Hulley v. Russia 2014
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319.The Tribunal concludes that, in respect of the period relevant for the Yukos tax assessments and decisions, while the “bad faith taxpayer” doctrine had not yet gelled in the way that it did in 2006, in Resolution No. 53, it had already been recognized and applied in some Russian court decisions. This conclusion, while based primarily on the Tribunal’s review of the cases,189 is also supported by the cross-examination of Mr. Konnov at the Hearing, as explained in the following paragraphs.
320.In his cross-examination of Mr. Konnov, Professor Gaillard focused on the sanction that the Russian Federation imposed on Yukos in the present case, rather than on the existence of any anti-abuse doctrine per se.
321.Mr. Friedman emphasized the limited scope of Claimants’ cross-examination of Mr. Konnov during his re-direct examination of the witness:
MR FRIEDMAN: Just to make sure I am clear, Mr Konnov, you understood the questions yesterday to be about the remedy that’s applied based on the anti-abuse doctrine, as opposed to the substance of the anti-abuse doctrine?
A.I thought that Professor Gaillard limited his question—and the Tribunal did the same thing—very specifically to the attribution; which I explained—and I think the
record said that—that I don’t view that as a separate instrument. But I was nevertheless asked the question about court cases with respect to attribution.190
322.As Claimants had stipulated to the existence of the bad-faith taxpayer doctrine (while contesting the scope and manner of its application), they instead implied in their argument that any such doctrine was irrelevant, since formal compliance with the legislation governing the low-tax benefits in the respective regions, including fulfilment of the terms of any applicable investment agreements, was sufficient to claim the tax benefits.191
323.Accordingly, in his cross-examination of Mr. Konnov, Professor Gaillard stressed the compliance of Yukos’ tax scheme with the existing legislative framework. In his answer, Mr. Konnov, while acknowledging that the formal requirements of the law may have been met, reiterated the relevance of the anti-abuse doctrine:
189The Tribunal also observes that the ECtHR, in its separate judgments relating to the claims against the Russian Federation brought by Yukos and Messrs. Khodorkovsky and Lebedev, respectively, considered the relevant domestic (i.e., Russian) law and practice, including the Russian courts’ case-law on substance over form and related doctrines. See ECtHR Yukos Judgment ¶¶ 428–68; Khodorkovsky v. Russia (2) ¶¶ 422–28.
190Transcript, Day 15 at 193–94.
191Reply ¶¶ 148–64.
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Q.So what you are saying is that the Law is not a good law, right? The Law which gives the regions the power to negotiate their taxes downwards in exchange for contributions to their fund is not a good law? The system is not good, as far as—
A.No, I am not saying that at all. I am not saying that at all. I am saying that what was done in this case, it was an abuse of law. So the Law was applied by Yukos in such an abusive manner so that, in violation of the constitutional principles which I’ve summarized in my report, Yukos did not pay taxes duty in Moscow. It used this
whole fraudulent sham arrangement, with the use of the Mordovian companies, to evade taxes in Moscow.192
324.Mr. Konnov’s insistence on the relevance of the anti-abuse doctrine, notwithstanding Yukos’ compliance with the strict letter of the law, can also be seen in the following extract of his cross-examination by Professor Gaillard:
Q.What do you call the proportionality principle? Is it the proportionality between the investment and the benefits?
A.Correct.
Q.Right. Is this—I will use the words “proportionality principle” within your meaning, what you just said, right? Is this proportionality principle found in the black letter of the Law of Mordovia; yes or no?
A.No. As I said—
Q.Okay.
A.—neither in Mordovia, nor in Kalmykia, nor in any other jurisdictions.
Q.Fine. And we have seen that in the agreements regarding the ZATOs, the trading companies had agreed to contribute to a fund 5% of their tax benefits. We have seen that earlier, yesterday or this morning, right?
A.Right.
Q.Okay. Now, going back to the Sibirskaya case, in the Sibirskaya case we have a decision of first instance where the taxpayer won; correct?
A.As I recall, correct.
Q.Right. And in the Court of Appeal the taxpayer lost, and it had to do with the Law of Kalmykia; correct?
A.No. No. There was no—again—
Q.But it was a Kalmykian company
. . .
A.No, it was not based on the Kalmykian Law. Obviously Sibirskaya was governed by Kalmykian Law; obviously Kalmykian Law did apply to it, to the same extent Mordovian Law applied to companies registered in Mordovia. But the assessment
was based on the proportionality principle, which, as we discussed, is not found—I think you used the words—in the black letters of the Law.193
192Transcript, Day 13 at 151–52.
