Posted Date : 11 Apr 07
ICLC, a LEA member, is doing its best to facilitate improvement of the Russian tax legislation. The work is aimed at enhancement of the Russian tax system, which is “young” enough and hence is not perfect. Such work is implemented in the Russian Federation on a constant basis. ICLC has its representative in the RF Chamber of Commerce and Industry who is a member of CCI task group working on improving tax laws and relevant law enforcement matters.
As a member of the RF CCI target group ICLC has been introduced to a draft of The Basic Trends of the Russian Federation Tax Policy for 2008-2010 developed by the RF Ministry of Finance.
The document suggests that the tax policy should be developed in the medium term with the top priority set on control over dual price formation for tax purposes. The RF Ministry of Finance has already developed Draft Project of Amendments to the RF Tax Code to deal with the said issues.
We do believe you and your clients who run business or have business associates in Russia could be interested in this information. Below you can find extracts from The Basic Trends of the Tax Policy covering the issues mentioned above.
As results from the up-to-date situation it is crucial for the Russian tax system to find possibilities to prevent usage of such transfer prices that bear relation to or are under control of companies whose aim is to minimize their tax liabilities. At that, the following key tax optimization methods based on application of transfer prices can be suggested:
1) Concentration of the added cost in a company that transfers its economic profit to the benefit of a third party and ceases its activities before paying taxes to the budget;
2) Concentration of profit in a company that pays the profit tax in the regions of the Russian Federation granting certain privileges for paying this tax. Such privileges can include:
- establishment of a reduced tax rate for the profit tax paid by organizations (reduced by 4 points in comparison with its maximum size);
- actual reduction of the profit tax rate for profit whose amount exceeds the one stipulated by the tax legislation in the form of giving subsidies from the budget equal to the amount of excess tax payments;
3) Concentration of profit in companies under control that are considered to be taxpayers in foreign countries with beneficial tax payment systems;
4) Minimization of other ad valorem taxes paid by corporations on the territory of the Russian Federation. Thus, for example, at collection of the tax levied on mining operations excepting hydrocarbon raw materials ad valorem tax rates are applied. It facilitates creating incentives to underprice transactions effected by Russian taxpaying companies which are under control of taxpayers of the tax levied on mining operations.
In Russia the major task to be implemented by tax authorities is undertaking measures preventing such kinds of manipulation. When the tax result is distributed between the parties which have performed a deal using prices resulted from the absence of interrelation between the parties, sanctions of administrative or criminal character shall be applied. At that, tax authorities implement control over both: transactions performed between companies formally related and transactions suspected of manipulating prices by previous concert with the aim to minimize tax liabilities.
Norms of the current Russian legislation do not allow to control tax payments in full in case the dual pricing methodology is applied.
Article 40 of the RF Tax Code contains norms and regulations giving the right to tax authorities to implement control over prices applied in transactions between taxpayers as well as to pass a motivated decision on the additional charge of the tax and penalty, calculated in way as if the results of this transaction would have been assessed on the basis of application of market prices for relevant goods, works or services.
In cases provided for by this Article, when the prices of goods, works or services applied by the parties to a transaction deviate upwards or downwards for more than 20 per cent from the market price of identical (homogenous) goods (works or services), the tax body shall have the right to verify the correctness of prices used by a taxpayer applicable to identical (homogeneous) goods (works, services) within a short period of time.
According to the current legislation in cases when measures of control reveal that actual prices deviate for the market prices by 20 % tax authorities have a right to charge tax amounts additionally basing on the market prices. Also the Article contains regulations on determination of identical (homogenous) goods (works or services) and prescribes a method for consequent realization and a cost-based one for determination of the market price of goods, works and services if no information on identical (homogenous) goods (works or services) is available.
It's essential to note that the current structure of Articles 20 and 40 of the RF Tax Code does not allow to apply dual pricing to fight tax evasion effectively. Thus, it provides that control over prices of transactions shall be based on deviation of the price used by a taxpayer from the price used by the same taxpayer before with regard to identical (homogenous) goods (works or services); such provision allows to control all transactions implemented with no respect to interconnection of or general control over these transactions. The analyses of judicial practices and opinions confirms the fact that 20% deviation between actual and market prices in most cases is used as a basis for charging additional tax amounts in accordance with Article 40 of the RF Tax Code. At that, it is not required to prove such interconnection between the parties participating in a transaction or their staying under general control.
