As a rule, not a single act of a tax audit goes without mentioning an unjustified tax benefit, which, according to the auditors, harms the budget; the provisions of Article 54.1 of the RF Tax Code, which came into force in August 2017, have consolidated this concept at the legislative level. The most effective ways to reduce additional tax charges imposed by the tax authorities in the context of the application of the new article can be developed even before the court. Partner of Tax Compliance law firm Mikhail Begunov shared his advice on how to do this. In 2017, the domestic tax legislation was enriched by Article 54.1 of the Tax Code of the Russian Federation - it replaced the concept of unjustified tax benefit, which had been applied since 2006. The new norm was designed to reduce the number of taxpayers using "aggressive" tax optimization mechanisms.
The accusations of exceeding the limits of exercising rights which the Federal Tax Service most often brought against taxpayers usually included: accusations of price manipulation, inclusion of economically unjustified intermediaries in the supply chain, reflection of transactions in a different period than they actually belonged to, accusations of sham transactions, reclassification of activities and transactions within the group.
The enactment of Article 54.1 has had a noticeable effect on the procedure for tax administration - among other things such notions as "reality of performance from a particular counterparty" and "economic feasibility of the transaction" have appeared in Russian law. Businesses did not adapt to the changes immediately: not understanding how to interact with the Federal Tax Service in the context of the new article, companies preferred to rely on the concept of due diligence and the standard counterparty audit, developed back in the period of the Resolution of the Plenum of the RF № 53 of October 12, 2006. But at some point the old measures were no longer enough to protect against taxmen's claims. Up until 2021 the business lacked explanatory letters and jurisprudence on the application of the new rules, but on March 10 of this year the Federal Tax Service issued a long-awaited Letter № BBV-4-7/3060@, helping companies find common ground with the tax authorities.
Prescription against abuse
So what is the meaning of the Article 54.1 of the Tax Code? In brief, this is the first article that regulates the issue of unjustified tax benefits received by a taxpayer. In it, the legislator defined the specific actions of the taxpayer, which are recognized as abuse, and the conditions that must be met for the taxpayer to be able to account for expenses and deductions for the transactions made.
The article establishes three fundamental prohibitions and conditions, non-compliance with which deprives the taxpayer of the right to reduce the tax base: firstly, the company must not misrepresent the facts of economic life. Secondly, the obligation under the transaction must be performed by that counterparty of the taxpayer, which is specified in the contract, or a subcontractor. Thirdly, the transaction must be economically justified and not aim to reduce tax. In this case the principle of good faith of the taxpayer applies, that is, the tax authorities have the obligation to fully evaluate the totality of facts and circumstances established in the course of the audit, indicating the possibility of applying the provisions of Article 54.1.
The experience accumulated by Tax Compliance attorneys in the sphere of tax audit and dispute support shows that law enforcement of the first two points does not cause any particular controversy in the courts and tax authorities, the same cannot be said about the third point, as, in fact, both the accounting of distorted transactions by the taxpayer (for instance, those that exist only "on paper") and the accounting of transactions that have not been performed by the declared contractor are ultimately aimed at tax non-payment.
For the whole period after the introduction of Article 54.1 of the Tax Code, the number of field tax audits, in which the tax authorities have applied the provisions of the new article, amounted to a little more than 2 thousand against the previous 7 thousand, which greatly exceeds the number of related court disputes. According to the Tax Service, these figures indicate a decrease in the administrative burden on business, but businessmen themselves are not satisfied with the practice of application of Article 54.1 of the Tax Code.
At Tax Compliance we pay special attention to the protection of the taxpayers' rights at the pre-trial stage of the tax dispute, which allows us to develop really effective ways to decrease additional tax charges. Our practice of the last three years has shown that a skillfully developed defense strategy and the evidence base can more than halve the size of additional tax charges at the pretrial stage.
Confirmation of reality
Often the tax authorities impute Article 54.1 of the Tax Code to taxpayers because of a misunderstanding of business processes, misclassifying the offense. For example, paragraph 1 of the article refers to misrepresentation, which can be understood as the artificial nature of the relationship between the taxpayer and the counterparty. Typical examples of distortion, the tax authorities refer to the creation of a scheme to split the business or the absence of the actual fact of the transaction, and at the same time they need to prove that the taxpayer committed the disputed actions intentionally.
Thus, during field tax audits, the tax authorities regularly pay attention to the scope of supply. The taxpayer's relationship with a supplier, which exists only on paper, is one of the typical examples of an unrealistic, not actually performed transaction. When auditing the tax authorities often prescribe in the act the conclusion that the supply of goods by the disputed counterparty and impute in this case a violation of paragraph 1 of Article 54.1 of the Tax Code. The law in such cases implies the absence of goods.
