On 27 January 2017, the Moscow Commercial Court ruled in favour of the tax authorities in the first ever decision* on the application of the transfer pricing (“TP”) rules under Section V.1 of the Russian Tax Code.
This decision is significant because it can be seen as a test case for the judicial interpretation of the TP rules. In the past, similar disputes were generally settled at the pre-trial stage.
The Russian Federal Tax Service conducted the TP audit of CJSC Dulisma Oil Company (the “Taxpayer”) and challenged the price of controlled transactions involving the sale of crude oil to a foreign trader registered in Hong Kong (the “Trader”).
The tax authorities claimed that, for the purposes of section V.1 of the Tax Code, transactions between the Taxpayer and the Trader should be treated as operations between related parties and are qualified as controlled transactions on the ground that (i) the Trader was registered in a territory mentioned in the list of offshore jurisdictions defined by the Russian Ministry of Finance; and (ii) the transaction involved the sale of goods traded on a global exchange.
In turn, the Taxpayer argued that (i) the parties were unrelated; (ii) the Trader occupied a dominant position on the oil market, which forced the Taxpayer to sell the goods at a reduced price; (iii) the Russian tax authorities used an inappropriate TP method and unsuitable sources of information; and (iv) the tax authorities had not taken into account the particular business environment of the transactions in question.
Despite the fact the Taxpayer retracted its counterclaim against the tax authorities and settled its tax indebtedness, the court nevertheless performed a substantive analysis of the case and the arguments presented by both parties to the dispute.
Given the exceptional complexity and novelty of the TP-related dispute (the first interpretation of the new rules and specificity of price formation by oil traders), the decision on this case was taken by a panel of three judges, although decisions in first instance courts are usually taken by a single judge.
This decision contains important features regarding:
- the choice of the applicable methodology and the sources of information; and
- the commercial terms to be taken into consideration when making a TP analysis.
In particular, the court noted that the Federal Tax Service had, when determining the applicable methodology and acceptability of the sources of information, approached a leading global energy information agency to help determine the applicability of the chosen quotations for the crude oil of certain brands to the particular economic conditions (delivery conditions and terms) of the reviewed transactions.
Further, the Federal Tax Service adjusted the chosen quotation by applying specific differentials in order to ensure comparability with the transaction terms. This goes to show the quality of the analysis carried out by the Federal Tax Service in terms of TP audits, which is materially deeper than the analyses of the territorial tax authorities regarding the application of the TP rules to non-controlled transactions (please see our previous Alert on the latter).
The court specifically noted that the choice of the applicable TP methodology had not been predetermined by the Taxpayer, who (i) had not prepared any TP documentation; and (ii) had failed to indicate the applicable TP methodology in its TP notification. Thus, the Russian tax authorities were not bound by the choice of the Taxpayer (which is normally the case, provided that this choice complies with the legislative provisions and transaction terms). As a result, they were free to determine the applicable TP methodology at their discretion based on the provisions of the Russian law.
Interestingly, the court also ruled that the proof of an unjustified tax benefit is not a mandatory criterion for the purposes of a TP control.
Finally, the court considered and checked the arguments presented by the Taxpayer regarding the particular business environment that allegedly forced it to reduce its prices. The court did not, however, find the arguments sufficiently justified.
Despite the fact that this case relates to a particular market (crude oil), the following issues should be taken into account by all taxpayers engaged in potentially controlled transactions:
- TP audits are not limited to the largest Russian companies; and
- it is crucial for taxpayers to prepare TP documentation in compliance with the Russian legislation, determine the applicable TP methodology and duly file the TP notification to restrict the capacity of the tax authorities to choose the applicable TP methods as part of a TP audit.
CMS Russia tax lawyers are monitoring further developments of the TP-court practice and are ready to advise companies on how to comply with the country’s TP legislation.
* In Russian