Hulley v. Russia 2014
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auditor (the auditors), the head of the company or private entrepreneur or their representatives; and
• materials of cross audits (in case these were performed).
However, these requirements are not met and source documents and tax returns of 17 companies mentioned in the Report are not attached to the Report, which virtually deprives OAO NK YUKOS of opportunity to assess accusations of tax offence brought against it.
It is also necessary to mention that in violation of the requirements of the abovementioned Instruction about fairness and reasonableness of the reflected facts, the Audit Report was written in obviously biased manner, with accusative tendency and starts with conclusions on presence of a certain tax evasion “scheme”. The obvious prejudice of the auditors does not allow to consider the Audit Report as the evidence of committed tax offence.662
632.The Tribunal notes that Article 100(2) of the Russian Tax Code requires a tax audit to contain “documentarily attested references to facts of tax offenses revealed during the audit . . . .”663
633.The Russian Tax Code also requires the Director of the Tax Authority to consider the taxpayer’s objections prior to issuing a decision (which may hold, or not hold, the taxpayer liable for a tax offense, or direct further tax control measures).664 Article 101(3) provides:
3.The decision to hold the taxpayer liable for a tax offense shall indicate the circumstances of the committed tax offence, how they were established by the audit, the documents and other evidence, which attest to these circumstances, arguments presented by the taxpayer for his defense and the results of their verification, the decision to hold the
taxpayer for specific tax offenses with a reference to the articles of this Code providing for such tax offenses and liability incurred.665
634.The 2000 Decision summarizes Yukos’ objections, but selectively so. Notably, Yukos’ specific objection regarding the tax authorities’ failure to document the facts allegedly underpinning the conclusions in the tax audit is omitted from the description in the Decision of Yukos’ objection no. 6.666 Moreover, while the decision contains responses or comments regarding some of Yukos’ other objections, it does not contain any response to this specific objection.667
635.The court decisions that affirmed the legality of the decision, both in first instance and on appeal, used similar wording to dismiss Yukos’ objection based on breach of procedure for conducting an audit:
662Ibid. at 14–15.
663Art. 100(2), Russian Tax Code, Exh. C-1704.
664Art. 101(1) and (2), Russian Tax Code, Exh. C-1704.
665Art. 101(3), Russian Tax Code, Exh. C-1704.
6662000 Decision, pp. 86–87, Exh. C-104.
667Ibid., pp. 87–90.
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Results of the audit and the Decision were formalized in compliance with requirements of Articles 100 and 101 of the Russian Federation Tax Code. The Decision indicates its subject, essence and features of the tax offense imputed to the taxpayer, with reference to Article 122(3) of the Russian Federation Tax Code. Demand for the payment of tax arrears, interest and fines indicated in the Decision of the Russian Federation Ministry of Taxes and Levies No. 14-3-05/1609-1 of 14.04.2004 are well-founded, comply with the current legislation and are supported by the primary documents of audit materials, presented by the Russian Federation Ministry of Taxes and levies to the Court for substantiation of its claim.668
636.The Ninth Arbitrazh Court of Appeal added that “[Yukos’] reference to a lack of documents and information confirming bad faith on the part of the taxpayer is unfounded.”669 The Tribunal observes, however, that neither court identifies any specific documents in coming to these conclusions; nor did Respondent submit to the Tribunal the record that was before those courts, or present a witness who could attest to it. This makes it impossible for the Tribunal to assess whether the tax authorities did indeed discharge their burden against Yukos in issuing and defending their tax assessments.
