Global Tax Alert | 24 September 2013

Russia's SAC's Presidium rules calculation of thin cap limitations must be prepared quarterly

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On 17 September 2013, the Presidium of Russia's Supreme Arbitration Court (the SAC) reviewed a case with respect to the calculation mechanism of the amount of deductible interest on “controlled” loans, i.e., loans received from or guaranteed by the shareholders. This is a significant new development in judicial practice with respect to the application of the thin capitalization rules.

Prior to this ruling, it was unclear whether the calculation of deductible interest under clause 2 of Article 269 of the Tax Code should be performed on a quarterly (standalone) basis as opposed to a cumulative basis in accordance with the tax reporting periods. Ministry of Finance clarifications and judicial decisions varied in this respect and businesses have applied varying positions in the face of this uncertainty. Some companies considered that if the net assets are increased e.g., due to an equity injection (or the “controlled” debt decreased due to its repayment) immediately before the end of a reporting period, then this leads to a re-computation of the debt/equity coefficient for the whole cumulative reporting period, rather than just the last quarter, ultimately resulting in an increase of the deducible interest for the reporting period.

The main issue debated at the hearing was the legitimacy of a recalculation of the thin cap ratio on a cumulative basis in subsequent reporting periods. Profits tax returns are normally filed for the first quarter of a calendar year, the first six months, the first nine months and the year as a whole (unless the taxpayer opts for monthly reporting which is uncommon). The taxpayer in the present case had recalculated interest deductions for each period covered by a tax return, resulting in the recognition of increased interest as deductible in relation to the earlier part of the tax year due to changes in its balance sheet at the year-end.

The tax inspectorate did not accept the recalculation of interest for periods covered by previous tax returns. The lower courts concluded that tax law did not prohibit the adjustment (recalculation) of deductible interest expenses, but the case was referred to the Presidium of the SAC for a supervisory review.

At its hearing on 17 September, the Presidium supported the position of the tax authorities and ruled that deductible interest expenses have to be calculated on a quarterly basis and should not be recalculated for subsequent changes in the taxpayer's balance sheet position.

This ruling of the SAC will force companies to act more quickly to rectify their thin capitalization if they wish to safeguard interest deductions in the first nine months of a tax year and not wait until the last quarter.

Once the ruling is published, a detailed Alert will be issued regarding the judges' reasoning and the enforcement of the ruling.

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

Ernst & Young (CIS) B.V., Moscow
  • Vladimir Gidirim
    +7 495 705 9716
  • Maureen O'Donoghue
    +7 495 228 3670
Ernst & Young LLP, Russian Tax Desk, New York
  • Julia Samoletova
    +1 212 773 8088

EYG no. CM3823