Over the past year, we have seen that the tax authorities have shown abnormal interest in the payment of income received by foreign organisations from sources in the Russian Federation. Whereas previously auditors were most often interested in confirming the status of the actual recipient of income in order to apply the favourable rate under an international treaty, recently we have seen a trend towards challenging the legal nature of the income paid and its business purpose.
In the December issue of Legal Insight, Sergey Ivanov, Senior Tax Consultant at TC, and Anastasia Arzhanova, Tax Consultant at TC, analysed the emerging trend, recent court practice and our company's experience in supporting such field tax audits.
What has changed in the approach of the tax authorities?
Presidential Decree No. 585 of 08. 08. 2023 suspended double taxation agreements with a number of ‘unfriendly’ states.
One of the most significant changes in this regard was the change in the taxation rate for income received by foreign companies from sources in the Russian Federation. Thus, when receiving all types of income from Russia, taxes will be withheld from them at the rates stipulated by the Tax Code of the Russian Federation rather than by double tax treaties (hereinafter - ‘DTT’):
- For dividends - the rate of 15% (the treaties could set different variants of reduced rates, for example 5% or 10%);
- For royalties and interest - a rate of 20% (agreements may have established a full exemption from tax on such income or reduced rates).
According to some tax officials, there is indeed a certain trend to check the legality of licence fee payments. It is connected with some differences in the interpretation of the concept of royalties offered by the Tax Code of the Russian Federation and double tax treaties (see the table below).
Art. 12 of FASB applies only to those types of income that are explicitly named in it. The rest will be subject to Art. 7 of MFRS ‘Profit from entrepreneurial activity’. There is no ‘return’ to the norms of the Tax Code of the Russian Federation.
What do we see in our practice?
We are currently accompanying an on-site tax audit, the main claim of which is the unjustified payment of royalties to a foreign rights holder. It is particularly noteworthy that the Russian subsidiary had been paying these royalties to the foreign licensee for more than 20 years, during which the structure of their accrual had not changed.
Based on the tax control activities carried out to date, it is possible to identify three main blocks by which the tax authority ‘tests’ the validity of royalty payments:
- Formal registration of trademarks (the right holder did not participate in the registration of trademarks, did not protect them on the territory of the Russian Federation);
- The taxpayer's activity is completely independent (all decisions regarding the purchase of raw materials, pricing, exports, production volumes and development strategy are made exclusively ‘within the perimeter’ of the Russian Federation, without coordination with the foreign company);
- ‘Overpayment’ of royalties (in respect of goods purchased by the taxpayer for resale, royalties are paid twice: the first time - when the goods are purchased abroad, the second time - when the goods are sold in the Russian Federation).
What are the possible consequences?
As a rule, the tax authorities make two types of additional charges following an analysis of royalty payment transactions:
- Charges for corporate income tax due to the exclusion of royalty expenses from the licensee's tax base;
- Additional withholding tax assessments due to refusal to apply the preferential rate stipulated in SOIDN (e. g., reclassification as ‘other income’ according to subparagraph 10, paragraph 1, Article 309 of the Tax Code of the Russian Federation).
Until recently, it was believed that the problem of tax risks of payment of licence fees to a foreign interdependent company was no longer relevant, as the court practice on this issue was formed in the period from 2018 to 2023. However, in the latest Review of legal positions of the Federal Tax Service of Russia, prepared based on the results of consideration of taxpayers' complaints for the 2nd quarter of 2024, the only case that is mentioned in the section “Profit Tax of Organisations” is devoted to the named problem [1]. For this reason, it is advisable to recall the approaches that have been developed by judicial practice in assessing the procedure for taxation of royalties paid to a foreign company.
Let's summarise the results
Practice shows that, indeed, licence fee review is a new trend that we believe will continue throughout 2025.
At the same time, there are many options for recharacterisation. If the relations between the right holder and the licensee have a different specific legal nature, the tax authorities will proceed from it when assessing the tax consequences of the transactions. For example, in the case of LLC ‘Leoni Rus’. [2] the auditors came to the conclusion that the licence agreement actually covers the contract of rendering consulting services by a foreign organisation to a Russian entity. As a result of this reclassification, the inspectors charged additional VAT on the basis of the fact that the place of rendering such services is recognised as the territory of the Russian Federation.
As a result, if a Russian entity pays royalties to a foreign group company, such a Russian entity should be ready to provide the tax authority with explanations as to the reasons for concluding a licence agreement and confirming the absence of the purpose of illegal optimisation in structuring the transaction.
[1] Letter of the Federal Tax Service of Russia No. BV-4-9/10821@ dated 20. 09. 2024.
[2] Decision of the Arbitration Court of the Nizhny Novgorod Region dated 01. 07. 2022 in case No. А43-19397/2021.
