Global Tax Alert (News from Transfer Pricing) | 25 July 2013

Final Ruling of Russia's SAC highlights the risks of a cost allocation approach to charges to Russian subsidiaries

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On 15 July 2013, a panel of judges of the Supreme Arbitration Court (the SAC) rejected a petition to refer a case to the Presidium of the SAC for a supervisory review. As a consequence, the taxpayer, part of a multinational group, is liable for significant additional tax plus fines and interest. The case is of wide interest because it concerns the deductibility of expenses recognized as incurred under agreements concluded with a foreign affiliate on the provision of strategic and ancillary consulting services.

The case highlights the tax risks that may arise if group costs are pushed-down to a Russian company based on an allocation policy and a service agreement.

The dispute arose from an on-site audit of the taxpayer. The tax inspectorate determined there was no evidence services had been provided for the value deducted by the taxpayer and concluded the supporting documents had been drawn up in order to secure an unjustified tax benefit. This view was supported by both the appeal court and the cassation court, which found that the evidence showed the company had received an unjustified tax benefit by recognizing the disputed operations for taxation purposes not in accordance with their true economic intent.

The SAC's determination concluded that the appeal and cassation courts applied the law correctly and noted that it is not within the authority of the Presidium of the SAC as a supervisory court to re-evaluate the facts of the dispute.

Based on the courts' decisions, it is possible to identify a number of key issues for Russian taxpayers deducting amounts invoiced by affiliates.

  • Russian tax legislation does not envisage cost sharing between legal entities or allow expenses to be transferred between legal entities.
  • A service agreement does not justify the transfer of costs between legal entities. Expenses incurred under a service agreement must relate to services received by the taxpayer in order to be recognized for tax purposes.
  • Tax inspectors often require more evidence of the provision of services than a contract, invoices and acceptance acts for services. Such documentation is a prerequisite for deductions but may be insufficient to guarantee them. Additional evidence that the economic intent of operations was in accordance with the documents may be required.
  • The pricing of the services in the case was based on the re-allocation of the service provider's costs to Russian members of the group in proportion to the revenue from the Russian market. This led to a 25-fold increase in the value of services recorded by the taxpayer in 2009. The taxpayer was unable to satisfy the tax inspectorate or the higher courts that this increase arose from any increase in the volume of services or change in the nature of the services received. Any significant variations in the level of service fees recorded by a Russian taxpayer should be supported by contemporaneous correspondence justifying the change, for example, because additional services were requested and rendered.
  • The courts do not accept OECD transfer pricing principles as justifying deductions inconsistent with Russian law.
  • The tax inspectorate's computation of additional profits tax payable was based on an expert's report. The SAC confirmed the right of the courts to take such reports into account, given that they may take into account any circumstances relevant to the determination of the results of a transaction.1
  • Petitions to the SAC and the cassation court do not provide further opportunities to establish the facts of a dispute. In tax litigation it is essential to provide all evidence necessary to support a petition to the lower courts.

These issues should be understood and taken into consideration by taxpayers wishing to reduce the risk of disputes about the deductibility of service fees payable to overseas affiliates.


1. Clause 12 of Article 40 of the Tax Code.

For additional information with respect to this Alert, please contact the following:

NSN Alliance (in cooperation with Ernst & Young (CIS) B.V.), Moscow
  • Sergei Nosov
    +7 495 755 9874
Ernst & Young (CIS) B.V., Moscow
  • Alexandra Lobova
    +7 495 705 9730
Ernst & Young LLP, Russia Tax Desk, New York
  • Julia Samoletova
    +1 212 773 8088

EYG no. CM3674