On June 10, Trade House Perekriostok LLC (hereinafter, the "Company",Taxpayer) filed a cassation appeal with the Supreme Court in the high-profile case regarding the tax consequences of intra-group restructuring. As of this writing, the decision on the complaint has not yet been made, but the conclusions of the lower courts have already become "scaremongering" for both tax consultants and business representatives on a variety of issues, including the concepts of business purpose and actual right to income, prejudice in tax cases, recharacterization of payment for shares and interest on a loan as dividends, and others.
The X5 Group had previously lost a similar dispute. At that time, it was refused to refer the dispute to the SCEC of the Supreme Court of the Russian Federation.
We suggest taking a walk with us through the main points of this case.
A BRIEF OUTLINE OF THE CASE
In 2013, X5 Group underwent a business restructuring aimed at transferring ownership of Russian companies, in particular Agroaspect LLC and Agrotorg LLC (hereinafter, Agroaspect and Agrotorg) from foreign entities to the Company (a Russian entity). The restructuring mechanism, in simplified form, looked as follows:
- The Company acquired shares of Agroaspect and Agrotorg from foreign companies of the group under a compensation transaction (sale and purchase agreements).
- Obligations to pay for the shares were performed as follows: a part of the shares was fully paid in cash, the other part was set off against counterclaims, and the remaining part was novated into a loan, including with the condition to pay interest.
- Interest on the loan was transferred by the Company to the foreign group company / set off against the counterclaim against the foreign group company - X5 Retail Holding Limited (Cyprus)/Speak Global Ltd (Cyprus).
- The funds paid out by the Company were subsequently returned to it through a sequence of intra-group transactions, including financial assistance and other.
POSITION OF THE TAX AUTHORITIES
Tax Authority assessed additional withholding tax at 15% rate with regard to payment of shares and interests, reclassifying these payments as dividends and stating that the disputed transactions did not have business purpose (aimed at withdrawal of money abroad and obtaining tax savings). The tax authority also refused to include the disputed interest in the Company's expenses.
TAXPAYER'S POSITION AND ACCOUNTING FOR DISPUTED TRANSACTIONS
For taxation purposes the taxpayer accounted for the abovementioned transactions as follows:
- The expenses on acquiring shares were not included by the Company in calculating the profit tax (cl.10 p.7 Art.272 of the RF Tax Code).
- When transferring payment for the shares to foreign organizations the Company did not calculate and withhold tax at source in the Russian Federation (Clauses 5 p. 1 and 2 of Article 309 of the RTC).
- Expenses in the form of interest on the loan were taken into account by the Company for the purposes of calculating the profit tax (Articles 252, 265 and 269 of the Tax Code). No withholding tax was withheld at the source when the interest was transferred (Article 11 of the CITA with Cyprus).
During the consideration of the case, the taxpayer provided the following main arguments justifying his chosen accounting treatment of the disputed transactions:
- The restructuring had a business purpose, which was to increase the transparency of the group structure and to create a consolidated group of taxpayers (CGT) based on Crossroads. It also allowed the taxpayer to dispose of significant amounts of Agrotorg and Agroaspect net income.
- Withdrawal of funds abroad was not the purpose of the transactions, as they were fully returned to the taxpayer's current accounts (in the form of financial aid).
- The plan to change the structure of the holding company had been previously agreed upon with the Federal Antimonopoly Service and the Luxembourg Tax Department.
- The payments in question cannot qualify as dividends due to the existence of a counterpart grant - the shares in Agroaspect and Agrotorg. In addition, dividends are a payment out of net profit, reducing it, and the taxpayer has not had it reduced.
MAIN CONCLUSIONS OF THE COURTS
The court of the first instance supported the arguments of the taxpayer. However, on appeal and cassation the case was resolved in favor of the tax authority. The key arguments that served as the basis for the decision in favor of the budget are given below.
There was no business purpose to the disputed transactions.
The courts have pointed out that before the Agroaspect and Agrotorg were part of X5 Group and controlled by X5 Retail Group. The ultimate parent company CTF Holdings Limited (Gibraltar) has not changed the position of its main assets, nor has the investment attractiveness of the group as a whole.
At the same time, the restructuring carried out was not accompanied by an increase in the taxpayer's capitalization (X5 Group shares continued to fall between 2013 and 2014). The change in Agrotorg's ownership structure did not result in administrative cost savings either.
The courts also pointed out that the purpose of creating a CTG could not justify the actions of the taxpayer and persons connected with him in creating conditions for the transfer of part of the CTG's revenue to foreign legal entities located in jurisdictions with a more favorable taxation regime.
Prejudicial significance of the circumstances in the Agroaspect case.
The appellate court pointed out that, contrary to the position of the court of first instance, the findings of the courts in a similar case of Agroaspect (A40-118135/19) should be applied in the present case.
Grounds for recharacterization of payments as dividends.
In general, the courts concluded that the interest and share payments paid were in fact a cover for dividend distributions and that the contracts concluded were not real transactions.
Thus, under the terms of the loans, their repayment by the taxpayer was made by the parties dependent on other obligations of the X5 Group, which made actual repayment of the loans virtually impossible. Payments made by the taxpayer were financed by loans from another group company and also returned to the taxpayer in the form of financial aid.
