What happened?

LLC STK Production Company (hereinafter - the Company, the Company, OOO STK PK) during the audited period purchased raw materials (yarn and thread) used in the production of textile products, which were subsequently sold to the Company's customers.

The Interdistrict Inspectorate of the Federal Tax Service of Russia No. 3 for the Smolensk Region (hereinafter - the Tax Authority, the Inspectorate) as a result of the field tax audit came to the conclusion that transactions with RAFFLS LLC and ALMIKON LLC were performed not by the above counterparties, but by other persons who were not parties to the contracts concluded with the Company, on the basis of which it imposed additional VAT and corporate income tax on all transactions with the disputed counterparties.

The Company, disagreeing with the decision of the Inspectorate, filed a petition with the Arbitration Court of the Smolensk Region.

Court proceedings

On 15 November 2023 the Arbitration Court of the Smolensk region considered a dispute in the case of LLC STK Production Company (№ A62-1441/2023) on the issue of the possibility of applying tax reconstruction and calculation of the taxpayer's actual tax liabilities.

As a result of Tax Compliance specialists' analysis of the actual circumstances of the dispute, a position was developed indicating the necessity of applying tax reconstruction and calculation of the Company's actual tax liabilities.

In the course of several meetings, it was stated that it was necessary to reduce tax claims:

• on income tax: on account of the cost of goods confirmed by the Chinese supplier JIANGSU GOOSTARS HOMETEXTILES SO., LTD (hereinafter - JIANGSU) (2nd link after the Disputed Counterparties), as well as on account of the estimated cost of transporting the goods from China to the Russian Federation based on the expertise;
• VAT: due to the amounts of tax actually paid by the Disputed Counterparties during the audited period;
• penalties: due to several mitigating circumstances ignored by the Tax Authority;
• penalties: due to the fact that penalties should not have been charged during the moratorium on bankruptcy proceedings.

As a result of the Tax Compliance lawyers' development of a legal position, as well as the collection of evidence, the Court supported the Company's position, pointing out the following grounds:

• A set of documented circumstances has been established, which testify to the absence of delivery of goods by the disputed counterparties to STK PK LLC and the creation of a formal document flow, the said organisations were engaged by the Company as "technical" organisations.
• At the same time, the tax audit has established a sufficient set of circumstances to determine the actual chain of relationships on the movement of goods and apply tax reconstruction.
• The circumstances of the case confirmed the need to purchase raw materials from JIANGSU.
• JIANGSU confirmed the fact of relations with the disputed counterparties, as well as the fact of shipment of yarn and thread to them. The volume of goods purchased by the disputed counterparties from JIANGSU correlates with the volume of goods sold by the disputed counterparties to the Company.
• In other words, the reality of the acquisition of goods due to production necessity has been confirmed: the Company could not produce the products sold to customers in the absence of the raw materials required for this purpose.
• In addition, the tax reconstruction should take into account not only the cost of raw materials, but also transport costs associated with the movement of goods from China to the territory of the Russian Federation, since these costs are objectively necessary, i.e. obvious.
• Given the impossibility for the Company to correctly establish the costs of transporting the goods, the Company initiated an expert examination to determine the amount of expenses for delivery services for the goods sold by JIANGSU to the disputed counterparties.
• Tax reconstruction in terms of VAT when establishing a specific seller (manufacturer) of goods can be carried out by excluding "technical links", however, in this case it was established that the manufacturer of goods is a Chinese organisation, therefore, when excluding "technical links" VAT will be 0% (as in an export transaction).
• At the same time, since the results of the audit established the fact that the disputed counterparties had paid tax to the budget from transactions with the Company, this amount is not subject to additional tax charges to the Company, as this would result in a double payment of tax to the budget.
• Thus, the amount of VAT paid by the Company's counterparties and attributable to transactions with the Company should be excluded from the additional charges levied on the Company.

Why is this case important?

This case is an example of a dispute where the taxpayer managed not only to apply tax reconstruction and calculate the actual tax liabilities of the Company for profit tax, but also to exclude from the additional charges imposed on the organisation the amounts of VAT in the amount paid by the counterparties of the business entity and attributable to transactions with the company.

Tax Compliance specialists succeeded in obtaining the court's satisfaction of the organisation's claims in terms of profit tax, reduction of fines and penalties in full.