637.Claimants sum up their argument on this important point in their Post-Hearing Brief with the following submission. The Tribunal notes that these crucial allegations of Claimants were never rebutted by Respondent:
In addition, the December 29, 2003 Audit Report did not comply with the requirements of the Russian Tax Code, including, in particular, by failing to document the factual allegations made and by relying on unidentified and undisclosed documents from the criminal investigation against Mr. Khodorkovsky. Continuing this flagrant breach of due process, the tax authorities refused to allow Yukos access to the documents upon which the purported claims were based, making it impossible for Yukos to defend itself. Notwithstanding the fact that the results of the court cases were determined in the Kremlin and it therefore could not possibly have made any difference how Yukos presented its defense, this refusal even to subject the purported claims to the scrutiny of Yukos’ lawyers attests to the Russian authorities’ complete lack of belief in the validity of those claims and their determination to destroy the company at a rapid pace.670
638.Respondent avers that “the unbroken thread of Yukos’ tax evasion” demonstrates that the Russian Federation’s assessments against Yukos were entirely proper, and marshalled a
668Resolution of the Ninth Arbitrazh Court of Appeal, Case No. 09AP-4078/04-AK, 23 November 2004, p. 5, Exh. C-147; see also Decision of the Moscow Arbitrazh Court, Case No. A40-17669/04-109-241, 26 May 2004, p. 21, Exh. C-116.
669Ibid., p. 9.
670Claimants’ Post-Hearing Brief ¶ 24.
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substantial amount of evidence that suggests that Yukos was abusing at least some of the low tax regions prior to 2003.671
639.However, the Tribunal observes that nearly all of the evidence on this point relates to the entities in Lesnoy and Trekhgorny. The Tribunal has not found any evidence in the massive record that would support Respondent’s submission that there was a basis for the Russian authorities to conclude that the entities in Mordovia, for example, were “shams”. Indeed, instead of pointing to any specific evidence on which the tax authorities might have based their finding that the Mordovian entities were shams, Respondent reversed the burden and asserted that “there is no evidence that the Mordovian shells ever had any greater substance than the Lesnoy shells”;672 and that “[f]actually, Yukos did not even attempt to demonstrate that any genuine trading activities had ever been conducted in Mordovia.”673 While the incomplete record before the Tribunal may not, in point of fact, establish that the Mordovian trading companies conducted genuine trading activities in Mordovia, the Tribunal notes that the Russian courts systematically denied Yukos’ motions to join to the proceedings its trading companies and the Government of the Republic of Mordovia. This leads the Tribunal to conclude that the Russian courts may have prevented Yukos from adducing evidence bearing on the nature of its activities in Mordovia.674 The record, insofar as the Tribunal has been able to find, does not reveal reasons, still less persuasive reasons, for denial by the Russian courts of joinder of the Mordovian government and the trading companies.
640.In the specific context of determining whether, in relation to the tax assessments against Yukos, the tax authorities discharged their own burden of proving Yukos’ bad faith so as to be able to rely on the “bad-faith taxpayer” doctrine, the Tribunal makes two observations. Firstly, the tax authorities failed to address at the time of the 2000 Decision, Yukos’ reasoned objection based on the absence of specific documents in the tax audit. Secondly, Respondent failed to identify during the Hearing any satisfactory evidence that the abuses found in the trading firms operating in Lesnoy and Trekhgorny were also found in the trading companies operating in Mordovia and all the other low-tax regions where Yukos entities were present. While it is true, and suggestive, that Claimants did not introduce evidence at the Hearing showing that trading
671Respondent’s Closing Slides, pp. 3–35.
672Ibid. p. 33.
673Ibid. p. 98.
674See Reply ¶ 286.
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companies which operated in Mordovia were not “shams”, it is first and foremost the conduct of the tax authorities that the Tribunal must examine in the context of the tax assessments that these authorities imposed on Yukos. Focusing exclusively on Claimants’ failure to demonstrate that the Mordovian entities were not “shams” would empty of meaning the important principle that the tax authorities had the burden of proving the taxpayer’s bad faith under Russian law. On this point, the following extract from the Pribrezhnoye decision issued by the Federal Arbitrazh Court for the North-Western District on 5 June 2002 (well before the tax assessments against Yukos) is instructive:
In addition, the IMNS’s reference to the absence of presentation of evidence by the Company on the conduct of its business in the ZATO territory, which was supported by the court, is erroneous.
Pursuant to Article 53 (part one) of the Arbitrazh Procedure Code of the Russian Federation in considering disputes on the invalidity of acts of State authorities, local selfgovernment authorities and other authorities; it is up to the relevant authority to prove the circumstances, which provided the grounds for issuing the said acts. Due to the fact that the disputed tax benefit had been granted to the defendant by a competent ZATO authority, and that the IMNS issuing the challenged non-regulatory decision found the granting of the benefit unlawful, the courts erroneously imposed the burden of proof on the Company.675
[emphasis added]
641.Looking at the tax assessments themselves, the Tribunal observes that, if there is an “unbroken thread” running through the tax authorities’ analysis of Yukos’ tax optimization scheme, it is the consistent and uniform finding that each trading entity is “interdependent” with Yukos. But that interdependence in the view of the Tribunal of itself does not establish bad faith on the part of all the trading entities.
