Russian Federation: Development Of Practice In Unjustified Tax Benefit Cases

In 2016 the Russian Federation Supreme Court rendered two judicial acts summarizing the approaches formulated in court practice when considering cases of unjustified tax benefit. At the same time, the RF Supreme Court formulated several key conclusions which, as can be expected, should bring greater clarity to considering this category of cases.

These are cases А40-71125/2015 (the Tsentrregionugol LLC case) and А40-87379/2014 (the Energokomplekt LLC case). Although the taxpayer won the first case and the tax authority won the second case, both cases essentially combine a common approach of the RF Supreme Court's Judicial Panel on Economic Disputes to considering cases of unjustified tax benefit.

The main criterion is the reality of the transactions

Both cases were about supply of goods involving suppliers that did not have the necessary resources (warehouses, transport and employees) to engage in supplies.

In considering these cases the RF Supreme Court's Judicial Panel on Economic Disputes put the question of the reality of the economic transactions completed by the taxpayer first. In the Tsentrregionugol LLC case (Ruling No. 305-KG16-4155 of the RF Supreme Court's Judicial Panel on Economic Disputes of 20 July 2016), the RF Supreme Court's Judicial Panel on Economic Disputes also emphasized that the tax authority should bear the burden of proving the transactions are not real.

In this case the fact that the supplies were real was confirmed both by documents (source documents, confirmations of product quality, evidence of movement of the product from suppliers to customer) and by facts (confirmation of resale of the product to end customers and testimony of contracting parties who confirmed delivery).

At the same time, the court declared that the handwriting examination report submitted by the tax authority confirming that the supplier's source documents had been signed by an unidentified person was inadmissible evidence. The reason for this was that the examination had been carried out without following the methodology.

On the contrary, in the Energokomplekt LLC case (Ruling No. 305-KG16-10399 of the RF Supreme Court's Judicial Panel on Economic Disputes of 29 November 2016) the court shared the tax authority's position that the supplies were not real. The reason for this was the consistent discrepancies in the documents evidencing that the documents were made formally only to obtain a tax benefit, as the movement of product reflected in them was economically unprofitable and, in some cases, even unrealistic.

As the appellate court ruling in this case shows, no warehouse was found at the address indicated in the documents, and the product was transported from Magnitogorsk and Novokuznetsk to Leningrad Oblast, then in the opposite direction to Samara, for which there were no rational economic reasons. It took just one day to ship the product from Leningrad Oblast to Samara, which is impossible for objective reasons. Furthermore, the contracting parties did not incur expenses typical for activity for supplying goods (payment for fuel and lubricants, lease of premises, payment of wages to movers and drivers).

Approaches to checking the taxpayer's due diligence

As the RF Supreme Court's Judicial Panel on Economic Disputes stated in the Tsentrregionugol case, in refuting the argument that the taxpayer did its due diligence, the tax authority should prove that the taxpayer knew of the violations by the contracting parties. The taxpayer in turn can clarify how it checked the contracting party's ability to perform the contract.

When considering the issue of whether the taxpayer showed due diligence, the question of carrying out standard actions to check the contracting party was essentially put on the back burner.  The RF Supreme Court's Judicial Panel on Economic Disputes gave two other factors greater importance.

First of all, the court considered the issue of whether the terms of the transaction corresponded to usual (market) terms. In the Tsentrregionugol LLC case the RF Supreme Court's Judicial Panel on Economic Disputes emphasized that the price at which the taxpayer purchased the product corresponded to the market price, while in the Energokomplekt LLC case the court noted the lengthy payment installments which it apparently considered a nonstandard transaction term.

The second factor was the evidence that the taxpayer was complicit in the actions of its contracting parties. The tax authority was unable to prove this in the Tsentrregionugol LLC case. In addition, the RF Supreme Court's Judicial Panel on Economic Disputes once again emphasized that the taxpayer should not be liable for the actions of contracting parties of the second and third levels which it is unable to influence. So the violations by the contracting parties (including nonpayment of taxes) cannot result in negative consequences for the taxpayer.

In the Energokomplekt LLC case the tax authority proved the taxpayer's affiliation with its supplier and with the foreign customer. However, this fact was not reflected in the judicial act of the RF Supreme Court's Judicial Panel on Economic Disputes.

Thus, the judicial acts rendered by the RF Supreme Court have shown that a taxpayer can win unjustified tax benefit cases. At the same time, it follows from the judicial acts that the court gave decisive importance to examining the circumstances of the transactions. So it should be expected that not only the courts but also the tax authorities will pay more attention to determining the facts in such cases at the tax audit stage.

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