Development of court practice on taxation of corporate restructurings

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On 13 February 2017 the Commercial Court of Vladimir Oblast delivered a judgement in case No. А11-6203/2016 (the “Judgement”) under the claim of Mondelez Rus Limited Liability Company (the “Company”). The Judgement demonstrates which questions the Russian tax authorities address when analyzing the tax implications of corporate restructurings by multinational companies at the level of their Russian assets.

As follows from the Judgement, in 2011 the Company acquired shares in Dirol Cadbury LLC (Russia) from Cadbury Russia Two Limited (UK) at the price of RUB 12.8 billion. The Company paid for the shares by transferring to Cadbury Russia Two Limited (UK) two credit notes under which interest was payable. Both the Company and Cadbury Russia Two Limited (UK) are indirectly held by the same parent company incorporated in the US. In 2011-2012 the Company accounted interest on the credit notes as expenses, and moreover did not withhold tax on payments made to Cadbury Russia Two Limited (UK) under the Russia-UK double tax treaty. In turn, the tax authority denied accounting of interest in the Company’s expenses, and also decided that the payments made to Cadbury Russia Two Limited (UK) should be treated as dividends.

In denying the Company, the court considered the following circumstances:

  • The Company had a debt obligation resulting from a series of consecutive transactions. In turn, taxes were not paid in the UK due to group relief on interest and intragroup redistribution of losses.
  • Cadbury Russia Two Limited (UK) transferred the income received to intermediate owners of the multinational group in the form of dividends.
  • Cadbury Russia Two Limited (UK) had features of a shell company, as the company did not have employees, the company did not incur risks, and the company’s only asset was the interest in Dirol Cadbury LLC (Russia). Furthermore, the British company was set up not long before the interest sale transaction.
  • Cadbury Russia Two Limited (UK) did not have any activity after completing settlements with the Company.
  • The Company did not have self-determination in the disputed transactions because the transactions were part of a program to integrate global organizational structures that was developed by the parent company in the US.
  • The interest in Dirol Cadbury LLC was received in non-monetary form.
  • The memorandum from one of the Big Four firms (on UK tax matters) and from one of the leading Russian academic institutions (on company integration processes) was irrelevant for considering the case on the merits.

It follows from the Judgement that the tax authority, guided by the doctrine that substance prevails over form, considered that the actual recipient of the payments treated as dividends was the parent company incorporated in the US. As a consequence, the Company should have withheld tax on dividends at the 5% tax rate (this rate is contemplated by the US-Russia double tax treaty for payment of dividends). However, the Judgement did not examine the issue of the beneficial ownership of the income. The tax authority also further cited the OECD report on the BEPS project devoted to hybrids.

The position of the tax authority and the court in this case creates risks of re-qualification of tax liabilities when implementing one or another form of corporate restructuring in multinational groups. We recommend to analyze implemented and planned mechanisms of corporate restructurings from tax risks perspective.

The experts of Dentons’ Tax practice are ready to provide you with comprehensive legal support for analysis of asset holding structures and financial flows, as well as planned corporate restructuring mechanisms from tax risks perspective.