Transfer Pricing in Russia
On January 1, 2012 the new TP law in Russia entered into force. These new regulations are generally based on the OECD Model Convention and significantly differ from the previous regulations in Russia. The adopted law adds a new section to the Russian Tax Code provisions concerning TPrules and abolishes the previous ones. The purpose of the new regulations is to implement a tax administration system in order to determine whether the prices used in transactions between related parties, or persons equivalent to them, conform to the “arm’s length” principle. The legislation attempts to avoid the transfer of profit to foreign or Russian companies which enjoy a lower profit tax regime.
Please note: The TP regulations are new both for Russian business and the tax authorities and they are still far from being well established and fully developed. In recent years, the Ministry of Finance and the Federal Tax Authority have issued several clarifications and instructions. Among the most important instructions is Order № ММВ-7-13/524@ dated July 27, 2012 of the Federal Tax Authority about the forms and instructions for the notification on “controlled” transactions. Controlled transactions are transactions that, based on given criteria, must be reported to the tax authorities. Also important is the letter of the Federal Tax Authority № ОА-4-13/14433@ dated August 30, 2012, with recommendations on the preparation of TP documentation. The TP notification is a statutory report which notifies the tax authorities about controlled transactions performed by the tax payer and must be submitted to the tax authorities by May 20 of the year following the calendar year in which the controlled transaction takes place. There is no specific form in which the TP documentation must be prepared, but it should contain certain information and data foreseen by the Russian Tax Code. The TP documentation should be maintained by the company and submitted to the tax authority only upon request and within 30 working days after the receipt of the request. The Russian tax authorities have still very limited practical experience with TP regulations that take into consideration the principles of the OECD Model Convention. The first TP audits only began in January 2014 and the very first court decision on TP matters was taken only in January 2017. It should be noted that the developed TP policy, as well as TP documentation, may need to be adjusted to new requirements of the regulatory authorities.
Important: The next deadline for submitting TP notifications is usually May 20.
Main provisions and definitions of the TP law
In order to determine how companies might be affected by TP regulations, it is necessary to firstly determine if they are regarded as “related parties” in the context of TP rules. The TP legislation provides for a large list of criteria to determine if two parties are deemed to be related. In practice, the most important ones are the following:
- Two parties are deemed to be related if an organization or an individual directly or indirectly participates in the other company and their interest exceeds 25%. Therefore, if a foreign parent company holds more than 25% of the equity of a Russian subsidiary, these two companies are regarded as being related parties;
- Two parties are deemed to be related if one and the same person participates in such organizations directly and/or indirectly, and such participation in each organization amounts to more than 25%. So, two subsidiary companies are regarded as related parties if the same person holds more than 25% of the equity in each company;
- Two parties are deemed to be related if they have the same individual as the general director. So, if the general director of a Russian subsidiary is also the general director in another company, these two companies are regarded as being related parties.
There are some other criteria such as membership in the supervisory board of companies, etc. Accordingly, an analysis of the specific situation is recommended.
Please note: The courts have the right to recognize parties as being related for reasons which are not directly foreseen by the Tax Code if the relationship between the parties may influence the conditions of performed transactions. It is important to note that even if independent companies which do not perform additional functions and do not bare any business risks faced by the related parties are included in the supply chain between the related parties, the transaction will be treated by the tax authorities as a deal between related parties and will fall under TP control. Consequently, TP regulations will be applied even if a “middle-man” is included in a transaction between the parent company and its Russian subsidiary.
The following transactions are regarded as “controlled transactions” and fall under the TPrules:
All cross-border transactions between related parties: The applicable threshold for cross-border transactions between related parties has significantly changed since 2012, when it amounted to 100m RUB. In 2013, this threshold was reduced to 80m RUB. Since 2014, the threshold has been fully abolished, meaning that all cross-border transactions between related parties are subject to TP control and that TP notification shall be prepared and may be requested by the tax authorities for all such transactions. This applies even for the smallest of transactions. Transactions within Russia: Domestic transactions between related parties will be controlled by the tax authorities if their amount exceeds 1bn RUB (since 2014).
Exception: Domestic transactions will not be subject to tax control if the transactions are performed between members of the same consolidated group of taxpayers or if all of the following criteria are met:
- Both parties are registered within the same region of Russia;
- None of the parties have economically autonomous subdivisions in other regions of Russia, nor pay income tax to the budgets of other regions;
- None of the parties have tax losses;
- The parties do not pay mineral extraction tax or other specific taxes.