At the same time, according to the ruling concluded between the Luxembourg tax authorities and the X5 group, the interest paid by the taxpayer to X5 Retail Holding Limited (Cyprus) and further by the latter to X5 Capital S.a.r.l. (Luxembourg) were treated by the tax authorities of the Grand Duchy of Luxembourg as dividends and were therefore exempt from taxation.
At the same time, the courts found that when summing up the payments for the shares in Agrotorg and Agroaspect in the two transactions, it can be concluded that the amount of payments is commensurate with the amount of the taxpayer's undistributed profits.
The courts also paid particular attention to the fact that the disputed transactions were out of the Company's previous practice of transferring assets into the Company's possession. In particular, shares in a number of other companies had been transferred to Perekrestok by way of a contribution to the charter capital without any payment.
Thus, the courts concluded that all of the completed transactions constitute a single series (in fact, they are one "step-by-step transaction"). At the same time these transactions and other circumstances confirm the absence of the parties' intention to fulfill its terms in terms of payment, and also testify to artificial creation of appearance of transfer of assets on terms of compensation.
The absence of an actual right to income from foreign organizations referred to by the taxpayer.
The appellate court asserted that a number of successive transactions had created conditions for the sequential (transit) transfer of funds from the taxpayer to X5 Retail Holding Limited (Cyprus) and from X5 Retail Holding Limited (Cyprus) to X5 Capital S.a.r.l. (Luxembourg).
Furthermore, all key decisions on transactions made by X5 Group companies were made by the same person - Franz Wolf, who during the audit period was the sole executive body not only of Perekrestok Holding Limited (Gibraltar), but also of CTF Holdings Limited (Gibraltar) - the main parent structure of the consortium into which the X5 Retail Group companies belong.
Thus, the ultimate parent company of the group was a company registered in Gibraltar, i.e. in a jurisdiction with which the Russian Federation has no double taxation treaty. In addition, the double taxation treaties could not be applied in principle due to the focus of the parties' actions on tax avoidance.
Other aspects indicating the presence of a "scheme".
Additionally, the appellate court drew attention to the "artificial" increase in the net assets in Agrotorg by increasing the size of its share capital. The money necessary for such an increase had been received as loans from the Company. After the foreign companies received these funds, they were returned to the Company in full.
It was also established by the court that there was no taxation of certain payments not only in the RF, but also in the jurisdiction of the recipients. Thus, the taxpayer's acquisition of a 6.7% stake in OOO Agrotorg from X5 Retail Group N.V. (Netherlands) in 2013-2014 involved cash payments which were not subject to profit tax under the Agreement with the Kingdom of the Netherlands.
COMMENTS ON TAX COMPLIANCE
The case under review is really rich in numerous circumstances and peculiarities both reflected in the judicial acts and remained in the courtroom and on the case file. Therefore, in our view, its influence on the development of judicial practice with regard to the interpretation of tax law norms is rather disputable. Thus, in future disputes, the party, which is uncomfortable with the conclusions of the court on the Perekrestok case, may reasonably appeal their inapplicability due to "other factual circumstances". However, certain points do deserve attention and discussion.
Given that the transfer of a valuable asset did take place, and in essence the claims were made about the manner of that transfer, perhaps the courts should have focused on examining the case through the lens of the doctrine of priority of substance over form rather than business purpose. What is particularly striking here is the "circular" nature of the cash flow in the novation of the principal into a loan with interest accruing and reflected as an expense.
In any case, as part of a group restructuring, it should always be taken into account that the tax authority will check to what extent the business interests (not tax) and the will of the taxpayer itself, and not the group as a whole, were present both in the decision to acquire the asset and in the choice of the method of such acquisition.
Prejudicial significance of the circumstances in the Agroaspect case.
The tax authorities and courts are now increasingly refusing to examine the case in detail if there are similar judicial acts analysing similar transactions or counterparties. At the same time adequate application of the provisions of Article 69 of the APC RF is rare. In particular, courts often ignore both the lack of identity of persons and the lack of prejudice in terms of conclusions about the legal qualification of legal relations and the interpretation of legal norms.
In the considered case the court of appeal instance just paid attention to the fact that the issues of legality of disputable transactions, the presence of the actual right to income have already been investigated in the case of Agroaspect and the court cannot give another assessment in this case. However, in view of the above, as well as in view of the formal absence of identity of persons, such an assertion is not indisputable.
Application of a double taxation treaty
In reclassifying the disputed payments as dividends, the tax authority concluded that the ultimate parent company of the group was CTF Holdings Limited, a company registered in Gibraltar, i.e. in a jurisdiction with which the Russian Federation has no double taxation treaty. In forming this conclusion, the logic of the court's application of the FTT concept deserves separate consideration, but we would like to draw attention to another conclusion of the court. In particular, that double taxation treaties cannot be applied in principle, since the parties' actions were aimed at avoiding taxation.
The proposed concept is an alarming sign and goes against the practice of applying national rules of undercapitalization. Thus, in a number of cases the SCEC of the Supreme Court of the Russian Federation has clearly stated that when reclassifying interest as dividends, the reduced rates provided for dividends under the relevant double taxation treaty are to be applied. We expect that this approach will not become widespread and will follow the development of practice.
We hope this article was useful for you. We have extensive experience in supporting intragroup transactions and will be happy to provide you with the necessary legal support.