Oda Russian Commercial Law 2007-1

In the court review of cases, the following case was reported without names:

A procurator initiated an action in the interest of the state and the society vis à vis the government of a constituent entity, arguing that the latter’s decision to grant privilege to a joint venture was invalid, since it was against the interest of the region. The joint venture was formed between a foreign company with 40% participation in the capital and two Russian companies for the purpose of developing an oil eld in an autonomous region. The royalty was set at 10% and the pro t tax was set at 32%. The foreign company contributed 40 million US dollars.

After the rst year of operation of the joint venture, there was a change to the land legislation and the tax rate went up. Export tax was also increased. The foreign company asked the government of the autonomous region to reduce the tax burden in accordance with the parameters in the Technical Economical Basis of the project. The government of the autonomous region exempted the joint venture company from export tax for three years and reduced the royalty by 5%.

The defendant – the government of the autonomous region – defended its position in court by reference to the grandfather clause in the 1991 RSFSR Law on Foreign Investment and Article 9 of the 1999 Foreign Investment Law of the Russian Federation.

The commercial court found the defence of the defendant to be with grounds and dismissed the claim of the procurator.16

5TAX AGENCY

The agency which is in charge of collecting taxes and levies in Russia used to be the Ministry of Taxes and Levies. The system was changed by the “Administrative Reform” in 2004, and the Ministry was replaced by the Federal Tax Service (Federal’naia nalogovaia sluzhba Rossii, “FSN”) and its territorial agencies.17

The Federal Tax Service is subordinate to the Ministry of Finance which, inter alia, gives written explanations on the application of the Federal tax law. The Federal Tax Service represents a “single centralised system” (Art.30). This wording is also a novelty introduced by the 2004 amendments.

The power of the Federal Tax Service includes the right to:

i)demand taxpayers to submit tax declarations, to provide documents and explanation which support the accuracy and timeliness of the calculation;

16Item 8, Information Letter No.58 of the Plenum of the Supreme Commercial Court, January 18, 2001.

17Edict of the RF Government, September 30, 2004.

ii)conduct tax inspections (proverka);

iii)seize documents in the course of inspections which demonstrates a violation of tax law, provided that there are suf cient grounds to assume that these documents would be destroyed, concealed, modi ed or replaced;

iv)summon taxpayers for questioning concerning payment of tax or tax inspection;

v)suspend bank transactions of tax payers and attach their assets in accordance with the procedure set by the Code;

vi)search the business premises of taxpayers and prepare an inventory of their assets;

vii)determine the amount of taxes payable by the taxpayer;

viii)demand taxpayers to rectify the violation of tax law and supervise the process of recti cation;

ix)collect unpaid taxes and the interest for the delay (pen’) and nes;

x)monitor the compatibility of large expenditure with the income of individuals;

xi)request from banks documents supporting the instruction for tax payment by taxpayers;

xii)involve specialists and experts and summon witnesses;

xiii)present petitions for the revocation or suspension of license for performing certain kinds of activities by taxpayers;

xiv)bring an action to the ordinary court or commercial court for:

(a) collecting tax sanctions for the violation of tax law;

(b)recognising registration of juridical persons and registration of individual entrepreneurs as null and void;

(c)liquidation of organisations regardless of the type of ownership;

(d)collection of unpaid taxes and corresponding interests and nes of more than three months from subsidiaries in cases where the proceeds from the realisation of products of the subsidiary have been paid into the bank account of the parent company or the other way around;

(e)accelerated termination of agreements on tax credits.

Monitoring of the large expenditure by individuals had existed under socialism, but the original 1998 Tax Code did not accommodate this system. On the other hand, the original Code had empowered the tax agency to apply to court for acknowledging a particular transaction of the taxpayer to be void and for permission to con scate the proceeds of the transaction for the bene t of the state budget. The tax agency was also empowered to con scate income arising from unlawful activities. By the July 1999 amendments, this new system of monitoring was introduced and the latter two provisions were deleted. It was thought that such measures would be better left to law enforcement agencies. However, under the general provision of the Civil Code, the agency is still entitled to

initiate an action in court in order to nullify a transaction on the basis of legal order and good morals (Civil Code Art.169).18

Aunique system under Russian law is the seizure of tax arrears and penalties from subsidiaries if the proceeds of the products of the company were paid into the subsidiary’s account, or in case the subsidiary is in arrear and the subsidiary’s proceeds were paid into the parent company’s account.

