Legal Risks of Share Donation in Russian LLCs

 

August 12, 2022

BRACE Law Firm ©

 

An owner of a share or a part of a share in the authorized capital (the "share") of a limited liability company (the "LLC" or "Company") is entitled to dispose of the share by donation. However, there are several restrictions on donating a share, provided for by civil law, special corporate legislation, and bankruptcy legislation.

When executing a transaction to donate a share or a part of a share in the authorized capital of an LLC, it is necessary not only to verify the legality of the transaction at the time of its execution but also to analyze the primary long-term legal risks. In this regard, we examine the main legal risks arising from the donation of a share in an LLC.

1. If a share in the authorized capital is donated in violation of the procedure for obtaining the consent of other LLC participants or the LLC itself (if required by the charter), an obligation arises to transfer the share or part of the share to another LLC participant(s) or the LLC itself

Donating a share in an LLC constitutes a procedure for disposing of a share owned by a participant in the Company's authorized capital. The ability to dispose of a share via donation depends on the provisions of the Company's charter, which may alter mandatory statutory requirements. A transaction for donating a share in an LLC's authorized capital is subject to notarial certification; absent such certification, the donation agreement is deemed not concluded.

A distinction must be made between donating a share to LLC participants and to third parties. As a general rule, a Company participant may donate a share or a part of a share in the Company's authorized capital to one or several participants of the same Company. The consent of other Company participants or the Company itself is not required for such a transaction. The LLC charter may establish otherwise. Thus, donating a share to other LLC participants is generally carried out without restrictions.

When donating a share or a part of a share in the LLC's authorized capital to third parties (if such donation is permitted), the consent of the other LLC participants is required. Such consent is deemed received by the Company participant alienating the share or part of the share if, within 30 days from the date of request to the Company (or within another period defined by the charter), the participant receives the written consent of the Company, or does not receive a written refusal from the Company regarding the alienation.

If a share in the authorized capital is donated in violation of the procedure for obtaining the consent of the Company's participants or the Company, a participant (or participants) or the Company may demand the transfer of the share or part of the share in court within 3 months from the day they learned or should have learned of such violation. Thus, if the procedure for obtaining consent is violated during a share donation, other participants may demand the transfer of such share under the mechanism of exercising their preemptive right. This right of other participants is unconditional. However, if the parties subsequently terminate the donation agreement, the demand for the transfer of the share based on the violation of the consent procedure will not be satisfied [1].

At the same time, Article 21 of Federal Law No. 14-FZ dated February 8, 1998, On Limited Liability Companies (the "Law on LLCs") does not contain a mandatory rule applying the preemptive right to acquire a share alienated under a donation agreement to other LLC participants. This indicates that a claim to transfer rights and obligations to such a participant based on such right cannot be satisfied [2]. That is, when a donation transaction of a share in the authorized capital is executed (provided such transaction is legal), the remaining participants (founders) of the Company do not enjoy a preemptive right to purchase the share. Consequently, if consent for such a transaction was obtained, the remaining participants may not demand the transfer of the share to themselves under the preemptive right. The preemptive right applies only to transactions involving the sale and purchase of a share in the LLC's authorized capital. The charter of a limited liability company may establish otherwise.

Frequently, the absence of this provision in the charter is used to bypass the preemptive right of other LLC participants regarding the sale of shares by using sham transactions — donation agreements. However, this rule (regarding the absence of a preemptive right when alienating a share to third parties via donation) does not apply if it is established that the actually concluded donation transaction covered a sale and purchase transaction to bypass the preemptive purchase rule.

In a specific case, the court established that the Company's charter contained provisions establishing the preemptive right of Company participants to acquire a share at the price offered to a third party, as well as the obligation of a participant intending to sell a share to a third party to notify the other participants and the LLC itself. According to the clarifications in paragraph 2 of Item 91 of Resolution of the Plenum of the Supreme Court of the Russian Federation No. 25 dated June 23, 2015, On the Application by Courts of Certain Provisions of Section I of Part One of the Civil Code of the Russian Federation (the "Resolution No. 25"), the consequence of violating a statutory preemptive purchase right is the granting to the holder of the preemptive right the ability to demand, in a statutory manner, the transfer of the buyer's rights and obligations to them.

According to paragraph 3 of Sub-item "b" of Item 12 of Resolution of the Plenum of the Supreme Court of the Russian Federation and the Plenum of the Supreme Arbitration Court of the Russian Federation No. 90/14 dated December 9, 1999, On Certain Issues of Application of the Federal Law "On Limited Liability Companies", the preemptive purchase right does not apply to the gratuitous transfer of a share by a participant to a third party. If there is a counter-transfer of a thing or right or a counter-obligation, the agreement is not recognized as a donation. The rules provided in Item 2 of Article 170 of the Civil Code apply to such an agreement. In the case under consideration, the courts, establishing the sham nature of the donation agreement, took into account the explanations of other participants regarding offers received to sell their shares, the absence of family or other close relationships between the parties to the transaction (which usually explain a donor's intent to gift property to another person), and the Company's possession of liquid real estate assets. The courts recognized that these circumstances, in aggregate, allow for the conclusion that the will of the parties was actually directed at concluding a sale and purchase transaction. Under such circumstances, the agreement was challenged [3].