193Transcript, Day 14 at 218–220.
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325.Having completed its review of what it considers to be the central evidence in the record in respect of the legal framework applicable to the Yukos tax optimization scheme under Russian law, the Tribunal now turns to the complex factual matrix involving Yukos’ trading entities in the low-tax regions.
4.The History of the Yukos Trading Entities before 2003
326.In the present proceedings, the Parties vigorously debated the significance of the history of the Yukos trading companies, including various tax audits that took place before 2003. The pertinent activities of Yukos’ trading companies took place in the regions of Mordovia and Kalmykia, as well as in the ZATOs of Lesnoy and Trekhgorny. The Tribunal will now summarize these activities and the results of the many tax audits which were issued.
(a)Mordovia
327.Mordovia is a region within the Russian Federation. Sometimes referred to as a “domestic offshore territory”, in the late 1990s it was granted some autonomy as regards taxation, which made it a more attractive destination for investment and business operations.194 This was part of a broader plan by the Russian Government in the 1990s to foster economic development in areas designated as “economically underdeveloped”.195 As noted earlier, the special exemption plan for domestic offshore territories was largely repealed as of 1 January 2004.196
328.On 9 March 1999, the Law of the Republic of Mordovia No. 9-Z (“Law 9-Z”) was enacted.197
Law 9-Z was the framework which allowed Mordovia to offer tax benefits to corporate entities operating in the region. Article 4.4 of the law states that “[t]he Government of the Republic of Mordovia shall determine the order and terms and conditions of granting the tax benefit under this Law, as well as the order of keeping reports and records to be able to obtain the tax benefits listed in this Law.”198
194Transcript, Day 1 at 45–48.
195Respondent Opening Statement, Day 2 at 109.
196See paragraphs 77 and 283 above; First Konnov Report ¶ 33.
197Law 9-Z, Exh. C-414.
198Ibid.
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329.Mr. Vladimir Dubov, a member of the Yukos management board199 and later a member of the State Duma for the Upper Volga region (which includes Mordovia), was the primary point of contact between Yukos and the regional and federal taxation authorities in Mordovia. He appeared as a witness on behalf of Claimants.
330.In his witness statement, Mr. Dubov stated the following:
On 20 December 1999, he attended meetings in Mordovia to explain Yukos’ plan to operate through trading companies in Mordovia. He met with Mr. Nicolai Merkushkin, the head of the Republic of Mordovia; Mordovian Prime Minister Vladimir Volkov,; and Mordovian Deputy Prime Minister Vladimir Ruzhenkov, who was also Head of the Administration of the Government of Mordovia. Mr. Dubov swears that “[a]ll terms and conditions associated with the use of trading companies in the Republic of Mordovia were discussed and agreed at the meeting, including that Yukos’ trading companies would pay [80 million rubles] per month to the Republic.” He stated that the Mordovian authorities “fully approved” of the plan.200
In late December 1999, he met with the Tax Minister of the Russian Federation, Mr. Alexander Pochinok, and Mr. Alexander Smirnov, one of Mr. Pochinok’s deputy ministers, to discuss Yukos’ plan to use trading companies in the Republic of Mordovia. Mr. Smirnov was very interested and called the head of the Special Inspectorate for Major Taxpayers, Mr. Aslambek Pasckachev, and the head of the Oil Department within the special inspectorate, Ms. Lydia Smirnova, into the in the meeting, to ask them to analyze the beneficial taxation plan.201
After that meeting, he spoke with Mr. Gusev, First Deputy Minister in charge of the VAT Department, to discuss Yukos’ plan. He thought this important as “it was obvious to me that any trading companies established in Mordovia would be claiming significant VAT refunds on the export of oil and oil products.”202 He also spoke with Ms. Olga Serdiuk,
199Transcript, Day 5 at 14.
200Dubov WS ¶¶ 20–21.
201Ibid. ¶¶ 22–23.
202Ibid. ¶ 24.
