ViciunaiRus LLC was engaged in production and wholesale distribution of its products. During the inspection, the inspection concluded that the chain of contractual relations between the Company and its sole official distributor in the Russian Federation artificially had established intermediates that do not have assets and personnel. At the same time, the price of products increased by more than 20% in the course of movement along the chain of counter parties. During the period from 2012 to 2014, the tax authorities considered the inclusion of intermediaries in the sales structure to be of a artificial nature and aimed at understating the sales revenue. The taxpayer was additionally charged profit tax and VAT, and the additional tax was calculated based on the resale price at which the goods were received by the distributor. In 2012 and 2013 the transactions between the taxpayer and distributor were controlled. In 2014 they were not. The taxpayer objected to the tax authority’s decision; among other things, the taxpayer argued that the tax authority was obliged to apply the methods of determining market prices set forth in Section V.1 of the Tax Code when making additional accruals, but applied a different method (took the last link price). The court of first instance and the court of appeal concluded that the tax authority had exceeded its authority to make transfer pricing adjustments during the tax periods under review for controlled transactions between related parties. With regard to the amount of additional accruals for the period of 2014, the court rejected the taxpayer’s argument that the tax authority was obliged to follow the methods of transfer formation when calculating the tax liability. The applied method of additional accrual – the use of the price of the last link in the chain of intermediates – was recognized by the court as lawful. The Supreme Court cancelled the decision of the lower courts and sent the case back for re-consideration. The conclusion of the lower courts that in the period 2012-2013 the Inspectorate carried out price control for compliance with the market prices was erroneous. The price control was not carried out, but a set of circumstances was established, testifying to the coherence of actions of interdependent persons in order to obtain unjustified tax benefit. Taking into account the proof of the fact that the Company received an unjustified tax benefit, the tax authority correctly calculated the income that the Company should have received when selling goods directly to an interdependent person without using intermediary firms. Click here for translation ...

Garnet-SPb was the exclusive representative of a German manufacturing company in Russia. Following introduction of restrictions on the supply of certain categories of goods to Russia by the European Union in 2014, the Company had used the services of an intermediary trading company. The intermediary offered the Company to purchase products previously purchased directly from the manufacturer. The difference between the export price of goods according to the manufacturer’s data and the price at which the goods were now purchased by the Company – through the intermediate – was over 40%. During the audit, the tax authority considered that the Company was able and actually exported the goods itself, the transition to the new delivery scheme was aimed at obtaining unjustified tax benefits in the form of overstatement of VAT deductions. The amount of additional income tax and VAT was calculated by the tax authority on the basis of the export value of these goods. The court of first instance ruled in favor of the taxpayer. The court did not see an unjustified tax benefit in the acquisition of goods from abroad through a chain of intermediaries due to the existence of restrictions due to EU sanctions. The new setup of supply was due to objective factors, and the tax authority unreasonably failed to take into account the Company’s arguments that under the EU restrictive measures the Company had grounds to engage intermediaries to guarantee the supply of equipment within the time agreed with its further customers. The tax authority has not proved, multiple deviation from market prices. The tax authorities had not established the market price of identical goods in Russia – taking into account its uniqueness and the current regime of measures limiting the turnover of such goods. The Court of Appeal overturned the decision of the Court of first instance and ruled in favor of the tax authorities. “On the basis of the investigation of the case materials the court of appeal concluded that in the case under consideration the tax authority rightfully proceeded from the established circumstances of artificial inclusion of disputed counter parties into the supply chain as intermediaries for the purpose of unjustified increase of the value of goods in order to overestimate the tax deductible expenses, therefore, it reasonably established the amount of expenses incurred by the taxpayer, taken into account for the purposes of taxation, based on the value of the equipment specified by the manufacturer” Click here for translation ...

Neftemash-Service LLC sold real estate (administrative and warehouse building, land plots, part of a workshop building) to two individuals that were also founders of the company and held the positions of general director and commercial director. The Company claimed the transactions were caused by an urgent need for capital, and that the reason for selling directly to the founders was that no third parties were interested in buying the properties. The Russian tax authorities held that the properties had been sold at non-arms length prices and issued an adjustment based on the market value. The court supported the position of the tax authorities. The price was lower than its market value at the time of sale, and the prices of land plots were substantially lower than their original purchase prices. Prices deviated from the market values multiple times (2-29 times). The tax authorities arguments in regard to the choice of pricing method (which was no a CUP) was found to be sufficient by the Court. The Company’s argument, that it was impossible to sell real estate at a higher price was rejected. In the opinion of the Court, the Company had no intention of selling the property to third parties. The Court also noted, that Neftemash-Service LLC continued to work in the building that was sold, but now under a lease agreements concluded with the founders. At the same time, the cost of maintaining the property continued to be carried by NefteMash-service LLC. The decision was upheld by the Court of Appeal and later the Supreme Court. A64-1247-2017 ...

