The Tax Compliance team successfully defended the client's interests in pre-trial proceedings, developing a legal position that allowed to significantly reduce the amount of additional tax charges.

What happened?

During the audited period, the taxpayer provided water supply and wastewater disposal services to facilities, including residential buildings, industrial facilities and social infrastructure facilities. At the same time, the Company's activities were regularly subsidised from the local budget.

The tax authority conducted a field tax audit of the Company, following the results of which the Inspectorate concluded that the Company had received an unjustified tax benefit in the following episodes:

Episode No. 1: Provision of motor transport services by a person who is not a party to the contract (subparagraph 2, paragraph 2, Article 54.1 of the Tax Code of the Russian Federation).

Episode No. 2: Unjustified inclusion in non-operating expenses of amounts of written-off receivables.

Episode No. 3: Illegal non-recovery of VAT, non-deductibility of VAT and overstatement of expenses on transactions, VAT and expenses on which were reimbursed by subsidies as gratuitous contributions to property that did not increase the Company's authorised capital.

Episode No. 4: Illegal non-inclusion in non-operating income of a part of the subsidy equal to capital investments in depreciable real estate and written off by the Company through the depreciation mechanism.

According to the legal position developed by Tax Compliance, the Company, while not disputing the amounts of additional charges imposed by the tax authority in Episode 2, disagreed with the tax claims in Episodes 1, 3 and 4.

Appealing the tax claims

Episode No. 1.

In the opinion of the tax authority, motor transport services to the Company were rendered by a person other than the contractual counterparty.

Tax Compliance specialists, based on the evidence available in the tax audit materials (e.g., primary documentation and witnesses' testimonies), managed to confirm the fact that the motor transport services were rendered by a proper person.

Episode No. 3.

In the opinion of the tax authority, the Company unlawfully failed to recover VAT, deducted VAT and overstated expenses on transactions for which VAT and expenses were reimbursed by subsidies as gratuitous contributions to property that did not increase the Company's authorised capital on the following grounds.

VAT

• Where a subsidy is received after expenses have been incurred in which VAT is charged on the acquisition of goods (work and services), VAT is recoverable in the period in which the subsidy is received.

• A subsidy received from budgets (local, budget of a constituent entity of the Russian Federation, federal) in the form of a gratuitous cash contribution to the company's property to repay the cost of purchased works is an operation not recognised as subject to VAT. This operation is accounted for on a separate sub-account, as well as the "input" VAT charged and repaid.

Corporate income tax

• The source of contribution from the shareholder is formed from the local budget. Gratuitous cash contributions to the company's property by the respective shareholder are provided in the form of a subsidy from the budget.

• Funds from the local budget as gratuitous contributions to the property, the authorised capital of the Company did not increase, were not an investment, but a subsidy (since only two forms are available to a commercial entity from the budget: investments and subsidies).

• The fact that the funds provided to the Company are a subsidy is confirmed by the characteristics of these funds (gratuitous, irrevocable, targeted, for financial support of costs, made in contributions to property without increasing the authorised capital).

• Consequently, the funds from the budget are allocated to the Company in the form of a subsidy as gratuitous contributions to property without increasing the authorised capital.

• As a general rule, an agreement under which a shareholder makes a contribution to the Company's property must be pre-approved by a resolution of the Company's Board of Directors or only by the shareholder, if the functions of the Board of Directors in the Company are performed by a shareholder. Based on the minutes of the meetings of the Company's Board of Directors, the Board of Directors did not approve the allocation of gratuitous contributions to the property.

• Taxpayers are entitled to take into account in forming the profit tax base only expenses that meet the criteria of Article 252 of the Tax Code of the Russian Federation, the source of which are funds received on a reimbursable basis.

• Tax legislation does not provide for the possibility to reduce the tax base for expenses incurred by another person (a municipality having only budgetary funds in its treasury) when calculating profit tax.