In addition to the former Ministry of Taxes and Levies, there was another agency by the name of Federal Tax Police. It was set up in 1992 as part of the then Federal Tax Service. Its task was to prevent, detect, and investigate violations of tax law which entailed criminal or administrative sanctions. The tax police was not subordinate to the tax agency, but rather, was an independent agency subordinate to the President and was expected to cooperate with the tax agency.

The tax police, which was notorious for its ruthlessness, was abolished in 2003. The Tax Code now provides that agencies of the Ministry of Internal Affairs participate in the tax inspection upon the request of the Federal Tax Service (Art.36). The enforcement function of the Tax Police was inherited by the Ministry of Internal Affairs. A commentary suggested that the strength of enforcement has not been affected by this change. The role of the Ministry of Internal Affairs in the area of tax enforcement is no less than that of the former tax police.19

6THE PROCEDURE

1)Tax Inspection

The tax agency is in charge of “tax control”, which is a procedural act to ensure compliance with the tax legislation, accurate accounting of taxes, and timely and full payment of taxes. It includes inspections, obtaining of documents and explanations, review of such documents and explanations, and the search of the premise and territory used for the pursuit of pro t.20

There are in-house inspections and on site inspections. The former are conducted in the of ce of the tax agency, while the latter take place on the tax payer’s premise. On site inspection is conducted upon a decision of the head of the tax agency. The maximum length of the inspection is two months (Art.89,

18Zrdelecskii, Kommentarii..., supra, p.97.

19Zakharov et al. eds., supra, pp.140-141.

20A.N.Kozyrin ed., Kommentarii k nalogovomu kodekusu RF, chast’ pervaia, Moscow 2005, pp.406-407.

agency with the relevant information regarding the opening and closing of the accounts by organisations (Art.86, para.1).

In cases where the amount in the account is insuf cient or where information on the accounts was unavailable to the tax agency, taxes can be collected from other assets of the taxpayer (Art.46, para.7). If the taxpayer is an organisation, the head of the tax agency adopts the decision and forwards it to the bailiff for enforcement.

In contrast, for enforcement vis à vis individuals, the above procedure via the bailiff is not available, and the tax agency has to resort to court procedure (Art.48).

For a delay in payment of tax, interest for the delayed period is also collected. This is set at the re nancing rate of the Central Bank and can be collected by the tax agency together with the unpaid tax by the procedure provided in the Tax Code (Art.75).

The Tax Code also provides for the procedure of imposing penalties – “tax sanctions” – for the breach of tax law. Taxpayers’ responsibility is pursued for intentional or negligent acts explicitly provided in the Tax Code. Breaches of tax law include:

i)delay in or failure to register with the tax agency as a taxpayer (Arts.116 and 117);

ii)delay in reporting the opening and closing of bank accounts (Art.118);

iii)failure to present tax declarations (Art.119);

iv)serious violations of rules on accounting the income, expenditure or the objects of taxation (Art.120);

v)non-payment or underpayment of tax by way of understating the taxable basis, other inaccurate calculation of tax or unlawful means (Art.122);

vi)failure to provide the tax agency with information needed for tax control (Art.126).

Banks are held responsible for failures to implement the decisions of the tax agency to suspend banking transactions (Art.134) and to collect taxes (Art.135) as well as for the failure to provide information on the nancial activities and operation of the taxpayer to the tax agency despite the legitimate inquiry by the latter (Art.135-1).

Violations of tax law entail sanctions in the form of nes (shtraf ). Failure to pay tax as a result of understatement of the taxable basis, for example, entails ane of 20% of the unpaid tax. The same act committed on intent entails a ne of 40% of the unpaid tax (Art.122).

Tax sanctions used to be imposed by court procedure, and not by the decision of the tax agency. However, this imposed a heavy burden on the commercial court. It was proposed to change the system and alleviate the burden of the court,

e.g. by introducing a requirement to rst go through the administrative procedure.22 In 2004, the commercial court handled 297,213 cases of such application from the tax agency, of which 71.3% were endorsed. Almost 30% of the cases of these cases involved an amount of less than 100 roubles.23 In 2005, the Code was amended and for a ne below a certain threshold, court procedure was no longer needed. For organisations and individual entrepreneurs, nes which do not exceed 50 thousand roubles can be imposed by the tax agency (Art.103.1, para.1). If the amount exceeds this limit, after adopting a decision to impose tax sanctions, the tax agency is to apply to the court for the imposition of tax sanctions (Art.104, para.1).