Thus, according to the Russian tax legislation a considerable deviation of the current price from the one used before can be a base for forming an opinion that the parties are interconnected that in its turn proves the necessity to implement control over transactions. However, the deviation between actual prices and the prices used before cannot be considered to be a substantial evidence of such interconnection between the parties of a transaction.
Charge of additional tax amounts with application of the dual pricing methodology is one of the most labor consuming researches carried out by tax authorities; however, the current legislation allows to minimize expenses borne by tax authorities for implementation of tax control in the field mentioned above; as a result additional expenses are borne by taxpayers including those ones who are good faith and do not use dual pricing, though find conceivable variations in prices that exceed limits established legislatively.
Besides mentioned above the current legislation has a number of other deficiencies resulting from inadequate and immature provisions of Articles 20 and 40 of the RF Tax Code. Innovations planned to be introduced in the tax legislation in the middle term are mainly aimed at elimination of the foresaid deficiencies.
Alterations in the tax legislation as related to dual pricing shall be made in the following areas:
а) Determination of interrelationship and interdependency of persons
The fact that the parties are interrelated shall be the reason for control aimed at dual pricing regulation.
b) Determination of an exact list of transactions under control.
Thus, types of transactions requiring specific control shall be stated including transactions between related persons, transactions on international contracts signed with companies acting under low tax jurisdictions and barter or bargaining transactions. It shall be noted specifically that control over price deviation taking place due to the counteragent or the time of a contract conclusion should be abandoned.
в) Introduction of a regulation to submit special declarations of transactions under control and of requirements to a list of documents to be submitted by taxpayers containing substantiation of usage of dual prices in transaction with related persons.
The amended version of the Tax Code shall contain provision confirming the liability of corporations participating in deals to be under control to communicate information on such deals and their key characteristics to tax authorities.
Provided by the fact that application of dual prices shall not be a method to evade taxation but just application of a price agreed upon by two related persons, it is considered unreasonable to impose any penalties on taxpayers regarded as related persons participating in transactions to be under control who prove to have given sufficient substantiation to the prices applied.
c) Introduction of institution of preliminary agreements for price formation.
Between taxpayers that conclude contracts to be under control and tax authorities. It shall be an instrument which allows related persons to conclude agreements prior to performance of the deal that will fix methods of price determination which will not result in any tax reduction. In case terms of such agreements are met in full, the price indicated in the contract shall be considered to be a market one and additional assessment is not required.
d) Introduction of new requirements to methods of market prices assessment as well as of principles of their application.
It causes difficulties to apply practically methods of assessing market prices (that are “arm's length prices” as called in compliance with international tax terminology) to prevent usage of dual pricing.
It mainly concerns acknowledgement of existence of a range of market prices, application of various methods of the market price assessment in case information about deals with homogeneous goods (works services) is lacking, determination of the order of actions undertaken by tax authorities at identification of exchange prices, etc.
At present it has become widespread to employ minimization of corporate tax liabilities by means of free manipulation of prices at transactions effected by related persons or persons under control. Thus, for example, with the aim to minimize tax liabilities a transaction can be registered in so called low tax zones and jurisdictions allowing usage of tax benefits, preferential tax treatments or tolerant to existence of losses recorded in tax accounting and nonpayment of taxes resulted from illegal liquidation of taxpaying companies.
One more negative consequence of applying dual price formation by groups of companies within the Russian tax payment system is transfer of a mobile tax base from one region to another that results in obtaining profit by some certain Russian regions whereas other ones incur losses. As a consequence of such manipulation not only budgets of those regions sustain losses but the Russian budget system in general.
The dual price formation principle is based on usage of a price different from the price that could agreed upon by two independent persons who are not connected by any relations resulting from common participation in the capital under control or agreement. Hence, if the factual price is different from the price that could be applied by two independent persons and the size of which could be determined by demand and supply conditions, one of the two parties participating in such a deal makes gains at the expense of the other party (in such cases profits gained and losses incurred shall be interpreted in comparison with the ones that could be gained or incurred in case the deal has been made between independent persons). The price of the deal made in such a way can be defined as a dual or transfer price.