642.In its objections to the Tax Audit (objection No. 1: “Illegal conclusions concerning legal definition of interdependent persons”), Yukos complained about the authorities’ reliance on interdependence as the principal factor motivating their conclusion that Yukos’ tax optimization scheme was a tax evasion scheme, noting that interdependence has a specific meaning under the Russian Tax Code (in Article 20), and with strictly determined legal
consequences (under Article 40). 676 These provisions allow authorities to disregard prices used in transactions between interdependent persons when those prices deviate by more than 20 percent from the market price, and to assess additional taxes and interest calculated as if the
675Pribrezhnoye, p. 5, Exh. C-1278.
676Objections against Report No. 08-1, pp. 1–5, 12 January 2004, Exh. R-335.
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transactions were concluded at the market price. Again, the Tribunal notes that this objection was not directly addressed in the 2000 Decision.677
643.The Tribunal notes that the relevant audit reports and decisions do refer generally to various factors that would seem to be relevant to a finding that the legislation in low-tax regions was being abused by Yukos. For example, they refer to the absence of trading activity in the regions and the absence of sufficient or even of any investment by the trading entities in the low tax regions. However, a close analysis of the tax assessment for 2000, for example, reveals that it was not established by the tax authorities that each of the trading entities which it labelled as a “sham” had no trading activity whatsoever, as opposed to just being “interdependent” on Yukos or not having physical facilities to handle oil and oil refining.
644.The Tribunal agrees with Claimants (and apparently also with Mr. Konnov) that it is nonsense to require a trading company to demonstrate physical interaction with the goods or commodities that it is trading, especially in the era of electronic communications. In this sense, the Tribunal is highly skeptical of the reasoning in the 2000 Audit Report (and subsequent reports) that the absence of physical movement of oil in and out of the low-tax region where the respective trading entity is located is evidence of a sham. The Tribunal observes that the reasoning on this point in the 2000 Audit Report is also inconsistent with the decision in the
Pribrezhnoye case.
645.In that case, the Federal Arbitrazh Court for the North-Western District reversed decisions of lower courts that had accepted the tax authorities’ efforts to impose additional eligibility requirements on a ZATO-based oil trading company beyond those laid out in the ZATO law. It explicitly noted that:
Under these circumstances the examination of whether the Company had fixed assets for oil products storage and transportation in the ZATO territory is beyond the scope of this case, because operations of trade in oil products, i.e. conclusion of contracts of sale, do not require the Company to own such fixed assets or for the oil products to be present within the ZATO territory.678
6772000 Decision, pp. 87–90, Exh. C-104. There is also only a minor reference to the objection in the Decision of the Moscow Arbitrazh Court, Case No. A40-17669/04-109-241, 26 May 2004, p. 19, Exh. C-116. (“The court considers unfounded the Respondents’ arguments that the status of interdependent entities has legal importance solely for the possibility of applying market prices to determine the results of the transactions for tax purposes. Interdependence of entities in this case is one of the circumstances by which the tax authority substantiates bad faith of the taxpayer.”).
678Pribrezhnoye, p. 3, Exh. C-1278
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646. The court added
The references by the courts to the facts that transfer and acceptance of crude oil occurred outside the ZATO territory; that [the manager of a customer company was in a different ZATO when the transfer was signed]; that the phone numbers of the rented office premises are recorded to the name of a person other than the Company; and that the defendant had not paid the office electricity bills are equally unfounded. The said circumstances per se do not refute the fact that the Company was doing business as a trade company in the territory of the ZATO, and they have no relevance for the case because they are not taken into account by tax legislation in determining eligibility for tax benefits.
