Ivan Tsvetkov, Head of Tax Practice at TC, commented on the reversal of practice in the Lukoil case in a Kommersant article.

Projects that initially seemed attractive for investment sometimes become unpromising, and then the business has to abandon them, and unfinished objects - to liquidate. The question of whether the costs of such facilities can be taken into account for the purpose of reducing profits tax often arises in disputes between companies and the Federal Tax Service. Recently, the Supreme Court of the Russian Federation (RF Supreme Court) gave an unambiguous answer to this question, allowing the deduction from the tax base of expenses for those unfinished projects which a company has decided to abandon. The Supreme Court of the Russian Federation issued a precedent decision on the issue of expenses taken into account when calculating profits tax for organizations. The position was formulated within the framework of the Lukoil tax case.

In the case in question, the Supreme Court of the Russian Federation actually made a turnaround in the practice on the issue of accounting for expenses for work preparatory to the liquidation of an object, which was mainly negative for taxpayers.

Previously, the courts, as a rule, were guided by the approach that in relation to construction in progress, only the costs of liquidation of the construction in progress should be included in expenses.

At the same time, the Supreme Court of the Russian Federation in its ruling rightly noted that Chapter 25 of the Tax Code of the Russian Federation does not contain a closed list of expenses that may be taken into account by taxpayers for profit tax purposes. Consequently, if a taxpayer for objective reasons refuses to build a facility, the relevant expenses incurred by a person may be validly taken into account for corporate income tax purposes.

The position developed by the Supreme Court of the Russian Federation in this definition seems to be relevant for all business sectors realizing all kinds of investment projects through construction of fixed assets. In addition to the oil and gas industry, this judicial act may be relevant for development companies, manufacturing organizations, as well as other representatives of the real sector.

The conclusion of the Supreme Court that economic feasibility and business purpose of incurring expenses is assessed at the moment of their recognition and is not excluded in case the taxpayer was actually unable to complete the process of creation of fixed assets due to objective economic reasons seems noteworthy.

At the same time, in order to prevent taxpayers from abusing their rights, the Supreme Court of the Russian Federation additionally noted that such expenses may be disallowed if they were incurred despite the fact that the economic feasibility of creating a fixed asset was no longer evident.

Thus, in case of accounting for expenses on construction in progress, taxpayers should be ready to confirm their economic feasibility, as well as the existence of a business purpose for refusing to continue construction due to its economic inexpediency. 

In this regard, it is advisable for businesses to consider the possibility of preparing, at each stage of construction of a fixed asset, “protective files” confirming the reasonableness of the taxpayer's incurrence of the relevant expenses, which, if necessary, will also be able to substantiate the reasons for refusing to continue construction.