• The Company did not actually incur its own expenses, as they were reimbursed in the form of gratuitous contributions to the property of the company, not increasing the authorised capital with their financial support by a subsidy from the budget of the municipal entity;

• The purposeful nature of the monetary funds transferred to the Company does not allow to reduce taxable income under the profit tax.

The Company submitted, in particular, the following arguments justifying the unlawfulness of the tax authority's position:

• The Company was given a contribution to property in the form of a subsidy for the purpose of financing forthcoming expenses for the provision of the Company's activities;

• It does not follow from the meaning and systemic interpretation of the provisions of civil, tax and budgetary legislation that subsidies of a targeted nature cannot be made as a contribution to the property of a company by a shareholder (participant), including a municipal entity represented by its authorised body having the status of a legal entity;

• The state authorities proceed from the understanding that a contribution to the property of a joint stock company in the form of a subsidy for the purpose of financing forthcoming expenses to ensure the company's activities is not counted as income in determining the tax base for corporate income tax;

• The amounts of VAT charged to the Company under relations with counterparties for payment are actually paid by the Company at the expense of its own property (cash).

Episode No. 4.

In the opinion of the tax authority, the Company unlawfully failed to include in non-operating income a portion of the subsidy equal to capital investments in the part accounted for in expenses written off through the amortisation mechanism on the following grounds.

Organisational income tax

• The Company is not entitled to calculate its tax liabilities taking into account par. Z pt. 1 Art. 251 para. 1 of the Tax Code of the Russian Federation, since the authorised capital of the Company was increased by increasing the nominal value of shares, which is carried out only at the expense of the property of the Company itself (additional capital), and therefore effectively excludes the shareholder's contribution, as well as the provision of such contribution in the form of a subsidy.

• The authorised capital of the Company was increased by increasing the nominal value of the share, i.e. at the expense of the property of the Company itself, not the shareholder's contribution.

• The subsidy increases the Company's own property (additional capital) but cannot be made as a contribution increasing the authorised capital.

• The subsidy was not a shareholder's contribution, was not a financial security of the shareholder's contribution, but was provided as payment for capital investments.

• Capital investments in the form of reconstruction and construction of depreciable fixed assets owned by the Company were fully made by the Company at the expense of the subsidy.

• The Company accrued depreciation in respect of these depreciable fixed assets, which was recognised by the Company as an expense.

The Company submitted, in particular, the following arguments justifying the unlawfulness of the tax authority's position:

• The provisions of budgetary and civil legislation do not directly restrict a joint stock company, 100 per cent of shares of which are owned by the municipality, in increasing the authorised capital in the case of budgetary subsidies both by placing additional shares and increasing the nominal value of shares.

• The authorised capital of a joint stock company by increasing the nominal value of shares shall be increased only at the expense of the company's property. Thus, it is possible to increase the nominal value of shares, among other things, at the expense of additional capital of a joint stock company.

• The subsidy in the dispute in question is the source of additional capital, which was not disputed by the tax authority during the tax audit;

• In view of the sole participant of the Company, it seems inexpedient to increase the authorised capital by placing additional shares, as the share of the shareholder will remain unchanged.

Results of the appeal

Following the study of the legal position, which was developed by Tax Compliance specialists based on the results of the analysis of the actual circumstances of the dispute, the tax authority made a decision to satisfy in full the Company's claims in terms of profit tax.

In addition, the tax authority satisfied the Company's claims (1) that the unused amount of losses from previous years should be carried forward to reduce the taxable base for profits tax, (2) that the penalty should be reduced due to mitigating circumstances (the penalty was reduced by 99%), and (3) that penalties should be calculated taking into account the moratorium on their accrual.

Thus, the claims made by the Company in respect of profits tax, the need to carry forward the unused amount of losses from previous years, the reduction of the penalty and penalties were satisfied by the tax authority in full, which made it possible to significantly reduce the amount of additional charges.