LLC Bogoroditskoye processed and preserved fish and seafood. During the period under review, these products were sold only to related parties. Following an transfer pricing audit, where the TNMM method was used, the tax authority concluded that the price of products paid by the related parties had been significantly lower than market prices, and that the non-arm’s length pricing had lead to an unjustified tax benefit. LLC Bogoroditskoye disagreed and brought the assessment to court The courts of first instance and the Court of Appeal found the assessment lawful, since sufficient evidence had been provided in support of the approach taken by the tax authorities. The (internal) CUP method has priority in Russia, but the tax authority justified the inability to apply it in the present case, as during the audit period LLC Bogoroditskoye did not enter into any transactions with persons who were not related. The subsequent sale price method can be used in situations “where the taxpayer under audit is a reseller of the purchased goods” but in this case LLC Bogoroditskoye was a manufacturer of the products and not a reseller. The cost method are mostly used in transaction involving the provision of services. The approach of the tax authorities (use of the TNMM method), was found to be both reasonable and in line with the tax legislation. А62-8105-2017 ...

A group company, PI, purportedly provided management services to the Ashin Steel Trading House. During the audit for FY 2013-2015 the tax authority came to the conclusions that Ashin Steel Trading House and the PI had “deliberately created a management relationship scheme so that service providers are listed on the staff of an entrepreneur who pays tax on the ONS with the object of taxation “income””. Significant sums of money was transferred to PIs in the form of payments for the provision of management services for their subsequent withdrawal and to the accounts of an individual (from the accounts of the PI), which allowed the Company to minimize tax revenues. The tax authority recalculated the Company’s expenses for the management services, using a combination of transfer pricing methods – cost plus and comparable profitability. The Decision of the Court of Appeal: The CUP method has priority, but in cases where it is not subject to application, the tax authority has the right to use one of the other methods:“Thus, the provisions of Article 105.7 of the Russian National Assembly do not establish the mandatory consistent application of methods for determining the market price of goods established by subparagraphs 2-5 paragraphs 1 of Article 105.7 of the Russian Federation, in the event that the method of comparable market prices cannot be applied. The tax authority in this case is entitled to choose from any remaining methods, as well as their « combination.” Due to the specifics of the PI’s activities, it was not possible to apply the CUP method, so instead the tax authorities had used a combination of methods. On this issue the Court stated: “the method used by the tax authority to determine costs is not contrary to tax law“. The court also referred to the industry-based performance measures summarized by the Federal Tax Service: The profitability of similar activities in 2013-2015 is significantly lower than the indicators used by the tax authority, in connection with which the court correctly stated that the measures applied by the tax authority do not violate the rights of the taxpayer. Click here for translation ...

ViciunaiRus LLC was engaged in production and wholesale distribution of its products. During the inspection, the inspection concluded that the chain of contractual relations between the Company and its sole official distributor in the Russian Federation artificially had established intermediates that do not have assets and personnel. At the same time, the price of products increased by more than 20% in the course of movement along the chain of counter parties. During the period from 2012 to 2014, the tax authorities considered the inclusion of intermediaries in the sales structure to be of a artificial nature and aimed at understating the sales revenue. The taxpayer was additionally charged profit tax and VAT, and the additional tax was calculated based on the resale price at which the goods were received by the distributor. In 2012 and 2013 the transactions between the taxpayer and distributor were controlled. In 2014 they were not. The taxpayer objected to the tax authority’s decision; among other things, the taxpayer argued that the tax authority was obliged to apply the methods of determining market prices set forth in Section V.1 of the Tax Code when making additional accruals, but applied a different method (took the last link price). The court of first instance and the court of appeal concluded that the tax authority had exceeded its authority to make transfer pricing adjustments during the tax periods under review for controlled transactions between related parties. With regard to the amount of additional accruals for the period of 2014, the court rejected the taxpayer’s argument that the tax authority was obliged to follow the methods of transfer formation when calculating the tax liability. The applied method of additional accrual – the use of the price of the last link in the chain of intermediates – was recognized by the court as lawful. Click here for translation ...

