Hulley v. Russia 2014

the tax assessments against Yukos that began in December 2003. Was the Russian Federation merely enforcing its tax laws, or rather was it carrying out a punitive campaign against Yukos and its principal beneficial owners? Were the other Russian oil companies subjected to the same tax enforcement actions by the Russian Federation, or was Yukos discriminated against and specifically targeted by the Russian Federation? Before turning to the question of the legitimacy of those tax assessments, which the Tribunal does in the next chapter of the Award, the Tribunal considers it important to address the first question: were Yukos’ practices in the low-tax regions, and specifically the practices of Yukos’ trading companies in those regions, lawful?

275.In sections 2 and 3 of this chapter, the Tribunal summarizes the evidence that was presented by the Parties regarding the structure and legal framework of Yukos’ tax optimization scheme. In section 4, the Tribunal distills, as best it can from the massive documentary record, the complex and extensive background relating to the activities and audits of the Yukos trading entities before December 2003. Finally, in section 5, the Tribunal reviews, on the basis of this complex record, the legality of Yukos’ tax optimization scheme under Russian law.

276.The Tribunal observes that it considers the question of the legality of the tax optimization scheme to be a matter of fact in the present arbitration. It is not the role of the Tribunal in the present proceedings to review and determine, as if it were a Russian court of appeal, the decisions made pursuant to Russian law in respect of the legality of this scheme. However, even in considering the issue as a matter of fact, the Tribunal’s observations on the legality of Yukos’ tax optimization scheme based on what the record reveals will inform its decision on the principal legal questions facing the Tribunal under the ECT.

2.The Structure of the Tax Optimization Scheme

277.The Tribunal has been presented with an enormous volume of material relating to Yukos’ structure and tax optimization scheme. In short, Yukos’ tax optimization scheme consisted of using “trading companies” located in the low-tax regions as intermediaries in the chain of transactions between Yukos’ core oil-producing entities YNG, Samaraneftegaz and Tomskneft at one end, and its customers at the other. The trading companies at issue were established in three types of low-tax regions. The first type was closed administrative territories, or ZATOs (Lesnoy, Trekhgorny, Sarov). ZATOs are territories established in the former Soviet Union as defense and nuclear sites, or as sites with sensitive military, scientific or industrial significance which faced economic catastrophe at the end of the Cold War. For this reason, special tax

-103 -

regimes were instituted in those territories aimed at boosting economic activity.134 The second type was “domestic-offshore territories”, regions that faced significant economic challenges and where the Russian Federation wanted to facilitate investment (Mordovia, Evenkia, Kalmykia).135 The third low-tax region was Baikonur, a former spaceport, which was treated as a ZATO but is on the territory of Kazakhstan.136

278.The names of the trading entities of particular relevance in this arbitration and the regions or ZATOs in which they were located are set out in the following table:

134Counter-Memorial ¶ 226, n.274. Law of the Russian Federation No. 3297–1 of July 14, 1992, “On Closed Administrative Territorial Entity,” Exh. C-404.

135Counter-Memorial ¶ 226, n.274. Article 1, Law of the Republic of Mordovia No. 9-Z on the Conditions of the Efficient Use of the Social and Economic Potential of the Republic of Mordovia, 9 March 1999, Exh. C-414 (hereinafter “Law 9-Z”); Article 1, Law of the Republic of Kalmykia No. 197-II-3 of 12 March 1999, “On Tax Benefits Granted to Enterprises Making Investments in the Economy of the Republic of Kalmykia,” Exh. C-413; Article 1, Law of the Evenkiysky Autonomous District No. 108 of 24 September 1998, “On the Particularities of the Tax System in Evenkiysky Autonomous District,” Exh. C-412.

136During his cross-examination, Mr. Konnov clarified the position of Baikonur as having “a special status, [it] is leased by the Russian Federation . . . . So there are three categories [of low-tax region].” Transcript, Day 14 at 54. See also, Decision of the Government of the Russian Federation No. 747, 25 October 2001, Exh. C-411.