In addition to these sanctions, the Criminal Code provides for penalties for tax evasion. Maximum 6 years deprivation of freedom is available for “especially large scale” evasion of tax payable by organisations (Art.199).

The harshness of the sanctions under the 1991 Law on the Basic System of Taxation led some taxpayers to take the case to the Constitutional Court:

As a result of the tax inspection, joint stock company Bolshevik, Svet and other companies as well as individual entrepreneurs were found liable for violations of the Law on the Basic System of Taxation of 1991 by the head of the tax inspectorate and the tax police. The plaintiffs claimed that the sanctions provided by the law were unjusti ably excessive, and that they were applied to the plaintiffs without due observance of procedure, and without establishing fault, which considerably harmed their constitutional rights to the free use of property for entrepreneurial activities.

The plaintiffs had been held responsible for violations of tax law and 1) had the entire amount of under-declared taxable income con scated and were imposed ofne of the same amount, 2) on repeated violations, had a ne of double the amount of the initial ne imposed (the amount could be multiplied by ve times, if the act was found to be intentional), 3) had nes for the failure to declare taxable incomes at 10% of the undeclared income imposed, and 4) had a penalty for the delay in paying tax imposed.

The Constitutional Court found that the law provided for responsibility for different types of violations without properly demarcating them. Sanctions provided by the law had failed to take into account the nature or the level of harm to society. The law contained ambiguous and often mutually indistinguishable concepts.Also, in the majority of provisions on violations, there was no direct requirement of fault as a prerequisite to the sanctions. Furthermore, the construction of the provisions allowed an overlapping application of various measures, penalising the taxpayer twice for one and the same act.

22EiZh, May 19, 2001.

23V.F.Iakovlev, “Itogi raboty arbitrazhnykh sudov v 2004 godu i zadachi po dal’neishei realizatsii sudebnoi reformy”, VVAS 2005 No.2, p.25.

The Court concluded that the relevant provisions of the Law on the Basic System of Taxation were against the Constitution.24

With the amendments by Part One of the Tax Code, sanctions and penalties have been more or less rationalised and streamlined.

Tax sanctions are subject to the period of prescription of three years from the day the breach was committed or from the next day of the end of the tax period during which the breach was committed (Art.113).

In June 2004, the Commercial Court of Moscow rendered a judgment imposing tax sanctions on Iukos for the tax period of 2000. Iukos argued that the period of prescription had already passed. The Court ruled that the period of prescription was applicable to taxpayers in good faith only. The appellate court, however, found this argument to be with grounds and reduced the amount of nes. The court of cassation, upon the request of the tax agency, asked the Constitutional Court to give an opinion on this matter, since the tax agency argued that this provision was against Articles 19 and 57 of the Constitution. The Constitutional Court did not nd the provision on prescription to be unconstitutional.25

In 2006, the Tax Code was amended and this provision of 3 year prescription was deleted from the Code.

3)Procedure for Contesting Decisions of the Tax Agency

Taxpayers are entitled to appeal against non-normative acts (decisions) of the tax agency as well as against the act or failure to act on the part of of cials of the agency, if they consider that their interests have been infringed. Appeal can be made to the higher echelons of the tax agency, or to the court. Resort to the former does not exclude the possibility of the latter (arts.137 and 138). Normative acts of the tax agency can also be appealed in court. Ordinary courts have jurisdiction in such cases.

Appeals by organisations and individual entrepreneurs fall within the jurisdiction of the commercial court, while appeals by individuals other than entrepreneurs are handled by the ordinary court.

24Decision of the Constitutional Court, July 15, 1999, Case No.11-P. Nalogovye spory: svornik dokumentov, second edition, Moscow 2001, pp.228-235.

25“Obzor deiatel’nosti arbitrazhnykh sudov v SMI, April 20, 2005”, in www.akdi.ru. Decision of the Constitutional Court, July 14, 2005, No.9-P.