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then Deputy Head of the Indirect Taxes Department and one of the three deputy First Ministers, Mr. Kirill Ugolnikov.203
Around late December 1999 or January 2000, he met with each of the deputy First Ministers at the Tax Ministry and at the Menatep office on Kolpachniy Lane to outline the plan for the Mordovian companies. Following these meetings, Mr. Smirnov called the Head of the Regional Department of the Tax Ministry in Mordovia, Mr. Aleksey Averiasov, in Mr. Dubov’s presence, to inform him that such discussions had taken place and that Yukos had been “given the green light at the Ministry level for the use of trading companies in the region.”204
He met with the then First Deputy Minister of Finance (later Minister of Finance and Deputy Prime Minister), Mr. Alexei Kudrin at the Ministry of Finance in January 2000. They discussed establishing Yukos trading companies in Mordovia so that Yukos could take advantage of tax benefits available in the region and that Yukos’ trading companies would be able to contribute to the regional economy through fixed monthly payments. Mr. Dubov recalls that “Alexei Kudrin consented to Yukos’ proposal, with the proviso that Yukos’ overall tax burden should essentially remain the same.”205
331.When he was cross-examined, Mr. Dubov repeated his statement that he told Mr. Kudrin that Yukos was planning to work in Mordovia through trading companies, as well as “which taxes it will pay in each level of national budget, which preferences would the budgets provide for Yukos, what benefits Yukos would reap from these preferences and what amounts would be paid in[to] the federal budget, and if there were any issues, how they were going to be resolved.”206
332.Mr. Dubov concludes in his witness statement that, after these meetings, “[i]t follows that all the relevant authorities, both federal and regional, including the Minister of Taxation, his first Deputies, and the First Deputy Minister of Finance were aware of, cooperated with and approved of Yukos’ plan to operate through the trading companies in the Republic of Mordovia
203Ibid.
204Ibid. ¶ 25.
205Ibid. ¶ 26. It is common ground between Claimants and Respondent (hereinafter “the Parties”) that the point of Yukos’ tax arrangements was to lower its tax burden, not to keep it at the level it would have been at without resort to them.
206Transcript, Day 5 at 84.
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to take advantage of the favorable tax climate.”207 In Mr. Dubov’s view, this was favorable both for Mordovia and the Russian Federation, as any improvement in the financial situation of Mordovia would decrease the burden it placed on the federal budget. According to Mr. Dubov, “[t]he Russian Federation was clearly interested in decreasing the significant disparities in well-being between the regions [of the Federation].”208
333.The record reveals that, as the trading companies began operations, VAT refunds to the companies were very significant. In fact, VAT refunds to the trading companies often exceeded the total amount of VAT collected in Mordovia from all the other companies operating on its territory. The regional section of the Federal Treasury therefore had to transfer the necessary funds to the Tax Ministry’s regional VAT Department. This decision to transfer funds, according to Mr. Dubov, had to be taken at the federal level, including obtaining the approval of the Ministry of Finance.
334.During his cross-examination, Mr. Dubov explained that “[w]hen, as a result of the operations of the trading companies, the VAT refunds increased many times over, many fold, by many hundreds of per cent, the Tax Ministry department asked the question why[;] the Tax Ministry, the Tax and Charges Ministry for Mordovia replied that we have Yukos trading entities incorporated here, these have to do with the Yukos exports; that is why the VAT refunds are so high.”209 He also stated that “[t]his is exactly why, before the scheme became operational, I had cleared [it] with the head of the department and the First Deputy Minister who was in charge of this department.”210
335.In addition, in his witness statement, Mr. Dubov affirms that the funds paid into the Mordovian budget were used to fund various projects, such as Internet House, an internet-training center, and the rebuilding of the Saransk Airport. In 2001, according to Mr. Dubov, several dignitaries, including President Vladimir Putin, repeatedly visited the area (using the airport) and discussed the trading companies’ work in the region. Mr. Dubov states: “During such visits, President Putin was told by Nicolai Merkushkin, the Head of the Republic of Mordovia, and other representatives of the Republic of Mordovia, about the social, cultural and industrial projects that had been developed in the region in the previous year through the support and
207Dubov WS ¶ 27.
208Ibid. ¶ 29.
209Transcript, Day 5 at 149–50.
210Transcript, Day 5 at 150.