-104 -

(b)Anti-Abuse Decisions and Doctrines Promulgated by Russia’s Federal Courts

284.Before considering the individual court decisions in which the anti-abuse doctrines are said to have been developed and applied, the Tribunal will describe the different courts within the judicial system of the Russian Federation.138

285.The Russian court system is based on four types of distinct judicial procedures—constitutional, civil, administrative and criminal.139 Each area has created its own court structure. For its civil procedure, Russia created a system of commercial, or “arbitrazh” courts. The arbitrazh courts have jurisdiction over general commercial disputes and disputes directly relating to commercial matters, such as tax disputes. At the first instance, there are 81 arbitrazh courts, located in and for the constituent entities of the Russian Federation.140 At the next level, the appellate instance, there are 20 appellate arbitrazh courts. Then, at the “cassation instance,” there are ten federal arbitrazh courts.141 At the apex of the Russian commercial courts system is the Supreme Arbitrazh Court of the Russian Federation.142

286.The Constitutional Court of the Russian Federation and the local constitutional courts of its constituent entities are the courts created for Russia’s constitutional procedure. Among its other functions, the Constitutional Court plays a supervisory role over all four Russian judicial procedures at the federal level; the local constitutional courts play the same role at the level of the constituent entities. The task of the Constitutional Court is to ensure compliance of the judiciary with the Constitution of the Russian Federation (“Russian Constitution”).143 In this

138This information is derived from the Constitution of the Russian Federation, Exh. C-1698 (hereinafter “Russian Constitution”) and other particulars in the public domain of interest to narration of the many decisions of the courts of the Russian Federation which the Tribunal reviews.

139Russian Constitution, Article 118(2), Exh. C-1698.

140Russia as a federation consists of 83 “constituent entities”—relatively autonomous territorial and political units. Most of them have their own constitutions, local laws, presidents, governments, parliaments, and court systems. Mordovia, for example, is a “constituent entity”. The judicial districts usually match up with these autonomous territorial and political units, but there are several “mismatches”: there are 83 “constituent entities” and only 81 first-instance arbitrazh courts.

141In 2000, the Russian Federation created “federal districts”, which are administrative units that group several “constituent entities.” Currently there are eight federal districts. Since there are ten federal arbitrazh courts but only eight federal districts, there is a “mismatch” there too. For example, the Siberian Federal District has two federal arbitrazh courts, which are the Federal Arbitrazh Court of the East Siberian District and the Federal Arbitrazh Court of the West Siberian District.

142In late 2013, the Ministry of Justice of the Russian Federation announced a judicial reform which would result in merging the Supreme Arbitrazh Court of the Russian Federation with the Supreme Court, which is the apex of the general jurisdiction courts. The reform has not yet been finalized.

143Exh. C-1698. The Russian Constitution defines the level of autonomy of the “constituent entities” by assigning certain governance matters of federal importance to the federal bodies while allowing the remaining matters to be

-107 -

capacity, the Constitutional Court is the court of last resort, which decides whether a particular law applied by the courts of lower instance is constitutional. For example, an individual or a company may apply to the Constitutional Court in a tax matter when the individual or company considers that a particular provision of the Russian Tax Code applied by an arbitrazh court is not incompliance with the Russian Constitution. The decisions of the Constitutional Court are not subject to appeal.

287.The Tribunal turns now to the anti-abuse principle under Russian law.

288.Respondent’s expert on Russian law, Mr. Oleg Konnov, introduced the anti-abuse principle as follows:

It is essential to distinguish clearly between the legitimate use of the tax benefits and abuse of tax law. Russian law generally prohibits abuse of law. The constitutional anti-abuse principle has been incorporated in some branches of law (e.g. civil law). However, it has been consistently applied even in branches of law where no explicit provisions have been included in the text of the law, e.g. labour law and tax law. In these instances, Russian courts have themselves developed anti-abuse doctrines. In the tax area, anti-abuse doctrines have been used to combat aggressive tax planning and abuse.

