Recent developments of court practice concerning the documentary support for deductibility of expenses attributable to a permanent establishment of a foreign company in the Russian Federation

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On 21 December 2016 the Commercial Court of Moscow delivered the Decision in case No. А40-121559/16-20-1035. In this case the court considered a dispute between ZAB Zementanlagenbau GmbH Dessau (Germany), which carries out business in Russia through a permanent establishment in Moscow (the “PE”), and the Federal Tax Service of Russia Interdistrict Inspectorate No. 47 for the City of Moscow (the “Inspectorate”).

A key episode of the case was consideration of the dispute over proper documentary support for deductibility of the foreign company’s head office expenses that were allocated to the company’s permanent establishment in Russia for the purposes of calculating of tax on profit received through that permanent establishment.

According to the facts of the case, the Inspectorate challenged the deductibility of costs transferred to the PE by the head office for profits tax purposes , because the set of documents submitted by the taxpayer for review were “insufficient and unclear.” In its turn, the PE accounted for the head office costs transferred under a letter of advice and calculated according to the approved method for allocating expenses in amounts corresponding to costs under acts of acceptance and invoices, with reference to documents drawn up according to customary business practices accepted in the foreign state.

Having considered all relevant facts and circumstances, the court decided in favor of the PE and declared the Inspectorate’s decision unlawful, stating the following:

  • The deductibility requirement to drawn up documents in accordance with the laws of the Russian Federation applies only to transactions conducted by subdivisions of foreign companies in Russia;
  • The head office transfers expenses to a branch (a permanent establishment) under an act of transfer of expenses, which could serve as a primary accounting document on the basis of which those expenses are accounted for when calculating profits tax. Either the act of transfer of expenses (the letter of advice) or other documents prepared by the head office in accordance with  its internal procedures and describing the transactions and amounts that can be attributed to a specific type of expense can be viewed as proper documentation of transfer of the head office’s expenses to its Russian permanent establishment;
  • The Inspectorate cannot disregard the deductibility of such expenses without properly examining the documents submitted by the PE for its review.

The decision in this dispute is generally consistent with the court practice of recent years on similar matters (e.g., RF Supreme Commercial Court Ruling No. 14307/07 of 8 November 2007, Moscow District Federal Commercial Court Ruling No. А40-1154/10-116-18 of 13 April 2011). What is remarkable here is that the court clearly opined on it being unacceptable for the tax authorities to issue a decision on formal grounds that is not based on detailed examination of the documents submitted by the taxpayer, even though they originated from a foreign state.

The lawyers of Dentons’ Tax practice have extensive advising and litigation experience in the taxation of foreign legal entities in Russia and can provide assistance both in formulating a legal position in disputes with the tax authorities over the creation of a permanent establishment of a foreign company in the Russian Federation and with respect to accounting for profits tax purposes of expenses incurred by the head office and attributable to the operations of the permanent establishment of that foreign company in the Russian Federation.