What has happened?
Letter No. SA-4-7/16152@ of 16 August 2017 "Concerning the Application of the Provisions of Federal Law No. 163-FZ of 18 July 2017 "Concerning the Introduction of Amendments to Part One of the Tax Code of the Russian Federation"" was published on the official website of the Federal Tax Service on 25 August.
The Letter contains guidance on issues relating to the application of the provisions of Article 54.1 of the Tax Code, which was introduced by Federal Law No. 163-FZ of 18 July 2017 with effect from 19 August. It also gives various instructions as to the methods by which tax authorities should check compliance by taxpayers with the provisions of Article 54.1.
The major points of the Letter are as follows:
- A tax authority should not determine a taxpayer's rights and obligations by computation
The FTS states that where a taxpayer has misrepresented the true economic substance of a financial transaction, the tax authority should not determine its rights and obligations by computation.
This means that where a tax authority finds the existence of either of the two circumstances specified in clause 2 of Article 54.1 (i.e. where the main purpose of a transaction was to enable the non-payment of taxes or transaction obligations were not fulfilled by a person who was a party to the relevant contract), the deduction of expenses and claims for VAT offsets must be disallowed in full.
- Tax authorities must not follow a formalistic approach in demonstrating the occurrence of tax base understatement or tax evasion
The FTS points out to tax authorities that the provisions introduced in clause 3 of Article 54.1 are intended to deter tax authorities from taking a formalistic approach to demonstrating that taxpayers have understated their tax obligations by challenging their transactions on purely technical grounds.
The FTS points out in this regard that since Federal Law No. 163-FZ does not provide for the application of the evaluative concept of "failure to show due circumspection", formal assertions of wrongdoing on the part of a taxpayer's contract partners (such as tax violations, the signing of documents by unidentified persons, etc.) cannot, in the absence of evidence refuting that transactions were genuinely performed by the contract party specified by the taxpayer, be regarded as a basis in themselves for disallowing expenses and deductions.
In carrying out tax control, therefore, a tax authority must establish whether a transaction was genuinely performed by the first-tier contract party or a person to whom the obligation to perform the transaction was transferred by contract or by law.
- Tax law does not prescribe negative consequences for actions of second- and subsequent-tier contract partners
The FTS expressly states in the Letter that the provisions introduced by Federal Law No. 163-FZ do not impose negative consequences on taxpayers for unlawful actions of second-, third- and subsequent-tier contract partners. This position has been maintained in case law, but it is the first time it has been overtly supported by the FTS, which had previously stated only that unlawful actions of lower-tier suppliers cannot in themselves be considered a basis for subjecting a taxpayer to negative consequences.1
- Tax authorities must collect evidence that a taxpayer (and its officers and shareholders/founders) deliberately acted to bring about conditions aimed exclusively at securing a tax benefit
The FTS cites indications of deliberate action, such as:
- evidence that contract partners at issue are under the legal, economic or other control of the taxpayer under audit, including by reason of being related entities
- evidence of conduit operations between related or affiliated parties to interrelated transactions, including via intermediaries, using special forms of settlements and payment schedules
- signs of collusion between the parties to a transaction, etc
These indications are generally consistent with the recommendations for proving the deliberate non-payment or underpayment of tax which were previously presented by the FTS.2
The FTS also draws the attention of tax authorities to the special rules governing the entry into force of Federal Law No. 163-FZ: it applies to in-house tax audits of tax declarations submitted to a tax authority after the effective date of the law and to on-site tax audits and tax audits of transactions between related persons that are ordered by the tax authorities after the effective date of the law.
The tax authorities are also required to present quarterly reports to the FTS on the implementation of the provisions of Federal Law No. 163-FZ. It is not yet clear what data those reports will contain.
What are the implications?
All in all, the letter does not provide any fundamentally new arguments that might be of use to taxpayers in disputes with the tax authorities. On the contrary, the approach set out in the letter could ultimately put taxpayers in a worse position than before.
The central issue is that of whether a transaction was genuinely performed by a first-tier contract partner (or a person to whom the obligation to perform the transaction was transferred by contract or by law).
Since the letter does not define what is meant by the "genuineness" of transactions, it is not clear what functions a contract partner needs to perform in order to prove that a transaction is genuine.
Nor can it be ruled out that the tax authorities will challenge transactions in which the taxpayer actually received what was due to it not from a contract partner but from another person not mentioned in the contract with the taxpayer.
The conclusions set out in the letter may lead to higher tax demands: whereas previously the tax authorities often calculated amounts of deductions and expenses that could lawfully be claimed, meaning that claims were only partially disallowed, they are now required to disallow the entire amount of expenses and VAT offsets.
One positive element of the letter is the FTS's instruction to tax authorities not to adopt a formalistic approach in evaluating a taxpayer's actions.
1 Letters of the Federal Tax Service No. YeD-5-9/547@ of
23 March 2017 "Concerning the Determination of the
Circumstances of an Unjustified Tax Benefit" and No.
SA-4-7/24825@ of 23 December 2016 "Concerning the Forwarding
of a Review of Legal Positions Reflected in Rulings Made by the
Constitutional Court of the Russian Federation and the Supreme
Court of the Russian Federation in the Second Half of 2016 on
2 Letter No. YeD-4-2/13650@ of the Federal Tax Service of 13 July 2017 "Concerning the Sending of Methodological Recommendations on the Determination in the Course of Tax and Procedural Audits of Circumstances Indicating Intent on the Part of Officers of a Taxpayer to Enable the Non-Payment of Taxes (Levies)".
First published 6 September 2017
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.