One should not be misled by the terminology. Even though the term “substance over form” is not commonly used in Russia, the terms “bad faith,” “abuse of rights,” “proportionality” and “business substance” are used to achieve the same result as the “substance over form” notion in other countries.

Courts (including the highest courts of Russia) accepted and consistently applied antiabuse measures both before and after the YUKOS tax cases. The anti-abuse doctrines have been evolving over the time. In some cases, the tax authorities challenged the abusive transactions based on the application of civil law principles (“sham” and “fictitious” transactions and transactions “deliberately contrary to fundamentals of civil law and morality”), and in others they applied the notions of “bad faith” and “unjustified tax benefit” developed by court practice. There were also cases in which the tax authorities used a combination of legal principles to challenge tax avoidance misconduct.144

decided by the “entities”. At the same time, the Russian Constitution does not allow the “entities” to act contrary to the Russian Federation even within the “entity’” assigned autonomy. For example, one of the tasks of the Constitutional Court is to ensure that the local laws of the “entities” are in compliance with the Russian Constitution and the federal laws.

144First Konnov Report ¶¶ 45–47. Mr. Konnov cites: Article 17(3) of the Russian Constitution, Exh. R-2211; Resolution of the Constitutional Court of the Russian Federation No. 3-P, 15 March 2005, section 4.3, Exh. R-2217 (as support for the proposition that the Constitutional Court describes non-abuse of law as a general legal principle); an assistant professor of the faculty of law of the Higher School of Economics Mr. Kurbatov, who writes: “In general terms, antiabuse principle is set forth in Article 17 (3) of the Russian Constitution according to which exercise of rights and freedoms by citizens and individuals may not violate rights and freedoms of other persons. This principle is set forth in Chapter 2 of the Russian Constitution governing rights and freedoms of citizens and individuals. However these rights and freedoms may be applied to legal persons to the extent their nature permits so (see, for instance, para. 1 Section 4 of dicta of the Constitutional Court Ruling No. 20-P dated December 17, 1996, para. 4 Section 2 of dicta of the Constitutional Court Ruling No. 24-P dated October 12, 1998).” (A. Ya, Kurbatov, ABUSE OF LAW: THEORY AND COURT PRACTICE (Consultant Plus, 2009), Exh. R-2214). Mr. Kurbatov also writes: “It would be fundamentally wrong to consider anti-abuse as only civil law (branch) principle. It may, however, be set in provisions of specific branches of law”); Resolution of the Plenum of the Supreme Court of the Russian Federation No. 2, 17 March 2004, at

-108 -

expert on the subject. And, as discussed further below, Claimants’ counsel chose not to crossexamine Mr. Konnov on the existence or evolution of the anti-abuse doctrines. At the same time, in argument, Claimants have challenged almost every aspect of Mr. Konnov’s testimony, including on the existence and evolution of the anti-abuse doctrine.

293.Therefore the Tribunal has had to delve into the voluminous record, including the translations of dozens of Russian court decisions and commentaries thereon, to come to its own view on what anti-abuse principles may have existed during the period relevant for an analysis of Yukos’ tax optimization scheme.

294.The earliest cases relied upon by Respondent, from the mid-1990s, appear to rely on a “substance over form” doctrine. These cases include Sibservice and the Resolution of the Presidium of the Supreme Arbitrazh Court No. 3661/96 on 21 January 1997 (“Yekaterinburg Telephone”).

295.Mr. Konnov summarizes these cases as follows:

a.As early as in 1996, the Russian Supreme Arbitrazh Court reviewed a case involving the Russia-Austrian joint venture Sibservice. Sibservice was assembling and selling computers. Its sales of computers were subject to VAT. In order to defer or avoid VAT payment, Sibservice entered into loan agreements with customers under which the customers purportedly loaned funds to Sibservice, and Sibservice purportedly repaid the loans by transferring computers to the customers. Based on the letter of the law, the making of the loan and the repayment of the loan (unlike sale of computers) were exempt from VAT. The Supreme Arbitrazh Court focused on substance of the transactions between Sibservice and its customers and ruled that the sale of computers had been artificially structured using the loan agreements, thereby supporting the position of the tax authorities. Specifically, the Supreme Arbitrazh Court noted that:

