How to apply the concept of the actual right to receive income?

The Russian Federation Federal Tax Service (RFFTS) summarized the practice of disputes regarding the application of the actual right to receive income, and issued Letter N CA-4-9/8285@ on April 28, 2018 to orient lower-level tax authorities and clarify how it should be applied in practice. In our review, we will look at the opinion of the RFFTS in detail.

This is not the first time that the RFFTS has generalized the arbitration practice on this issue. A previous Letter N CA-4-7/9270@ was issued on May 17, 2017, which is almost a year ago. What changed over the past year, and has the RFFTS changed its approach?

What is this letter about?

Most of the criteria and methods discussed in the new letter are already familiar to taxpayers. As in the previous letter, the main idea is that if a foreign company using the benefits of a double taxation treaty is not the actual recipient of income, but participates in the operation purely technically, the benefit will be deemed applied without justification.

The application of benefits without grounds is determined by the following criteria:

  • the participation of a foreign company is not connected with the attraction of capital to Russia
  • lack of a business objective in the transaction
  • absence of a foreign company’s business activities
  • the foreign company has no other sources of income, except for loans and interest to interdependent, affiliated entities
  • insignificant expenses for salaries and social contributions from a foreign company
  • “transit character” of payments
  • the activities of a foreign company are not subject to financial or other risks
  • a foreign company has no authority to dispose of income
  • lack of independence in the decision-making of the foreign company’s directors

What is meant by entrepreneurial activity?

It is noteworthy that the RFFTS provides a more detailed explanation as to what is meant by  “entrepreneurial activity of a foreign company:”. There were no such explanations in the previous review.

For example, it is explained that activities such as investments and financing of companies within a group (holding) or interdependent, affiliated companies are not considered entrepreneurial. At the same time, the use of such a business model is very popular. Often a group of companies appoints one company that finances all companies in the group. Such companies accumulate monetary funds either by attracting third-party financing, or by obtaining all temporarily free funds of the group companies on their accounts.

Since such activities are not recognized by the tax authorities as entrepreneurial, interest payments to such companies should not use tax preferences, according to the tax authorities. Thus, discrimination of some business models is introduced, and payments to companies whose main type of activity is financing the companies belonging to the group fall into the risk zone.

Also, the RFFTS does not recognize either providing information and consulting services or performing operations to acquire shares of various companies (if the company owns them formally and does not participate in their activities independently and / or these companies do not conduct real business activity) as business activity. Moreover, payments for information, consulting, and other similar services provided by the parent company to a subsidiary company can be recognized as a dividend payment.

What happens in practice?

In practice, we often see situations when a subsidiary company in the Russian Federation does not have employees in all competencies that the company needs. Many functions are outsourced to the parent company, which determines how the business of  the entire group of companies will be built and actually operate subsidiaries.

There are also cases when the management of a group of companies is allocated to a separate business, this company does not produce anything except for consulting, and its main clients are the companies of the group. If you read the letter of the Federal Tax Service literally, it turns out that such structures are also not acceptable. To be exact, they are permissible, but tax benefits under double taxation treaties regarding payments to such foreign companies are not applicable. Speaking about this, the RFFTS obviously forgot that they do not have the right to discriminate against certain ways of doing business. They cannot arbitrarily decide in which cases the business is conducted in such a way that the benefit is applicable and in which it is not.

What can be concluded?

The position of the RFFTS does not agree with the position expressed by the Plenum of the Supreme Arbitration Court of the Russian Federation in Resolution No. 53 of October 12, 2006 “On Evaluation by Arbitration Courts of the Justification of Receiving a Tax Benefit by the Taxpayer”. According to this, the possibility of achieving the same economic result with a lower tax benefit received by the taxpayer through the commission of other transactions that are or may not be prohibited by law, is not grounds for recognizing the tax benefits as unreasonable. As a criterion for determining the possibility of applying benefits, the RFFTS proposes testing the deals involving foreign companies for a business purpose. Thus, the tax authorities apply this criterion, developed within the framework of the concept of unreasonable tax benefit.

What we offer to support you

SCHNEIDER GROUP employees who are familiar with judicial and law enforcement practice will help you test the risks before the concluding a deal and also verify the correctness of the primary documents preparation. We will analyze the planned deal(s) and supporting documents for legal and tax risks, help to build a competent structure for owning and managing the business and cash flows, and take into account the latest requirements of the tax authorities.

If you have any questions, please contact us. We will be happy to help you.

Artem Ardashev
Tax Expert
+7 (495) 956 55 57
Olga Lux
Senior Tax Expert
+7 / 812 / 458 58 00