Please note: There are some ambiguities with respect to controlled transactions of permanent establishments of foreign legal entities. According to letter N 03-01-18/9-183 of the Ministry of Finance from December 2, 2012, the threshold for cross-border transactions shall be applied to transactions between subdivisions of foreign entities in Russia (permanent establishments, branches, representative offices) and affiliated Russian legal entities. It should be noted that Russian subdivisions of foreign legal entities are also Russian taxpayers, and therefore shall also prepare TP notifications and documentation. Only the allocation of profit between the foreign head office and the Russian subdivision is not yet fully subject to TP regulations. However, an amendment to the Russian Tax Code already indicates that the functions, risks and assets of a company shall be taken into account when determining the taxable income of such subdivisions in Russia. Hence, it is quite probable that the tax authorities will also, in the future, direct their attention to such expenses and income transfers. As Russia does not fully apply TP rules to the allocation of profit between foreign head office and Russian subdivisions double taxation problems might occur. Therefore careful structuring is recommended when larger projects in Russia are to be implemented via such subdivisions of foreign legal entities.
Other Transactions: Cross-border transactions between non-related parties, including transactions with exchange-traded commodities (crude oil, petroleum products, ferrous and non-ferrous metals, fertilizers, precious metals and gemstones) and transactions with foreign entities registered in low-tax (“offshore”) jurisdictions blacklisted by the Russian Ministry of Finance, are subject to control if the income obtained under such transactions exceeds 60m RUB per year. Transactions within Russia are subject to TP controls if the aggregate income from such transactions exceeds 60m RUB per calendar year and if one party of a transaction is:
- A payer of mineral extraction tax and the transaction involves goods that are subject to the mineral extraction tax at a percentage rate;
- Exempt from profit tax or applies a 0% tax rate, while the other party is a payer of profit tax in Russia and does not apply a 0% tax rate;
- A resident of a special economic zone, while the other is not a resident in that special economic zone.
Transactions within Russia are subject to TP controls if the aggregate income from such transactions exceeds 100m RUB per calendar year, and if one party applies the unified agricultural tax or the unified imputed income tax while the other party pays profit tax under the general rules.
Transfer Pricing Methods
Even though Russia is not an OECD member state, its recent TP rules are largely based on the OECD Guidelines. In the Russian Tax Code, the following methods are stipulated for determining the conformity of prices applied to controlled transactions to “arm’s length” prices:
- Comparable market price method
- Resale price method
- Cost plus method
- Transactional net margin method (TNMM)
- Profit split method
If you want to know more about the Transfer Pricing methods, read our overview.
Please note: Russian TP rules stipulate that the comparable market price method has priority over other methods and should always be examined. However, in practice the most applicable TP method in Russia is TNMM. The following sources of information can be used to perform a TPanalysis:
- Information on the prices and quotations of Russian and foreign commodity exchanges;
- Customs statistics on cross-border trade of the Russian Federation which is published or provided on request by a federal authority; Information on prices (or the range of price fluctuations) and exchange quotations contained in official information sources;
- Information from pricing agencies; џ Information on transactions performed by the taxpayer.
Please note: The above list of information which may be used to determine market prices is not exhaustive. However, data from Russian legal entities shall be used first and foremost, and only in case the information is not available are taxpayers are allowed to apply foreign information sources.
Transfer Pricing Notification
In the order № ММВ-7-13/524@ dated July 27, 2012, the Federal Tax Authority provided the format requirements of the TP notification and detailed instructions on what kind of data to fill in and how to file the notification. The notification consists of the following parts:
Title page with details of the taxpayer;
Form 1A ─ information regarding the controlled transaction:
- Basis for TPcontrol of the transaction;
- Information on the controlled transaction;
- The amount of income received and expenses incurred regarding the controlled transaction;
- Information on the applied TP method and information sources used (not obligatory).
Form 1B ─ information regarding the subject of the transaction:
- Detailed information about the transaction (description, TN VED, OKP, OKVED codes, number of buyers / sellers, contract number and date, country of origin, place of delivery, conditions of supply, amount, price, etc.);
Form 2 ─ details about the counterparty:
- Company name, registration details, tax number, registered office.
Transfer Pricing Documentation
In the letter № ОА-4-13/14433@ dated August 30, 2012, the Federal Tax Authority clarified the format requirements of the TP documentation. According to this letter, the TPdocumentation shall consist of the following parts:
- Title page with details about the parties of the transaction;
- Description of the company’s activities regarding the formation of prices of the controlled transaction. This section shall include details about the goods / works / services of the controlled transaction to determine comparable goods/works/services and information on the level of competition in the respective market of the company, including information on major competitors of the company;
- Details about the group of companies including information on major competitive advantages of the group of companies and details about tangible and intangible assets influencing its competitiveness;
- Details of the controlled transactions and functional analysis; џ Selection and justification of the applied TP methods: In this part, the taxpayer shall indicate the selected TP method, justify the selection, specify the used information sources and make an economic analysis by calculating the price range in the market or profit margin range;
- Range of prices or profitability in the market, including:
- Description of the approach used for the selection of the comparable transaction or organizations with an indication of the information sources used;
- Description of the functions, risks, and assets used in the comparable transactions or organizations;
- Description of adjustments to ensure compliance with the “arm’s length” principle;
- Calculation of the profit range in the market taking into account the details of the controlled transaction;
Other information might be specified in the documentation if the taxpayer desires. The amount of extra information provided should correspond to the complexity of the transaction. It should be also noted that a separate TP documentation package shall be prepared for each type of controlled transaction.
