The new regulations which have been passed as part of Federal Law “On Amendments to Certain Legislative Acts of the Russian Federation Relating to Development of the Rules for Price Determination for Taxation Purposes” on July 18, will come into force from January 2012, with no fines applicable until 2014, when fines of 20% will apply until 2017 when fines of up to 40% will apply.
The law will see changes to related party provisions, controlled transactions and the threshold and market price variations applicable, as well as document provision. Alina Strokina, Auditor at GSL Audit, says that under the new provisions both taxation officials and companies will need to focus on economic substance of transactions.
“Both tax authorities and businesses will face considerable changes. When new regulations become effective, the best part of responsibility will be laid on market participants directly. In particular, the proposed law sets the new principles as to how the duty to justify the use of transfer pricing shall be allocated. The priority is given not to the legal form of the transaction, but to its actual economic substance. The government expects that the preplanned changes will allow the organization of better control over the accuracy of tax computation and payment where it concerns transfer pricing, and give a boost to optimization of the grounds for defining the conformity of prices applied in controlled transactions.”
Strokina added that a key impact of the changes will be a reduction in the use of transfer pricing to avoid taxation.
“One of the objects of the proposed law is to reduce as much as possible the variants for the transactions aimed at avoiding taxes, for instance: by redistribution of total profit to the company or subdivision which is subject to lesser tax. The proposed law reads that less than due proceeds received in related transactions will be taxed as though the proceeds were received in full in the transactions between non-related parties at the market price.”
Evgeny Timofeev, Partner, Head of Russian/CIS Tax Practice, at Goltsblat BLP, which has issued advice to its clients about the changes, says that a key factor for the corporate sector to be aware of is the range of controlled transactions.
“Due to significant thresholds for domestic transactions to be deemed controlled many Russian entities will be out of scope of the new rules (except for special exclusions for transactions with entities using zero rates or beneficial tax regimes). However, any cross-border transactions with related parties are deemed controlled without any threshold. The multinationals will have to prepare the transfer pricing documentation supporting their prices and take into account specific rules of the new law.”
Strokhina also highlighted controlled transactions as a key facet of the new legislation, which she says could add to the paperwork of Russian companies with international counterparties.
“The transactions which bring less than 60 million roubles per year have been excluded from the list of controlled foreign transactions with global exchange traded goods and transactions with offshore residents or residents of low tax jurisdictions. At the same time, the list of controlled foreign transactions with global exchange traded goods was supplemented with mineral fertilizers transactions. Besides, transactions with affiliated foreign counterparties will be subject to control, too. The majority of advanced European and Asian countries, as well as the USA, have compulsory requirements with regard to recording of transfer prices, and quite frequently these requirements are not the same as those of the Russian proposed law. Thus, many group companies will have to prepare Russian documentation as well as transfer pricing documents prepared in countries of foreign counterparties.”
Goltsblat BLP’s Timofeev also noted that the legislation is more focused on the economic impact of transactions, with specific transfer pricing audits from taxation authorities overseeing use of transfer pricing.
“The 20% safe harbour on price has been substituted by market price range. Criteria for controlled transactions and related parties are extended significantly. Transfer pricing assessments can be made only under special type of transfer pricing audits conducted by the Federal Tax Service, and pricing cannot be subject to review under a general tax audit. New concepts such as advance pricing agreements and corresponding adjustments are introduced.”
Timofeev notes that the changes have largely come about due to an inability of taxation authorities to administer transfer pricing under the previous regime.
“Without touching upon tax fraud, use of transfer pricing is wide-spread, mostly due to inability of tax authorities to effectively administrate the transfer price deviations. Since using the underdeveloped transfer pricing mechanism was pretty difficult for tax authorities, they often tried to attack taxpayers using other instruments, eg if the price of purchased goods or services was significantly higher than the market level they disallowed expenses for tax purposes claiming lack of their economic justification.”
Strokhina from GSL Audit notes that despite the additional administrative burden for companies operating with international counterparties, the legislation will help to clarify the taxation implications of using transfer pricing.
“We believe that in the whole the proposed norms of the law will have a positive influence on the use of transfer pricing by Russian business. The law provides a clear set of methods to be used for price determination – the method of comparable market prices, the method of further sales price, the method of conversion product sales price, the cost plus method, the method of comparable profitability, and the method of profit distribution. The proposed law provides for the right of the taxpayer to make a preliminary pricing agreement with the Inspectorate of the Federal taxation Service. The proposed law stipulates liability in case of: non-payment or insufficient payment of taxes, failure to notify concerning controlled transactions, breach of pricing agreement by the taxpayer. Besides, the scope of sources for transfer pricing information will be widened, too: statistics accounts, financial statements, and customs statistics on foreign trade.”