Development of the practice of determining market price for tax purposes in arm’s-length transactions

On 1 August 2016 the Commercial Court of the Republic of Tatarstan delivered a decision in case No. А65-2248/2016 (the “Decision”) under the claim of A1-Nedvizhimost Limited Liability Company (the “Company”).
The Decision illustrates the practice of tax control of prices in arm’s-length transactions in light of Russia’s Supreme Court Rulings:

  • No. 308-KG15-16651 of 11 April 2016 (StavGazoborudovaniye LLC);
  • No. 305-KG16-4920 of 22 July 2016 (Delovoy Tsentr Minaevskiy LLC);
  • No. 305-KG16-9205 of 8 August 2016 (Office Realty LLC) and others.

In this situation the tax authority challenged the validity of the Company’s recovery of part of the VAT (about RUB 7 million out of RUB 49 million) because the purchase price of the real estate was allegedly unreasonably inflated. The court of first instance agreed with the tax authority, declaring that the partial refusal to refund VAT was justified based on the following:

  1. the interdependence of the Company and the seller of the real estate, and also the concerted nature of their actions to recover VAT, is established on the basis of circumstantial evidence, in particular, the Company and its counterparty obtaining bank guarantees to recover VAT via the application procedure from the same bank. The reason for that approach is that “it is enough for tax authorities to prove that there is reason to doubt the taxpayer’s good faith, which the taxpayer must refute or prove nonexistent”;
  2. the purchase price for the real estate (RUB 211,700,000) exceeded the following amounts which the court, following the tax authority’s lead, considered indicators of a justified price level:
    1. the price at which the seller purchased the real estate (RUB 19,365,885);
    2. the seller’s costs for construction (repair) of the real estate (RUB 94,886,805);
    3. the real estate’s value in the seller’s accounting records (RUB 97,847,365.08);
    4. the appraisal by the appraiser engaged by the tax authority (RUB 164,793,000);
  3. although the transaction price was determined based on the appraiser’s report made before the transaction, that report was not admitted by the court, as it had been ordered by the Company’s counterparty, and the Company itself did not submit an alternative appraiser’s report;
  4. although the amount by which the actual price of the arms-length transaction deviated from the price used by the tax authority was not more than 30 percent in relative values, it was deemed sufficiently material for tax control of the price of the arm’s-length transaction because the difference in absolute values was RUB 46.9 million.

The Decision reflects the pro-fiscal perception by court practice of the approaches voiced by Russia’s Supreme Court, which is worth taking into account when setting and justifying intragroup prices, including those in arm’s-length transactions. What is more, we have observed that disputes based on price adjustment for tax purposes in arm’s-length transactions are swiftly topping the list of all types of tax disputes as a whole. In many cases it is not important for the local tax authorities whether a transaction is made between independent persons, whether the parties inflated the amount thresholds, whether the price is adjusted for VAT purposes, whether harm is caused to the treasury, etc.
The lawyers of Dentons’ Tax practice have considerable experience in (i) reducing tax risks associated with intragroup pricing, such as real estate transactions, including structuring business deals and preparing transfer pricing supporting documentation; (ii) advising on transfer pricing disputes—including representing in the RF Supreme Court—arising during pricing audits under Article 105.17 of the RF Tax Code, and audits of arm’s-length transactions, and are prepared to provide comprehensive support to your business in these matters. If you are interested in our transfer-pricing services, capabilities and experience, we would be happy to send you our detailed presentation.

Dzhangar Dzhalchinov

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