVak): Taxpayers should do business with reputable banks and avoid doing business with partners of doubtful reputation, especially when they are mala fide taxpayers.
It is important to try to meet indexes of profitability and effective tax rates elaborated by the tax authorities and to avoid rapid changes in business activities.
Taxpayers should also avoid selling products or services at a price which sharply differs from market prices and/or transactions with residents of blacklisted countries, such as Cyprus and the British Virgin Islands.
Transactions and tax structuring should always be carried out on the basis of genuine business considerations rather than tax planning strategies.
ITR: What is the first step a company should take when it becomes involved in a dispute with the Russian tax authorities?
RVak (pictured right): Companies should immediately engage professional tax litigation lawyers and create a project team of in-house and external lawyers working on assignment together.
Taxpayers must be compliant with the requests of the tax authorities, but be prudent at the same time. It does not do any good to help curing explicit procedural and other mistakes of tax authorities before the case goes to court. Demonstrating such mistakes in court will help to win the case while rectifying them before the court hearing will just make the case of the tax authorities stronger.
RV: Usually a taxpayer plan for a tax dispute and it should not come as an unexpected exercise. There are a number of things which are hugely important, for example, when you have a tax decision there are a number of tax misstatements that the tax authorities may bring against you and you need to prioritise which are most important for you in terms of: the amounts involved; the complexity of the issue and the critical impact the issue will have on the business. Taxpayers must focus on these things rather than trying to fight all sorts of problems at the same time, confusing the judge and confusing advisers.
Taxpayers must work out which issues they can compromise on and settle and which issues they will aggressively fight.
Secondly, taxpayers must understand the merits of their case and do a pre-assessment of whether litigation is going to succeed. There is not much sense spending a lot of money on consultancy in fighting an issue which has already been adversely decided at a high level of court system.
ITR: How should a company organise its tax dispute team and tax advisers when it is involved in a tax dispute?
ET (pictured below): In Russia, tax disputes rarely last more than 18 months. Within that time it is usually possible to go through the administrative appeal stage and three stages of the litigation. My advice would be to make sure the external lawyers involved have full support from the staff in terms of provision of information necessary and to avoid joint teams from two or more law firms as they may follow
ITR: How can a company maintain a good relationship with the tax authorities during a tax dispute?
RV: Any case needs to be run on the basis of professional standards. I don’t think the relationship needs to be good or bad, it just needs to be professional. During a dispute, the authorities may request documents and if the requests are reasonable, taxpayers should provide them in a timely way, but if taxpayers do not think it is relevant then they can refuse to provide them.
ITR: Do you see any future trends in the areas the Russian tax authorities will focus on?
RVak: Recent jurisprudence where passive foreign financing companies were effectively disregarded, such as the Naryanmarneftegas case, suggests that tax authorities may attempt to develop this success further and extend it to passive foreign holding companies.
Beneficial ownership is another area of possible disputes. Lastly, as of mid-2013, tax authorities will effectively conduct transfer pricing audits under new legislation, which will result in significant tax adjustments and major tax disputes as well.
RV: I think the tax authorities will be more aggressive in looking at thin capitalisation positions of companies. I think they will be revisiting their approach and there will be more and more challenges against moving debt and fusion into the Russian Federation by companies.
In the next 12 months I don’t think that any specific transfer pricing cases will be on the agenda but obviously, various transfer pricing cases will be looked at from a different perspective, for instance, in terms of the economic justification of deduction of certain expenses. I think there will also be more focus on the tax treatment of royalties.
I think the tax authorities will be choosy in looking at big numbers. The trend we are seeing is that the number of cases is reducing but the amounts involved are much bigger than we saw several years ago.
The tax authorities are prioritising their focus and demonstrating a big appetite for cases which can bring more revenue.
The substance over form case for thin capitalisation and shareholders’ loans re-characterisation (Naryanmarneftegas) was a very significant win by the tax authorities, which impacts a lot of tax planning of Russian joint ventures, transactions and structuring.
Taxpayers must be more careful now in joint venture transactions, to agree on how the shareholders will finance the joint venture to make sure that the finance is not re-characterised as a shareholders’ loan if they want to infuse any debt through a sister company.