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cooperation of Yukos.”211 Mr. Dubov also recalls that President Putin had been told about several other improvement projects funded by Yukos’ support, such as the building of plants for machinery construction, construction materials and the production of optic fiber; the realization of a number of environmental projects such as the recycling of rotten wood and raw materials; the rehabilitation of the meat industry; reconstruction of the Saransk Theatre and Saransk Art Museum; the construction of two asphalt plants just outside of Saransk; and the reconstruction of the Saransk-Moscow highway.212
336.Mr. Dubov concludes that “[i]t follows that the federal authorities, who had to authorize the VAT refund, as well as any subsequent transfer of funds, were fully aware of Yukos’ trading structure, including the activities of the production and trading companies and the transactions between them.”213
337.The Tribunal notes that during his cross-examination, Mr. Dubov could not confirm that the VAT forms submitted by the trading companies to the Tax Ministry contained the full particulars as to how the tax optimization scheme was being implemented by Yukos. This was because, as he said, he was not familiar with the specifics of the VAT submissions although he knew that they would be submitted to the Leninsky district of Saransk (Mordovia) and they were likely to be very large.214 It seems unlikely to the Tribunal that such information would have been disclosed in the VAT forms, as the tax benefits of the low-tax regions did not extend to VAT.
338.During his cross-examination, Mr. Dubov affirmed that he only discussed with Mr. Kudrin “the general scheme”, not the formalities or the details of the activities of the trading companies.215 The Tribunal further notes that in his witness statement, Mr. Dubov asserts that “[p]rior to the attacks on Yukos, which began in the Summer of 2003, the Russian authorities never
challenged the legality of this structure or the materiality of the facts underlying this During his cross-examination before the Tribunal, he stated that he had no
211Dubov WS ¶ 33.
212Ibid. ¶ 33; Memorial ¶ 711.
213Dubov WS ¶ 44.
214Transcript, Day 5 at 152–54.
215Transcript, Day 5 at 81–83.
216Dubov WS ¶ 12.
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knowledge of the use of the ZATO Lesnoy companies,217 and in light of such testimony, Mr. Dubov’s evidence must be understood as being limited to Yukos’ activities in Mordovia.
339.In the following subsections, the Tribunal will review the detailed information that was presented to it regarding the trading companies incorporated in Mordovia.
i.Alta-Trade (Mercury XXIII)
340.Alta-Trade was incorporated on 17 December 1999 as Mercury XXIII pursuant to the resolution of a meeting of the company’s founders, Polikant ZAO and A-Trust OOO, each with a 50 percent [RUR 5,000] stake in the share capital. In March 2001, Nefteinvest OOO became a shareholder, taking a 2 percent (RUR 200) share in the company’s share capital.218 In August 2001, Yukos-Import OOO acquired the shares of Polikant ZAO and A-Trust OOO, and became the owner of 98 percent of the share capital (RUR 9,800).219
341.On 27 June 2001, Alta-Trade concluded an investment agreement with Mordovia, which was supplemented in March 2002.220
342.The record reveals two decisions by the Saransk Tax Inspectorate in 2001 where Alta-Trade was denied the right to offset the VAT in respect of some of its activities. The decision of 15 June 2001 notes that Alta-Trade is “an enterprise producing oil products and selling its output domestically and [abroad],” that it purchases crude oil from Yu-Mordovia, and that sales are made through OAO NK Yukos and ZAO Trading House Angarsk-Nefto as commission agents.221 The decision of 29 October 2001 refers to transactions with, for example, Siberian Transportation Company and noted that the commission agent was Yukos Export Trade.222 Thus, this information pertinent to the activities of Alta-Trade in Mordovia and linking AltaTrade to the Yukos “family” was known to the authorities as early as 2001.
217Transcript, Day 5 at 101–102.
218Field Tax Audit Report No. 08-1/1 of OAO Yukos Oil Company, 29 December 2003 p. 34, Exh. C-103 (hereinafter “2000 Audit Report”).
219Ibid. pp. 34–35.
220Investment Agreement No. 5, 27 June 2001, as supplemented, Exh. C-1114.
221Decision of the Inspectorate of the Ministry of Taxes and Levies of the Russian Federation for the Leninsky District of Saransk No. 23, 15 June 2001, Exh. C-1110.
222Decision of the Inspectorate of the Ministry of Taxes and Levies of the Russian Federation for the Leninsky District of Saransk No. 48, 29 October 2001, Exh. C-1116.