Bulatovskiy Basalt LLC extracted and sold basalt rubble. The rubble was sold to three related intermediaries, whom in turn, resold the rubble to the final buyers. The resale price was on average double the transfer price. The tax authorities considered that the sole purpose of incorporating intermediaries into the sales structure was to obtain an unreasonable tax benefit in the form of underestimation of the profits from the sale of rubble and the tax base. According to the tax authorities, Bulatovskiy Basalt LLC could instead have enter into contracts with the final buyers directly. The tax authorities issued an assessment of income based on the resale of the rubble to the final Consumers. Bulatovskiy Basalt LLC brought the case to Court. The courts of the first and second instance ruled in favor of Bulatovskiy Basalt LLC. The courts took into account the existence of reasonable reasons for the involvement of intermediaries, including the presence of real functions.The first instance court considered the method used by the tax authority to calculate the amount of the additional charge to be the price of subsequent sale (Article 105.10 of the Tax Code).The courts indicated that the subsequent sale price method should not have been applied in this case, since the method of comparable market prices has priority.The tax authority did not substantiate the use of the subsequent sale price method actually applied and did not refer to the provisions of Chapter 14.3 of the Russian TC.The tax authority incorrectly applied the subsequent sale price method. The gross profit margin of comparable companies was not calculated. Click here for translation ...

Since 2012, the Company had rented out premises in its administrative building. Among the tenants were both independent parties, and a related party. For the related party, the rent were 10-20 times lower than for the independents parties.The related party tenant subleased, more than 97% of the space it had rented.Furthermore, the cost of operating the building and utility payments were more than 4 times the rental income received. Following an audit for FY 20XX-20XX the tax authority issued a tax assessment on the basis that the Company had received an unjustified tax benefit as a result of price manipulation in a transaction with an related party.The income adjustment had been determined based on the cost plus method, as the tax authority claimed to have been unable to obtain information on rental prices of similar buildings The Courts agreed that the lease agreement was concluded between related parties on non-arm’s length terms and that the Company had received an unjustified tax benefit as a result of the transaction. Nonetheless the tax assessment was declared invalid on formal grounds due to the incorrect application of the cost plus method, which led to unreliable results.In accordance with paragraph 3 of Art. 105.7 of the Tax Code the CUP method has priority, and other methods are applicable only in cases where it is impossible to apply it or its use will not allow to draw a reasonable conclusion about the conformity of transaction prices to market prices.The courts concluded that the tax authority had failed to prove that it was impossible to apply the CUP method. The inspection did not receive undisputed evidence of absence of publicly available information named in clause 1 of Article 105.6 of the Tax Code.At the same time, the Inspectorate had also applied the cost plus method incorrectly: it examined the net profitability of costs rather than the gross profitability of costs, which is a violation of the paragraph (b). Art. 105.11 para. 1 of the Tax Code.The Supreme Court review board agreed with the conclusions of the lower courts, stating in its ruling that an appeal should not be approved for consideration by the Supreme court, due to the incorrect application of methods of determining the income subject to taxation, which led to the unreliability of the tax liabilities calculations. Click here for translation ...

OJSC Mostovsky was engaged in the extraction of sand for construction. The sand was sold to related parties who then resold the sand to final customers. The price paid by the final customers was significantly higher than price paid to Mostovsky by the related intermediaries. Following an audit for 2012-2013, the tax authority held that the setup using intermediate re-sellers was artificial and constructed to obtain an unjustified tax benefit. An assessment was issued based on the “subsequent sale price-method”. Mostovsky disapproved of the assessment and brought the case to court. In their court filing they proposed use of the CUP method. The court found that Mostovsky’s transfer prices had not being arm’s length and that an unjustified tax benefit had been obtained, but disagreed with the method chosen by the tax authority. The “Subsequent Selling Price-method” had not been applied correctly by the tax authority, since: – the inapplicability of the CUP method had not been properly justified; – the gross margin had not been calculated for the tested transaction; – the market interval of gross profitability was determined based on incomparable activities. On that basis, the court considered that the CUP method should be applied based on comparable internal and external transactions. Click here for translation ...

The dispute in this case was transactions involving distressed asset/debt transaction. The tax authorities found the DAD transactions of russian receivables under a “DBO distressed debt structure scheme” lacked economic substance, and denied the taxpayers involved tax decuctions of USD 4.5 and 12.2 million. A report provided on behalf of the government analyzed whether a rational investor would have entered into the transaction were it not for the claimed tax benefits. The Courts opinion: “there was no realistic possibility for the transactions at issue to break even absent any tax benefits.” Hence the transactions were not recognized. US Tax Court, Case No. 11051-10, 6853-12 ...