“The conclusion of the state tax inspectorate that Joint Venture Sibservice supplied the goods on the condition of the prepayment of their price [is justified] since the relations with the customers (buyers) were actually developed that way (supply, contractor relationships) regardless of the name of the agreement.”

b.One year later, in 1997, the Russian Supreme Arbitrazh Court reviewed a case involving the state-owned enterprise Yekaterinburg City Telephone Network. In 1994, the state-owned enterprise had concluded what they claimed to be several joint venture agreements with private persons and legal entities according to which the participants allegedly agreed to cooperate for the purposes of developing the telephone network of the city of Yekaterinburg. The private persons and legal entities made what purported to be joint venture financing contributions to the state enterprise which they claimed were exempt from VAT and VAT surtax under the then applicable law. The tax authorities conducted a tax audit of the state enterprise and concluded that in practice no true joint venture activity had been conducted and, therefore, VAT and VAT surtax had to apply. The Presidium of the Russian Supreme Arbitrazh Court supported this conclusion:

-110 -

“fictitious”, refuting the Respondent’s claim that such theories as the “bad faith taxpayer” concept conferred authority to re-attribute revenues between companies.150

298. Claimants also challenge the relevance of the Energomashbank ruling:

If that case has any relevance to these arbitrations, it is as a wholesale condemnation of the tax authorities’ formalistic approach to VAT, divorced from the actual facts, as in breach of Yukos’ constitutional rights. The constitutional issue in the case was the taxpayer’s right to a fair opportunity to defend itself against tax claims by the State before a court, and the Constitutional Court held that respect for this right meant that courts could not limit their inquiry to purely “formal conditions”, but rather must examine the actual facts.151

299.Putting aside, for the moment, the remedy of re-attribution in the case of a finding of abuse, which the Tribunal considers in Chapter VIII.B of the present Award (in connection with the tax assessments themselves), the question here is whether the decisions cited by Respondent support the existence of a judicial anti-abuse doctrine in tax cases.

300.Respondent insists that they do. Focusing specifically on the Sibservice and Yekaterinburg Telephone cases, Respondent characterizes these decisions of the Supreme Arbitrazh Court as demonstrating that Russian courts have recognized and applied anti-abuse rules in the tax area to combat aggressive tax planning and abuse since at least 1996.152 In its Rejoinder, Respondent dismisses Claimants’ comments on these cases as “misleading”:

Claimants misleadingly suggest that Respondent’s reliance on the 1996 Sibservice decision and the 1997 Yekateringburg City Telephone Network decision “involve[s] the application of principles enshrined in Article 170 of the Russian Civil Code” . . . . But nowhere in these decisions do the courts rely on, or even mention, Article 170 of the Civil Code. Rather, in both the Supreme Arbitrazh Court upheld the tax authorities’ assessments by looking at the substance of the challenged transaction, as opposed to its form.153

301.Based on its review of these cases, the Tribunal observes that Respondent’s submission appears to be well-founded. Article 170 of the Russian Civil Code provides as follows:

Article 170. Invalidity of Mock and Sham Transactions

1.A mock transaction, i.e., a transaction made only for appearances without an intent to create the legal consequences corresponding to it, is void.

150Reply ¶ 234 (citing Russian Civil Code, Part I, Article 170, Exh. C-1270; Sibservice, Exh. R-288; Yekaterinburg Telephone, Exh. R-289; and Accounts Chamber Report on the Results of its Audit of OAO Sibneft, December 2002, Conclusions, (finding that transactions involving Sibneft’s trading companies complied with Article 170 and that “under current legislation there is no other basis for considering such interrelationships (or transactions) as fictitious and invalid.”) (emphasis added), Exh. C-1282).

151Reply ¶ 236. (Original footnote omitted.)

152Rejoinder ¶ 648.

153Rejoinder ¶ 648, n.987.

-112 -