Please note: The Russian tax authorities generally cannot request TP documentation until June 1 of the year following the calendar year when the controlled transaction took place. Requested documents shall be submitted to the Russian tax authorities within thirty working days after receipt of the relevant request.
Transfer Pricing Audit
The local tax authorities have no power to perform an audit on prices applied by a taxpayer since such an audit is performed by a separate government body. A special department has been established by the federal tax authorities for TP audits purposes.
A local tax authority which has received notification from a taxpayer regarding controlled transactions shall submit the notification to the federal tax authorities within 10 days of receipt. Based on the provisions of the Tax Code, we consider that the TP audit may be a lengthy procedure.
The duration of a TP audit shall not exceed six months. However, the tax authorities may prolong the duration of the tax audit in exceptional cases for another six months.
The tax audit may be prolonged for an additional six months period if information from foreign tax authorities, experts, translation of documents, etc. is required. In case the requested information is not received from the foreign tax authorities, the TP audit may be extended for another three months.
Provided that the tax authorities identify deviations between the price applied to the transactions and the market price, which led to an understatement of tax, they have two months for the preparation of an act containing the audit results.
Please note: The taxpayer has the right to appeal the audit results within twenty working days after receipt of the act. The tax authorities then have between ten days and a month to review the objections and issue a relevant decision. Therefore, the total duration of a TP audit can be up to two years.
For 2014 – 2016, the penalty is 20%, and starting from 2017, 40% of the outstanding tax liabilities.
Software Solutions in 1C, SAP or MS Dynamics
Many companies which have transfer pricing reporting requirements face the question of how to prepare all the required notifications for the state bodies.
The following versions of 1C enable the preparation:
- 1C Corporate
- 1C ERP
- 1C Enterprise
These software packages are standard solutions for preparation of the notification. However, they are not ready-to-use products, but simply tools for uploading data in the required format in order to send it (via TAXCOM or some other provider) electronically to the relevant institutions. Before the electronic submission, specialists must process, correct and adapt this data.
Should thousands of customs tariffs be booked manually?
Nobody wants to manually enter tariff numbers into templates or to prepare an entire package of notification documents themselves. That is why companies must first make an analysis of the version of 1C they should use and, if necessary, update it or change to a new version (1C Accounting version, for example, does not offer the integral solution for the preparation of transfer pricing notification).
What to do if a Russian subsidiary works in SAP or MS Dynamics?
Different SAP consulting companies already offer software solutions for the preparation of TP notification. Nevertheless, they, like 1C solutions, will not help your company to get around the need for preliminary and further processing of the generated data which must be submitted to the state authorities. The costs of such solutions often exceed the budgets set by companies.
Furthermore, nobody can guarantee that it will not be necessary to make additional modifications or costly program updates in case of changes in legislation or state body requirements.
MS Dynamics still does not have a corresponding software solution and companies do not know how to fulfill the requirements of the Russian legislation using
SCHNEIDER GROUP has developed for SAP and MS Dynamics a tool that allows to export all required data from SAP and MS Dynamics in EXCEL-format and import the data to 1C for the preparation of the TP notification.
What does this mean for you?
We consider that with the enforcement of the (new) TP regulations in Russia, Ukraine, Poland, Kazakhstan and Belarus, the matter of TP in the different countries will attract the increased attention of the relevant tax authorities. Therefore, the management of the
company’s pricing policy and documentation of transactions will require additional consideration by taxpayers.
The following steps should be undertaken in order to be prepared for a TP audit:
1. Examine intercompany transactions in order to prepare a list of transactions which are subject to TP control and verify whether or not you are above the relevant thresholds and need to prepare TP notifications and TP documentation.
2. Select the appropriate TP method under the local law.
3. Analyze the performed functions, involved risks and used assets in order to prepare a functional analysis.
4. Carry-out a benchmark analysis.
5. Prepare the TP notification / report and TP documentation.
It should be taken into consideration that the preparation of the TP documentation is a time-consuming procedure. Therefore, it is important to calculate what additional personnel should be hired or to outsource the process to external consultants. However, preparation for the TP policies implementation should start as soon as possible in order to meet legislative requirements.
Please note: Due to country-specific differences in TP law, the TP methods used in the above mentioned countries might differ significantly.
How we can help you
SCHNEIDER GROUP has a team of accountants and tax experts with extensive experience in accounting and taxation in our offices in Russia, Ukraine, Poland, Kazakhstan and Belarus, who will be pleased to provide you with:
- An analysis of your transactions which may be subject to TP control;
- A benchmark study to check if your intercompany prices comply with the “arm’s length” principle
- Preparation of the TP documentation for your controlled transactions;
- Preparation of the notifications/reports to the tax authorities about controlled transactions;
- Support to your in-house team in preparing TP documentation and notifications.