In 2023, one of the most interesting categories of tax disputes was the consideration by the courts of the question of whether an increase in the charter capital of an organization at the expense of undistributed profits of foreign participants of previous years is income of such foreign participants which is subject to withholding tax.

Anastasia Tarasova, Junior Tax Consultant at Tax Compliance, shared the results of the analysis of court practice in this category of disputes.

What happened?

Federal Law No. 251-FZ dated 29.07.2018 "On Amendments to the Law of the Russian Federation "On Organization of Insurance Business in the Russian Federation" (hereinafter - "Federal Law No. 251-FZ dated 29.07.2018") amended the requirements for the minimum amount of the charter capital of insurance organizations.

Some insurance organizations with foreign participation increased their charter capital at the expense of retained earnings of foreign participants of previous years.

Based on the results of desk audits, such companies were held liable for the unlawful failure to withhold and remit the amount of corporate income tax on income paid to foreign organizations. A number of insurance organizations (Sovcombank Life Insurance LLC, JSC ERV) did not agree with the additional assessment of withholding tax and appealed to the Moscow Arbitration Court to invalidate the decision of the tax authority.

Background

Foreign experience

In 1920, the U.S. Supreme Court considered the case of Eisner v. Macomber. Macomber", which considered the question of whether a shareholder of a company has an income when the share capital of the company is increased from retained earnings of previous years.

The circumstances of this dispute were related to the fact that when Standard Oil Company increased the share capital of its shareholder Ms. Macomber received 1,100 additional shares with a par value of about USD 20,000. The increase in the share capital was due to the company's accumulated profits undistributed to the shareholder in previous periods.

Since current U.S. law expressly provided that stock dividends were income, the question of whether a tax should be assessed was a matter of controversy.

The Justices were divided in the case by a 5 to 4 ratio. The majority determined that there was no income to the shareholder under the Sixteenth Amendment because the shareholder did not actually receive cash or other property and retained the same proportionate ownership interest in the corporation that the shareholder had before the dividend was paid.

Dissenting from this position was Justice Brandeis, who, in a dissenting opinion, pointed out that there was definitely income within the meaning of the Sixteenth Amendment, because the Sixteenth Amendment contemplates taxation of income from any source, i.e., the idea of the framers of the amendment was that anything that could reasonably be considered as income should be considered as income.

Justice Brandeis's opinion was subsequently upheld by U.S. Supreme Court justices in other similar disputes decided against the taxpayer (United States v. Phellis, Rockefeller v. Phellis, Rockefeller v. United States 257 U.S. 176 (1921), and Cullinan v. Walker 262 U.S. 134 (1923)).

Russian experience

In Russian practice, the tax consequences of an increase in the MC at the expense of retained earnings of the organization's participants of previous years are also considered ambiguously by the financial authorities and courts:

• Position #1. Income from the increase in the nominal value of shares in the authorized capital at the expense of retained earnings arises on the date of registration of the increase in the authorized capital [1]
• Position #2. Income from an increase in the nominal value of shares in the authorized capital at the expense of retained earnings arises on the date of actual receipt of money from their sale [2]

It is noteworthy that the HAC RF at different times adhered to both the first and the second position.

Thus, if in 2011 the HAC RF was not in favor of taxpayers [3], in 2013 the legal position of the highest court changed [4] . The HAC RF came to the conclusion that the income caused by the increase in the nominal value of the shares of the participants of the company, until the moment of realization by them of any of their property rights certified by the corresponding share in the authorized capital, the participants of the company is absent.

The ruling of the Supreme Arbitration Court of the Russian Federation of 2013 put an end to this category of disputes for a long period of time.

New Disputes 2023

In 2023, the courts considered three cases on this category of disputes in favor of the tax authority.

The main arguments of taxpayers and courts are summarized as follows:

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At present, two cases have already been considered in three instances [8], where the courts supported the tax authority. In the case of JSC Mir Business Bank (No. A40-243943/2022), a cassation appeal has been filed with the Supreme Court of the Russian Federation.

The practice formed in 2023 demonstrates that the courts have adopted a conservative stance on this issue. At the same time, as in 2013, the final point in this matter will still be set by the highest court.

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[1] Definition of the Russian Federation from 26.04.2011 № VAS-5515/11, Definition of the Constitutional Court of the Russian Federation from 16.01.2009 № 81-O-O-O, Resolution of FAS West Siberian District from 06.02.2013 in case № A45-14697/2011, Letter of the Ministry of Finance of Russia from 26.01.2007 № 03-03-06/1/33, Letter of the Federal Tax Service of Russia from 15.06.2006 № 04-1-03/318.

[2] Decision of the Supreme Arbitration Court of the Russian Federation of 11.10.2013 № VAS-13599/13, Decree of FAS Moscow District of 26.02.2009 № KA-A41/1046-09 in case № A41-12524/08, Decree of FAS Volgo-Vyatsky District of 02.06.2008 in case № A29-5650/2007, Decree of FAS East Siberian District of 25.07.2006 № A33-18719/05-F02-3629/06-C1 in case № A33-18719/05.

[3] Definition of the HAC RF from 26.04.2011 № VAS-5515/11.

[4] Ruling of the Supreme Arbitration Court of the Russian Federation of 11.10.2013 No. VAS-13599/13.

[5] The above argument was stated by the taxpayers in the cases of OOO Sovcombank Life Insurance (No. A40-272044/22-183-5166) and JSC ERV (No. A40-211798/22-154-2864).

[6] Case of JSC "ERV" (No. A40-211798/22-154-2864).

[7] The case of Sovcombank Life Insurance LLC (No. A40-272044/22-183-5166).

[8] Case of Sovcombank Life Insurance LLC (No. A40-272044/22-183-5166), JSC Mir Business Bank (No. A40-243943/2022).