The main method of protection in this case is to document the actual movement of goods from the time of purchase until the subsequent sale or use in production. It is important for the taxpayer to submit a commodity balance calculation to confirm the quantitative balances of goods needed to ensure the smooth and continuous operation of the company. It would be useful to confirm that the transaction was not made with the deliberate purpose of tax optimization - this can be evidenced by the schemes of refund or circular movement of money on accounts with the supplier or his financial controllability.
In Tax Compliance practice we had a case when the Federal Tax Service assessed additional tax arrears of a large pharmaceutical company due to an unconfirmed supply of goods. Our lawyers appealed the decision of the tax authorities at pre-trial proceedings and proved that the purchase and use of the goods was realistic in view of the specifics of the production cycle. Additional arguments in this case could be the absence of other suppliers of similar goods, as well as the lack of controllability and interdependence with the disputed counterparties (in order to avoid shifting the tax liability on the audited entity).
Measure twice and cut once
Another striking example of distortion is the creation of a scheme of splitting the business for the purpose of the unlawful application of special tax regimes. Such schemes also fall under Art. 54.1 of the Tax Code, and the recent court practice shows that taxpayers have resorted to this method in the hope of reducing their tax burden.
Usually tax savings are achieved in the following way: a taxpayer who is on the general taxation system, uses companies under his control that apply special tax regimes, and distributes the proceeds from his activities to all participants in the scheme. If the tax authority suspects a company of unlawful splitting, it will, firstly, have to prove that it does not play a real economic role in the existing business process, and secondly, establish the ultimate beneficiary for the entire scheme.
It is important to remember that the tax authorities have recently been trying to move away from the formal approach, and in addition to the fact that each participant in the business process must meet the signs of independence, the taxpayer must be ready to justify to the inspectors the reasons for creating and features of the interaction of a particular company, part of a common group.
One of the signs that the participants of business splitting schemes acted in concert in order to obtain a tax benefit is the fact that one of its participants is the beneficiary of the scheme. The tax authorities are increasingly confronted with this phenomenon.
In order to justify the position before the tax authorities on the absence of artificial splitting of the business, an important criterion for assessing the legality of formation of a group of interdependent persons is the economic purpose for splitting the business.
Tax Compliance has appealed the results of field tax audits of cases related to splitting of businesses: the legal concept of our lawyers allows proving that the participants of the economic process were established to obtain a significant economic effect, using different sales techniques to gain the largest market coverage. Where there is a reasonable economic purpose, the identity of the activity being conducted is not in itself a substantial criterion for assessing the fact that a business split scheme was created. Besides, in the case of tax consulting for a company in HoReCa sector, Tax Compliance lawyers managed to elaborate a legal position that substantiated the independence of companies and eliminated the risks of artificial business splitting due to the commercial concession agreement between the participants of the business process.
Tax reconstruction as a way of defense
It is not easy to work and in cases where the tax authorities qualify an offense under paragraph 2 of Article 54.1 of the Tax Code. In this case, the tax authorities do not deny the existence of a product or service, but in addition to confirming the existence of a valid business purpose, the taxpayer must prove that the transaction was actually performed directly by the disputed counterparty.
For example, to confirm the circumstances of the execution of construction work it is important for the taxpayer to provide documents that would confirm the availability of human resources in the disputed counterparties, such as applications for admission of representatives of disputed counterparties to the territory of the inspected company, logs of safety regulations, etc. In the case of transactions for the purchase of goods, supporting documents will be transport papers or testimonies of the carriers of goods.
When the document turnover with the declared counterparty is of a formal nature, but the obligation is actually performed by a third party, the taxpayer is prohibited to claim a VAT deduction or include expenses in the tax base for CPT under formal and unreliable documents - but this does not relieve the tax authorities from their obligation to find out whether under the guise of such papers were conducted real business operations, to identify their real purpose and determine the true extent of tax liabilities. How to defend oneself against claims of tax authorities, when the latter impute the delivery from the wrong person?
The main method of protection in this case is the use of tax reconstruction according to the letter №БВ-4-7/3060@ of March 10, 2021 of the Federal Tax Service of Russia: it allows taking into account the real volume of expenses related to the services of actual contractors or suppliers, taking into consideration the submitted source documents or an expert examination of the market value of the goods or services. It is important for the taxpayer to confirm the absence of an actual tax benefit in the form of an unreasonable markup on goods/services or to calculate the actual tax benefit based on the amount of unreasonable markup on the transit link. In our practice, there was a case when upon the results of an on-site audit the tax authorities denied a VAT deduction and recognition of expenses of a controlled transit counterparty due to the assumption that the goods had been purchased directly from the manufacturer. The position of Tax Compliance lawyers allowed proving wrongfulness of tax arrears calculation from the full amount of the transaction with the disputed counterparty.