There is no requirement that the appeal should be lodged with the superior body rst. In fact, more than 90% of appeals go directly to the court. In 2005, there were 48,414 cases where the validity of the decision of the tax agency was contested by taxpayers. Surprisingly, in 72.6% of these cases, the taxpayers’ claim was accepted by the court.26 This was attributed to the low quality of the decisions of the tax agency by the president of the Supreme Commercial Court. On the other hand, the Federal Tax Service released a chart which shows the amount of claim which was accepted by the court against the total amount of claim brought to the court by the tax agency. In 2002, it was over 80%, while in 2005, it was around 30%.27

Some companies with foreign investment have successfully contested decisions of the tax agency in the commercial court.

A closed joint stock company, Koka-Kola Bottlera Orel, initiated an action at the commercial court of Orlov province vis à vis the tax agency of the district. The tax agency had ordered the company to pay 3,890,893 roubles in VAT and a 35,241 roubles penalty for the delay.

The decision of the rst instance court found part of the order of the tax agency to be void. In the cassation instance, the decision was reversed.

The issue was whether the company was allowed to enter in the tax declaration the amount of VAT paid by the company in the fourth quarter of 1995 as capital contribution when the foreign investor imported materials (sugar), packing cases, and xed assets. The tax agency did not allow this, and therefore, the declaration by the company was found to be lower than the actual VAT to be paid and the company was ordered to pay the difference plus the penalty.

The Supreme Commercial Court ruled that the amount of VAT paid at the border tothecustomsof cecouldbedeductedwhencalculatingthetaxpayabletothebudget at the time of the realisation of the product, insofar as the materials imported were used for the production and distribution of the product in Russia. This depends on the composition of the imported materials, so the case was referred back to the lower court in order to determine the composition of the imported items.28

Skanska Construction Company Ltd. brought an action for the recognition of the tax agency’s decision to be invalid. The rst instance court dismissed the claim, but the appellate court acknowledged it. At the cassation instance, this decision was upheld.

26www.arbitr.ru/news/totals/2004/4.htm.

27“Analiz rassmotreniia nalogovykh sporov v sudebnom poriadke za 2000-2005 goda”, www. nalog.ru.

28Decision of the Presidium of the Supreme Commercial Court, January 18, 2000, Case 4653/99.

In this case, as a result of on site inspection, the tax agency, despite the objection of the plaintiff, determined that corporate pro t tax and the tax for the use of the automobile road were not fully paid. The pro t tax was for the construction work carried out by the plaintiff. The tax agency was of the view that with the transfer of the completed work on a non-gratuitous basis, the plaintiff has made a pro t. However, the court of cassation found that the transfer of the construction site was not the same as the transfer of the completed work. In fact, this case involved a transfer of the construction site which resulted from a settlement of dispute between the plaintiff and a Russian company “VSM” after the termination of a subcontract agreement. The plaintiff had suspended the work and the agreement was terminated because of the breach on the part of the Russian party.

The Treaty against Double Taxation between the Russian Federation and the United Kingdom and Northern Ireland was found to be applicable in this case. According to the Treaty, pro ts of companies are taxed in the host country only when there is a permanent establishment. The Treaty provides that a construction site quali es as a permanent establishment only when the work continues for more than 12 months. The court of cassation found that the period of work did not exceed 12 months. Besides, the payment the plaintiff received was a compensation of the loss caused by the Russian company for the breach of contract and was not a pro t.

Therefore, the court upheld the judgment of the appellate court.29

According to the survey by an accounting rm cited earlier, 80% of the respondents indicted that they had had disputes with the tax agency in the past three years. 92% of those disputes were brought to court. Of the 101 cases in which the respondents were involved, VAT and pro t taxes were by far the main areas of disputes. In 58% of the cases, the contested amount was over one million US dollars. 90% of the reported court cases ended in favour of the tax payer. It should be added that while the respondents’perception of the tax agency is below average, the perception of the court system is above average.30

7MAJOR KINDS OF TAXES

1)Corporate Pro t Tax

Pro t tax was introduced in 1991. There was some confusion at the inception when an “enterprise income tax” was introduced soon afterwards, coexisting

29Decision of the Federal Commercial Court of North-West District of February 20, 2004, A5617837/03.

30Ernst & Young, 2005 Survey of Taxation Issues in Russia, on line version, pp.6-8.