The examination of the said circumstances by the first instance court and the court of appeal reveals their misinterpretation of Article 5(1) of the ZATO Law, in that the court went beyond the eligibility criteria for tax benefits that are explicitly set forth in this provision. In violation of Article 3(7) of the TC, the first instance court and the court of appeal regarded the absence of any criteria on doing business in ZATO territory other than fixed assets, workers on payroll and salary payments as grounds for the independent establishment of such criteria by a tax authority or a court.679
[emphasis added]
647.Finally, the Tribunal agrees with Claimants that the criterion of “proportionality” seems to be difficult to apply as a stand-alone basis to invalidate the structure in the low-tax regions. This is due to the fact that the proportion between the tax savings and the investment in the low-tax region should have been readily apparent to the tax authorities on the face of the tax filings and related tax documents. On the other hand, where properly evidenced, a grossly disproportionate arrangement combined with an “empty shell” structure could, in the Tribunal’s view, validly attract the attention of the authorities under the “anti-abuse” doctrine.
648.To conclude, it thus appears to the Tribunal that the Tax Ministry, in its assessments against Yukos, painted all of the Yukos’ entities in the low tax regions with the same brush, even though it marshalled little, if any, documented evidence that all, and not only some, of the trading entities were abusing the low tax regime in which they had respectively been constituted. On the one hand, the Tribunal accepts that, if Claimants had evidence of genuine business activity of the trading companies in the low-tax regions, they would have introduced it or referred to it orally. Accordingly, resolution of these critical issues is not free from doubt. But on the other hand, and on balance, where neither side was able to demonstrate the facts, but where Yukos’ files were in the hands of Respondent, the Tribunal feels justified in holding Respondent bound by the burden of proof. Respondent failed to meet that burden. Moreover, it refused to join Mordovian authorities and the trading companies to the litigation.
Furthermore, the re-attribution remedy was unprecedented at that time in the Russian
679 |
Ibid., p. 4. |
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Federation. Respondent’s resort to re-attribution appears to be linked to its determination to impose a massive VAT liability on Yukos.
(b)VAT
i.Introduction
649.Claimants argue that the imposition of VAT by the tax authorities, and more specifically their refusal to attribute to Yukos the trading companies’ VAT returns and refunds, is arbitrary because (a) it is undisputed that the goods at issue in the underlying transactions were exported and that the trading entities timely and duly filed VAT returns (and thus that the transactions benefited from the exemption from VAT or zero percent rating, depending on the year);680
(b)the refusal to attribute the trading companies’ VAT returns and refunds to Yukos is inconsistent with Respondent’s attribution to Yukos of the trading companies’ revenues for purposes of calculation of tax (be it profit tax or VAT or any of the other taxes); and (c) Yukos’ refilings of VAT returns were rejected on the basis of technicalities, thus demonstrating that Respondent had no intention of treating Yukos in good faith.681
650.Respondent takes the position that the VAT assessments against Yukos were perfectly proper, and consistent with the corporate profit tax assessments. In both cases, Respondent argues, the assessments were based on the application of Russian tax law to the true situation, established by the tax authorities, that Yukos was the “real taxpayer” and “actual exporter” in the various transactions that the trading companies had entered into. Respondent’s position is also based on its assertions that under Russian law, the granting of a zero percent VAT rate is subject to compliance with stringent documentary requirements; and that it is undisputed that Yukos itself never filed regular VAT returns or proper amended VAT returns in relation to the transactions in question.682
651.The Tribunal observes that there was no element in Yukos’ tax scheme that enabled Yukos to benefit improperly or illegally from a VAT exemption or a zero percent rating. As noted earlier
680 |
See Second Konnov Report ¶ 84, n.137. Mr. Konnov explains: “Prior to entry into force on January 1, 2001 of |
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Chapter 21 of the Russian Tax Code governing VAT, VAT was governed by Law of the Russian Federation |
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No. 1992-1, On the Value Added Tax, December 6, 1991 (the ‘VAT Law’). Under the terminology of the VAT Law, |
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exports were ‘exempt’ from VAT whilst under the Russian Tax Code they are subject to 0% VAT rate. In substance, |
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exemption from VAT on exports was similar to the 0% tax regime.” Ibid. |
681Claimants’ Opening Slides, p. 63.
682Respondent’s Opening Slides, p. 111.