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343.In April 2002, Alta-Trade’s first ever field tax audit was conducted. It covered the year 2000.223 The report from that audit noted the tax-benefit structure under Law 9-Z and the investment agreement between Mordovia and Alta-Trade. It noted that Alta-Trade was engaged in “crude oil refining [through intermediaries], sale of crude oil and oil products in the domestic market, as well as for export.”224 It noted the tax benefit structure under Law 9-Z,225 and that the company had no capital assets on its balance sheet.226 It also noted that Alta-Trade’s accounting and tax services were completed by Yukos Invest.227 The Audit Report found no violation of any tax laws.228
344.As will be seen in the next chapter, tax reassessments would eventually be made against Yukos for Alta-Trade for the years 2000,229 2001,230 2002231 and 2003,232 totaling RUR 7,143,036,557 (approximately. USD 238,101,219).233
ii.Fargoil
345.Fargoil was registered with state authorities on 23 May 2001. The sole founder of Fargoil was Mikhail Nikolayevich Silayev, who owned 100 percent of the share capital (RUR 10,000). On 25 May 2001, he transferred full ownership of the shares to Nassaubridge Management Limited, a company incorporated in Cyprus, for RUR 11,000.234
346.According to the Ministry of Taxation, “[i]n order to get the opportunity to have dividends
taxed at a 5% rate, Nassaubridge Management Limited, pursuant to Article 10 of the
223Field Tax Audit Report No. 02-52 of OOO Alta Trade, 19 April 2002 ¶ 2.3, Exh. C-1120.
224Ibid. ¶ 1.7.
225Ibid. ¶ 2.8.
226Ibid. ¶ 2.5.
227Ibid. ¶ 2.2.
228Ibid. ¶ 2.5. However, there was a 500 ruble (Approx. USD 17) fine for Alta Trade’s Director because of incomplete presentation of all required documents.
229Decision No. 14-3-05/1609-1, 14 April 2004 pp. 26–27, Exh. C-104 (hereinafter “2000 Decision”).
230Decision No. 30-3-15/3, 2 September 2004 p. 55, Exh. C-155 (hereinafter “2001 Decision”).
231Decision No. 52/896, 16 November 2004 p. 101, Exh. C-175 (hereainfter “2002 Decision”).
232Decision No. 52/95, 6 December 2004 p. 56, Exh. C-190 (hereinafter “2003 Decision”).
233Fiscal Years 2000–2004, Breakdown of the tax reassessments against Yukos by region or ZATO and company, excluding interest and fines p. 6, Exh. C-1752 (hereinafter “Yukos Tax Reassessment Breakdown”). The RUR to USD exchange rate is approximate, based on a rate of 30:1.
2342002 Decision, p. 106, Exh. C-175.
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Agreement between the Government of the Russian Federation and the Government of the Republic of Cyprus on Avoidance of Double Taxation of Income and Capital of 5 December 1998, made a direct investment in Fargoil OOO capital, equivalent to USD 120,000 (Bank Payment Order No. 1 of 7 February 2002, issued by Nassaubridge Management Limited, worth 3,590,000 paid as a share capital contribution based on an application of 31 January 2002).”235 Fargoil’s accounts were prepared by Yukos Financial Accounting Centre OOO.236
347.An investment agreement was concluded between Fargoil and Mordovia on 27 June 2001, and supplemented on 26 March 2002.237 In April 2002, a report of the Directorate on Implementation of the special-development program was issued pursuant to that agreement, which indicated that Fargoil had contributed over RUR 102 Million to the region.238
348.In September 2003, a Field Tax Audit Report for 2001 to 2002 was issued. It found no violation of Article 40 of the Russian Tax Code; but did find some underpayments, resulting in
an order to Fargoil to pay additional road tax and income tax in the amount of RUR 590,847,939 (USD 19.7 Million). Notably, the report concluded that “Fargoil lawfully used exemptions applicable to all taxes under review.”239
349.Tax reassessments would eventually be made against Yukos for Fargoil for the years 2001,240 2002241 and 2003,242 totaling RUR 130,243,731,762 (approximately USD 4,341,457,725).243 The Tribunal notes this was by far the largest of the tax reassessments levied against any one of the trading companies.
235Ibid.
236Ibid. p. 107.
237Investment Agreement No. 9, 27 June 2001, as supplemented, Exh. C-1142.
238Report of the Directorate on Implementation of the Republic’s Special-Purpose Development Program of the Republic of Mordovia for 2001–2005 on the Use of Investments Received from OOO Fargoil under Investment Agreement No. 9 of June 27, 2001 for the Year 2001, 15 April 2002, Exh. C-1118.
239Field Tax Audit Report No. 02-105 of OOO Fargoil, 3 September 2003 ¶ 2.16, Exh. C-1124.
2402001 Decision, pp. 110–11, Exh. C-155.
2412002 Decision, pp. 123–24, Exh. C-175.
2422003 Decision, pp. 76–77, Exh. C-190.
243Yukos Tax Reassessment Breakdown p. 6, Exh. C-1752. The RUR to USD exchange rate used here is based on a rate of 30:1.
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