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Sept. 8 — A Russian technology distributor lost a court appeal to regain use of value-added tax deductions in a case becoming more common as Russian tax authorities step up challenges of expenses taken on related-party transactions.
The Arbitration Court of Moscow District, in a decision (Case No. A40-197337/2015) announced Sept. 1, upheld lower court decisions denying VAT deductions to a Moscow-based distributor of Hitachi Data Systems and Huawei Technologies solutions and disallowing expenses that weren't documented in agreements with related contractors and therefore lacked economic substance.
Russian tax authorities found that the distributor, Dominant Trade LLC, understated its 2011 and 2012 income tax by wrongfully including expenses for the costs of equipment bought from two related contractors, Stock Market LLC and Lagos LLC, and then seeking a refund of the VAT it had paid on those costs. The tax authorities charged Dominant Trade with additional taxes and penalties totaling more than $10 million.
Moscow-based attorney Denis Zaytsev said VAT-deduction denials on related-party transactions are becoming more common in Russia. Russia's highest court in July ruled against the taxpayer in a similar case concerning a shipping and construction company that failed to show it actually shipped steel sheet (162 TMIN, 8/22/16).
In the Dominant Trade LLC case, the Arbitration Court of Moscow District concluded that the taxpayer created only a formalistic document and that the VAT deduction that Dominant Trade had claimed didn't arise in the normal course of business with the two contractors.
It said two lower courts rightly concluded that Dominant Trade “acted without due diligence and care and it must have known about the abuses committed by contractors.”
Attorney Zaytsev said the court cited case law from 2006 that notes that a lack of clear criteria for determining the reality of business activity “generates some controversy” when considering whether actions have a real business purpose.
Zaytsev told Bloomberg BNA Sept. 7 that in practice, this results in bona fide taxpayers, who actually incur the costs listed in their declarations, sometimes being denied income tax expenses and VAT deductions on related party transactions “simply because their contractors have flaws in legal documents or do not look very reliable.”
On the other hand, according to the case law, fraud by third parties alone can't indicate that the taxpayer isn't entitled to tax benefits. Zaytsev said the taxpayer should prove that it conducted all the transactions with third parties with due diligence and show it had no intent of receiving unjustified tax benefits.
Companies should check contractors to ensure they meet the criteria based on which tax authorities might suggest the unjustified tax benefits, Zaytsev said, such as making sure the company's legal address is real and that the company has the material and technical resources to provide the services listed in the contract.
“If the taxpayer proves in court that he conducted all the necessary verifications, the odds greatly rise that he wins this position and regains the right for income tax expenses and VAT deductions,” Zaytsev said.
By Natalia Suvorova
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