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in this Award, VAT is a uniform federal tax that benefits from an exemption or a zero percent rating if the transaction involves an export to a foreign purchaser. In other words, even if Yukos’ tax scheme was entirely unlawful (or unlawful in some respects), and the authorities were justified in attributing the trading companies’ revenues to Yukos for tax purposes, there is no suggestion by Respondent that the trading companies (or Yukos) did anything “wrong” vis- à-vis VAT with their tax scheme. The Tribunal must consider the propriety of the multibillion dollar VAT assessments against Yukos in this context.
652.The Tribunal addresses the specific questions arising on the topic of the VAT assessments in the following subsections.
ii.Was the Imposition of VAT Payments on Yukos Inconsistent with the Attribution to Yukos of the Trading Companies’ Revenues?
653.Claimants assert that when the Russian Tax Ministry reattributed to Yukos all of the revenues (including the export revenues) of its trading companies, it should have attributed to Yukos the VAT refunds previously obtained by the trading companies with respect to their exports. Instead, in what Claimants characterize as a “contradiction with its own theory,” the Tax Ministry chose to impose the amounts on Yukos, justifying the VAT payment demands on the failure by Yukos, as the “real taxpayer”, to file on time “the documentation required to validate the VAT exemption or the 0% VAT rate”.683
654.Claimants sum up their argument in their Memorial as follows:
This formalistic position, systematically challenged by Yukos before the arbitrazh courts, but endorsed without any thorough analysis by these courts, was obviously circular: the trading companies, not Yukos, had exported oil and oil products and filed all the necessary documentation; under the applicable laws, Yukos did not have to file and could not have filed such documentation at the relevant times. The fact that, even when Yukos attempted to submit the updated VAT returns in its own name to satisfy the Tax Ministry, its submissions were simply rejected as improper and untimely, amply shows the Tax Ministry’s bad faith and true intentions.684
683Memorial ¶ 321–22.
684Memorial ¶ 322 (citing as regards Yukos’ tax reassessment for the year 2000, Decision of the Moscow Arbitrazh Court of 26 May 2004, 28 May 2004, p. 19 of the Russian original, Exh. C-116; as regards Yukos’ tax reassessment for the year 2001, Resolution of the Ninth Arbitrazh Court of Appeal of 9 February 2005, 16 February 2005, p. 23 of the Russian original, Exh. C-167; as regards Yukos’ tax reassessment for the year 2003, Decision of the Moscow Arbitrazh Court of 21 April 2005, 28 April 2005, p. 59 of the Russian original, Exh. C-196, and Resolution of the Federal Arbitrazh Court for the Moscow District of 18 November 2005, 5 December 2005, p. 17 of the Russian original, Exh. C-197; as regards Yukos’ tax reassessment for the year 2004, Resolution of the Ninth Arbitrazh Court of Appeal of 11 August 2006, 18 August 2006, p. 35 of the Russian original, Exh. C-336; as regards Yukos’ tax reassessment for the year 2002, Transcript of the hearing held at the Moscow Arbitrazh Court on 14–16 December
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655.In its Counter-Memorial, Respondent asserts that the tax authorities were justified to treat Yukos itself as the real party in interest, “which for VAT purposes, meant treating it as the real exporter. This approach simply reflected reality.”685 As such, Respondent argues, Yukos could have benefited from exemption (or “zero-rating”) only if, as “the true exporter”, it had timely filed “the requisite documentation in the correct manner.”686
656.Claimants reaffirm their position in their Reply, stating that Respondent’s position on VAT “was wholly inconsistent with the entire re-attribution theory upon which all of the other purported tax claims were premised.”687 In short, Claimants argue that “it was arbitrary and contradictory for the authorities to re-attribute the trading companies’ oil, revenues, profits, tax liabilities and activities to Yukos but to refuse to re-attribute to Yukos those companies’ entitlement to VAT refunds.”688
657.More specifically, Claimants note that “there is no support in Russian law for the tax authorities to conclude that the ‘true exporter’ could be someone other than the legal owner as reflected in the relevant documentation.”689 In particular, Claimants assert that neither Article 165 of the Russian Tax Code nor the decision of the Constitutional Court690 affirming the constitutionality of Article 165, on which Respondent relies, say anything about “true exporters”.691
658.The Tribunal notes that, in audit reports and decisions prior to the reassessments in December 2003, there are frequent references to the trading companies’ use of export agents. For example, in Decision No. 23 in respect of Alta-Trade, the decision notes that “Oil products are being exported through commission agent OAO NK Yukos and ZAO Trading House Angarsk-Nefto.”692 To prove that exports in fact took place, more than ten commission agreements were provided to the authorities, along with
2004, p. 21 of the Russian original, Exh. C-183; as regards Yukos’ tax reassessment for the year 2003, Decision of the Moscow Arbitrazh Court of 21 April 2005, 28 April 2005, p. 59 of the Russian original, Exh. C-196).
