Transfer pricing court practice development: the first positive decision in favour of a taxpayer
August, 25th 2017
The Moscow Commercial Court on 16 June 2017 took the first positive decision* in favour of a taxpayer in a case relating to the application of the Russian transfer pricing (“TP”) rules under Section V.1 of the Russian Tax Code. Specifically, the court held that approx. RUB 1b (approx. EUR 14m) had been unlawfully charged as additional tax accruals. This decision contains some important conclusions that can be useful for taxpayers in terms of documentation of controlled transactions for TP purposes, as well as in case of disputes with the tax authorities regarding the application of the rules of Section V.1 of the Russian Tax Code.
The Russian Federal Tax Service (“FTS”) conducted the TP audit in relation to a company (the “Taxpayer”) and challenged the prices used in the Taxpayer’s controlled transactions that involved the sale of fertilisers (“potassium chloride”) to a related counterparty residing in Switzerland.
The Taxpayer filed a notification on the controlled transactions and prepared TP documentation in relation to the disputed transactions. The Taxpayer chose the comparable profitability method (“CPM”) and calculated the arm’s length profitability range, based on the financial data of comparable independent companies, using the Bureau van Dijk (BVD) database as the source of its information.
Based on the results of this analysis, the profitability of the Taxpayer’s foreign counterparty, selected as the tested party, turned out to be lower than the minimum value of the profitability range calculated in accordance with the chosen methodology.
The FTS in turn challenged the Taxpayer’s choice of the TP method and conducted its own analysis, using the method of comparable uncontrolled price (“CUP”). Based on the TP audit result, the FTS determined the deviation of the prices used in the controlled transaction from the arm’s length’s level. The FTS based its analysis on the price quotations of an independent pricing agency (Argus).
The FTS also challenged the aggregated approach chosen by the Taxpayer, as well as the comparability of the selected companies, whose financial data were used to calculate the arm’s length profitability range.
The court supported the Taxpayer’s position, basing its decision on the following premises:
- The tax authority should have applied the same TP method chosen and documented by the Taxpayer. The tax authority did not provide sufficient evidence in support of the inapplicability of the TP method chosen and the data of the companies selected by the Taxpayer. The court noted that the failure of the tax authority to apply the TP method used by the Taxpayer or to provide sufficient evidence to justify the inapplicability of such method is sufficient to invalidate its decision.
- The Russian tax legislation expressly allows the application of the CPM methodology on an aggregated basis (for a group of homogeneous transactions). The Taxpayer is free to determine the scope of the aggregated transactions at its own discretion, taking into account the principles of completeness and reliability of comparable parameters.
- In case of the application of the prices determined by the tax authority, the Taxpayer’s counterparty would not have been able to derive a sufficient profit to cover its operational costs and carry out its commercial activity.
The court also did not detect any tax optimisation features in the Taxpayer’s operations, taking into account the fact that the Taxpayer’s counterparty is not situated in a “tax haven”.
Further, this court decision contains important methodological interpretation of the Russian TP rules, notably, the parts relating to the approach to the preparation of the TP documentation and argumentation of the Taxpayer’s position. In particular, the court has confirmed that the Taxpayer under the CPM methodology has the right to calculate the profitability based on the results of the whole financial year, and not separately under each concluded transaction. This provision, among others, ensures the use of comparability of the financial data of the comparable independent companies that are available in public sources of information. The court also agrees that the calculation of the profitability of each of the Taxpayer’s multiple transactions may be technically impossible in such cases.
The court indicated that when applying the CPM methodology, unlike the CUP methodology, the comparability of the functions and activities of the comparable companies prevail over the comparability of their goods.
At the same time, the court, interestingly, did not independently verify the correctness of the Taxpayer’s profitability calculation or the financial data used in such calculation. The court accepted the Taxpayer’s calculation, despite the presence of certain discrepancies that were revealed by the tax authority.
Although, this decision was taken in the first instance, taxpayers could start using some of the conclusions proposed by the court when documenting their TP policy.
In particular, this is the second court decision on TP issues (please see our comments on the first TP court decision here) that stresses the importance of the preparation of the TP documentation according to the Russian rules, insofar as the method and approach, which are chosen by the Taxpayer and reflected in such documentation, are binding on the tax authority when conducting its audits.
Taking into account these new developments, particular attention should be paid to the preparation of the TP documentation in relation to controlled transactions, as well as to the filing of TP notifications on a yearly basis, as this can decrease the risk of a TP tax audit and help avoid additional tax accruals as a result of such audit. In case of a tax dispute, it may reverse the burden of proof on the tax authority that will be bound by such TP documentation.