Last summer turned out to be quite rich in tax events and decisions. Amendments to tax legislation in terms of personal income tax, introduction of VAT for simplified taxation system and amnesty for ‘splitting’ business will be discussed in the professional community for a long time to come. 

In addition to the tax reform adopted in July this year, August was also rich in court decisions, including on issues that have long been controversial in practice and regularly become the subject of disputes between taxpayers and tax authorities. 

Ivan Tsvetkov, Head of Tax Practice Ivan Tsvetkov commented on the importance of accounting for construction in progress: ‘When accounting for construction in progress, taxpayers must be prepared to confirm their economic feasibility and the existence of a business purpose in refusing to continue construction.

We will discuss the most significant cases for practice below. 

1. Accounting for expenses relating to construction in progress - Case of PJSC Lukoil Oil Company (A40-288396/2021). 

Until recently, the issue of the legality of accounting for expenses on construction in progress was one of the many controversial subjects of disputes, which was ambiguously resolved by the courts. 

Despite the existence of positive decisions for taxpayers (Case of LLC ‘ZMI-Profit’ № A76-17698/2015, PJSC ‘Paper Mill “Kommunar” № A56-9767/2018), disputes were usually resolved in favour of the tax authorities (Cases of LLC “NPO ”Chemical and Metallurgical Company’ № A19-22028/2016, JSC ‘RTTCOM. RU NO. A40-98004/2020, PJSC ROSTELECOM NO. A40-281861/2022). 

The courts were mainly guided by the approach that, in relation to construction in progress, only expenses for the liquidation of construction in progress should be included in expenses. At the same time, the business community argued that it is lawful to include in non-operating expenses the cost of a fixed asset when it is liquidated.

In August this year, the Supreme Court of the Russian Federation considered the cassation appeal of Lukoil Oil Company PJSC. 

According to the actual circumstances, the Inspectorate conducted a desk tax audit, following which it concluded that the Company had improperly included in non-operating expenses the cost of unfinished construction of fixed assets under investment projects which it had decided not to realise for economic reasons. 

The courts of three instances supported the Inspectorate, noting that expenses include only the costs of liquidation of the construction in progress. 

However, the Supreme Court of the Russian Federation supported the Taxpayer, stating the following: 

Chapter 25 of the Tax Code of the Russian Federation does not contain a closed list of expenses;

If the construction of fixed assets ceases for objective reasons, the expenses incurred by a person may be legitimately taken into account for profits tax purposes.

It should be noted that the conclusions of the Supreme Court of the Russian Federation are fully consistent with the realities of entrepreneurial activity, when the construction of an object that initially appears to be investment-attractive may become unprofitable for a business, and therefore its further construction is inexpedient for objective reasons. 

In order to prevent taxpayers from abusing the right, the Supreme Court of the Russian Federation additionally noted that such expenses may be refused to be accounted for if they continued to be incurred despite the fact that the economic feasibility of creating a fixed asset was no longer evident. 

Thus, when accounting for expenses related to construction in progress, taxpayers should be prepared to confirm the economic feasibility of the expenses incurred and the existence of a business purpose for refusing to continue construction due to the economic inexpediency of such construction.

2. Recharacterisation of a contribution to the property of a subsidiary organisation as a gratuitous transfer of property - Case of OOO Viaz (A65-19667/2024). 

The issue of imposition of VAT on an operation involving a contribution to the property of a subsidiary organisation has always been the subject of close attention of the tax authorities and is not new to practice. 

In the dispute in question, the Company decided to make a non-monetary contribution to the property of its subsidiary in order to increase the latter's net assets. The Inspectorate, conducting a desk tax audit, found that the Company had carried out a transaction involving the gratuitous transfer of property, which is subject to VAT. 

The court sided with the Taxpayer, pointing out that making a contribution to property is an additional way of investment in the capital of an organisation by its participants. By transferring part of its property to a subsidiary company, its participant, as a rule, expects to receive a positive effect from its use, which should ultimately translate into an increase in profits to be distributed to the participant.

In rejecting the Tax Authority's arguments, the Court noted that the Inspectorate had not provided evidence that the Company's will in transferring the disputed property as a contribution to property was aimed at the gratuitous transfer of that property without acquiring any rights. The transaction carried out by the Taxpayer is of an investment nature, as it directly affects the increase in the amount of net assets and, consequently, the amount of profit distributed to the participant. 

Additional interest to this case is also due to the fact that the Court rejected the reference of the Inspectorate to the explanations of the Ministry of Finance of Russia, in which the state body indicated that operations on contribution of immovable property to the property of a legal entity are subject to VAT. 

Thus, when making a non-monetary contribution to the property of a subsidiary organisation, it seems advisable to prepare appropriate ‘protective’ files confirming the investment nature of the transaction.