685Counter-Memorial ¶ 1073.
686Ibid. ¶ 1074.
687Reply ¶ 244.
688Ibid.
689Reply ¶ 245.
690Resolution of the Constitutional Court of the Russian Federation No. 12-P, 14 July 2003, Exh. R-1501.
691Reply ¶ 246.
692Decision No. 23 on partial refusal to refund/offset VAT (Alta-Trade), 15 June 2000, p. 1, Exh. C-1110
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“certificates of transactions entered into by the commission agent, bank statements evidencing crediting of funds to the commission agent’s accounts, bank statements evidencing crediting of funds to OOO Alta-Trade’s accounts, commission agents reports, copies of complete custom freight declarations and shipping documents confirming export of goods by sea outside the CIS member states[,] . . . complete customs freight declarations [with] the necessary notes made by customs authorities – “clearance allowed”, “goods exported”, and also notes made on shipping documents – “loading allowed” on loading instructions, notes made on marine bills of lading concerning acceptance of cargos for transportation.693
659.The Tribunal also notes that, in these audits, the taxation authorities did not appear to be concerned with these relationships. Several other audit reports and decisions also mention the use of export agents.694
660.In its Rejoinder, Respondent maintains its position regarding the propriety of the VAT assessments and their consistency with the profit tax assessments against Yukos. Respondent explains why Claimants are wrong, in its view, for characterizing the VAT assessments as being arbitrary and contradictory:
Once again, Claimants are wrong. The authorities’ approach with respect to Yukos’ VAT liability was consistent with their approach to Yukos’ corporate profit tax liability. In both instances, they treated Yukos as the actual owner and exporter of the oil and oil products, and therefore the actual entity responsible for both profit tax and VAT. Thus, the authorities found that:
(i)Yukos was the real party in interest in the challenged transactions.
(ii)The profit generated through those transactions was Yukos’ own profit, which Yukos had fictitiously allocated to the trading shells for no purpose other than to evade taxes which it otherwise was obligated to pay.
(iii)Yukos, not its trading shells, was the real exporter of the oil and oil products that were the subject matter of those transactions.
The inescapable conclusion from these findings is that Yukos, not its trading shells, should have filed the requisite documents to claim a 0% VAT rate, which as discussed below Yukos did not do properly. The VAT was thus due from Yukos and the Yukos VAT assessments were proper.695
661. Claimants sum up their position in their Post Hearing Brief:
693Ibid.
694See Decision No. 48 to deny refunding (offset) VAT (Alta-Trade), 29 October 2001, p. 1, Exh. C-1116; Decision No. 53 on partial refusal to refund/offset VAT (Mars XXII), 27 December 2004, p. 1, Exh. C-1117; Field Tax Audit Report No. 02-52, 19 April 2002 ¶ 1.7, Exh. C-1120; Field Tax Audit Report No. 02/105, 3 March 2003 ¶ 1.10, Exh. C-1124; Field Tax Audit Report No. 02-126, 22 October 2003, p. 3, Exh. C-1125; and Exh. C-1121, p. 3, which notes Article 165 of the Russian Tax Code, and states “No offense were discovered during the audit as to whether the value added tax actually paid to suppliers for materials acquired/booked, work performed or services provided, to the extent they were used to produce export goods, has been properly refunded/credited; whether OOO Ratmir had documents to support actual exports of such goods, and whether it properly assessed tax on domestic sales of goods.”
695Rejoinder ¶¶ 706–7.
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