3. Withholding tax in respect of income paid by a management company of a ZPIF to a foreign organisation - Case of G. P. I. MC LLC (A5622968/2024). 

In recent years, the use of ZPIFs has become increasingly popular when it comes to the need to choose an asset ownership structure or to carry out business activities with the lowest tax consequences. However, some business representatives mistakenly believe that the use of ZPIFs is guaranteed to allow them to avoid potential claims from the tax authorities. 

At the same time, the trend emerging in court practice shows that the institution of ZPIF is not an ultimatum solution that will protect from tax claims, including when it comes to international tax structuring. 

According to the dispute, following the results of a desk tax audit, the Inspectorate concluded that the Company had created a scheme of illegal tax optimisation whereby income from the use of immovable property in the Russian Federation was paid to a Cypriot organisation under the guise of other income in respect of which a favourable taxation procedure was provided for.

The court upheld the conclusions of the tax authority, reclassifying ‘other’ income paid to a foreign organisation as income from the lease of property, recognising the Company as a tax agent. 

The Court additionally noted that the application of SITN in terms of preferential rates is possible only if it is established whether the person claiming the benefits is the actual recipient of the relevant income. In the case at hand, the Court concluded that the Cypriot organisation was only an intermediate link, did not benefit from the funds transferred to it, and carried out a transit transfer of funds through the chain. 

This case is the first dispute in the Russian arbitration practice, where the issue of withholding tax at source in relation to a Russian ZPIF was considered. The tax authorities are beginning to evaluate more closely the activities of Russian ZPIFs from the point of view of possible abuse of this structure by taxpayers. 

Another peculiarity of this dispute is the fact that the Court actually confirmed the right of taxpayers to apply the provisions of the LEDN even when international tax structuring is carried out through Russian ZPIFs. However, the taxpayers have to prove that the foreign entity is the actual recipient of the income and does not act only as an intermediate link in the relevant chain. 

4. Recognition of an iron ore quarry as an object of corporate property tax - Case of Huatai Mining Company LLC (A78-4578/2024). 

It should be noted that the tax authorities often pay close attention to the recognition of a particular fixed asset as subject to corporate property tax. 

As follows from the Court's decision, the Company received an iron ore quarry from its parent company as a contribution to its authorised capital. 

The Company decided not to register the iron ore pit as a fixed asset and did not consider it to be subject to property tax, as it believed that the deposit itself could not be considered a man-made object. 

The court disagreed with the Taxpayer's conclusions, pointing out that the quarry was an anthropogenic object and that the Company's actions were aimed at unlawfully excluding the quarry from the fixed assets subject to property tax. 

The Court additionally noted that at the time of the transfer, the quarry met all the criteria for recognition as a fixed asset: it had been used for a long period of time (more than 12 months), the Company did not consider its further resale, the quarry had been brought to a condition that implied the possibility of its exploitation and was capable of generating income for the company. 

Another circumstance that influenced the Court's decision was the fact that the quarry was accounted for by the previous owner as a fixed asset and was included in the objects subject to property tax. 

Thus, businesses should bear in mind that it is quite problematic to justify the reasons for non-payment of property tax on acquired objects in cases where the said objects were included by their past owners in the list of objects subject to property tax. 

5. Application of corporate property tax benefits in the Moscow Region for investors - Lenta LLC case (A41-5115/2023). 

Many constituent entities of the Russian Federation provide property tax benefits for entities engaged in investment activities. At the same time, the legality of the application of these exemptions by taxpayers is often the subject of a dispute with the tax authorities. 

According to the factual circumstances of the above dispute, the Inspectorate conducted a desk tax audit, following the results of which it came to the conclusion that the Company had unlawfully applied the property tax privilege provided for by the legislation of the Moscow Region. It concerned the Company's use of warehouse buildings - distribution centres - for the purpose of selling alcoholic and tobacco products. 

In the opinion of the Tax Authority, the property tax exemption provided for by regional legislation does not apply to facilities used for retail trade and the sale of excisable products.

The court partially supported the Taxpayer, pointing out that the relevant property tax exemption should be applied if the fixed assets created are not intended directly for wholesale and retail trade. In fact, the privilege in respect of warehouses may be applied if they are not used for the direct sale of goods. 

In the Court's opinion, the Inspectorate did not provide sufficient evidence confirming that trading operations were carried out directly in warehouses. 

At the same time, the Court decided to impose additional property tax on the use of premises for the purpose of storing alcoholic beverages in proportion to the total area of the disputed facilities. 

This case is one of the few resolved in favour of the taxpayers, since, as a rule, courts in similar disputes deny the taxpayers to apply the relevant benefits in full. 

The approach taken by the Court in this dispute to assess the legitimacy of the application of property tax exemptions by investors appears to be the most appropriate in resolving similar disputes.