2. Qualification of an Agreement for Donation of a Share in an LLC as a Sham Transaction

A significant risk when executing a donation transaction — both between individuals and, to a greater extent, between legal entities — is the risk of challenging the transaction as a sham, specifically one covering a sale and purchase agreement for a share in the authorized capital. Item 2 of Article 170 of the Civil Code provides that a sham transaction, i.e., a transaction entered into to cover another transaction, including a transaction on different terms, is void. The rules applicable to the transaction the parties actually intended to make apply, taking into account the substance and content of the transaction. In accordance with the clarifications in Item 87 of Resolution No. 25, a sham transaction, i.e., a transaction entered into to cover another transaction, including a transaction on different terms or with a different subject composition, is void. In connection with being a sham, only the transaction aimed at achieving other legal consequences and covering the actual will of all transaction participants may be recognized as invalid. The intent of one participant to conclude a sham transaction is insufficient to apply this rule.

Accordingly, the specific feature of proving grounds for recognizing a transaction as a sham lies in the applicant's duty to confirm that the will of the parties was not directed at the emergence of legal consequences arising from the concluded transaction (donation agreement), but at the execution of another covered transaction.

By virtue of Item 1 of Article 572 of the Civil Code, under a donation agreement, one party (the donor) gratuitously transfers or undertakes to transfer to the other party (the donee) a thing in ownership or a property right (claim) against itself or a third party, or releases or undertakes to release the donee from a property obligation to itself or a third party. If there is a counter-transfer of a thing or right or a counter-obligation, the agreement is not recognized as a donation. The rules provided in Item 2 of Article 170 of the Civil Code apply to such an agreement. Thus, upon establishing the fact that a sale and purchase transaction was covered, the court recognizes the donation transaction as invalid [4].

However, not every donation of a share in the authorized capital can be challenged. The subject of proof in cases regarding the recognition of sham transactions as invalid includes the fact of the transaction's conclusion, the actual will of the parties to execute the covered transaction, the circumstances of the agreement's conclusion, and the discrepancy between the parties' expression of will and their actions.

When assessing a share donation agreement from the perspective of the reality of the contract, the following circumstances must be considered:

• The presence of family relations between the transaction parties;
• The presence of liquid assets in the Company whose share is being alienated via donation;
• The deal structure (specifically, whether the donation is the sole transaction or if other transactions involving the Company's shares occur within a short period);
• The financial position of the donor and the presence of signs of insolvency;
• Provisions of the Company's constituent documents regarding the presence/absence of restrictions on transactions with shares via paid alienation and the advantages of alienation via gratuitous transactions.

It should be noted that donation between commercial legal entities is prohibited, making the donation of shares in the authorized capital between legal entities impossible.

As indicated in a judicial act regarding a specific case, to determine whether an agreement was concluded between the parties, what its terms are, how they relate to each other, whether the parties' expression of will coincides with their actual common will, and whether the agreement is a sham transaction, it is necessary to apply the rules for contract interpretation established in Article 431 of the Civil Code. Courts concluded that the donation agreement was concluded by the donor as a subject of civil law relations possessing the freedom of will to conclude civil law contracts and freedom to dispose of their own property. The plaintiff challenging the share donation agreement to recognize it as a sham transaction covering a participant's withdrawal from the Company did not present evidence to the case file that the parties pursued other goals when concluding such a transaction. The courts noted that when concluding a sham transaction, both parties must pursue a common goal and reach an agreement on all essential terms of the transaction covered by the legally executed transaction; however, such common goal (withdrawal of a participant from the Company implying payment of the actual value of their share to the withdrawn participant) is not evident from the case materials [5].

At the same time, in an attempt to execute a donation transaction between legal entities, it appears that a notary would refuse to certify such a transaction due to a direct legislative prohibition. When executing a transaction to donate a share in the authorized capital, to establish the true will of the parties and the intent to specifically donate the share in the LLC, the Company's financial position appears to be a significant criterion for assessing the authenticity of the will. The presence of liquid assets in such a Company would indicate a distortion of the will of the donor and donee (in the absence of personal relationships between the transaction parties).

Transactions with a distortion of will during their execution will be recognized as sham. Furthermore, one method of defense when executing a donation transaction covering a sale and purchase agreement may be a claim for the transfer of the share to the appropriate person. Only a participant of the Company may be such a person.

When applying the rules on sham transactions, it should be considered that not only one but several transactions may be concluded to cover a transaction. In such a case, the covering transactions are void, and the rules applicable to the transaction the parties actually intended apply, taking into account its substance and content. For example, if a court establishes that a participant in a limited liability company concluded an agreement to donate a part of their share in the authorized capital to a third party to subsequently sell the remaining part of the share, bypassing the rules on the preemptive right of other participants, the donation agreement and the subsequent sale of the part of the share may be qualified as a single sale and purchase agreement concluded in violation of the named rules. Accordingly, another Company participant has the right to demand the transfer of the buyer's rights and obligations to them in court.

In a specific case, the court recognized a set of transactions as invalid, effectively covering a single sale and purchase transaction to a third party, who was initially introduced into the Company by donating 1% of the shares in the authorized capital and subsequently sold seventy-five percent of the shares with a small time gap [6].

In the event of alienation or transfer of a share or part of a share in the Company's authorized capital on other grounds to third parties in violation of the procedure for obtaining the consent of the Company's participants or the Company, as well as in violation of a prohibition on the sale or other alienation of a share or part of a share, a participant (or participants) or the Company is entitled to demand the transfer of the share or part of the share to the Company in court within 3 months from the day they learned or should have learned of such violation. In the event of the transfer of a share or part of a share to the Company, expenses incurred by the acquirer of the share or part of a share in connection with its acquisition shall be reimbursed by the person who alienated the share or part of a share in violation of the specified procedure.

3. Qualification of an Agreement for Donation of a Share in an LLC as an Imaginary Transaction

In addition to sham transactions, which are typically concluded to illegally bypass the preemptive rights of participants in sale and purchase transactions, imaginary transactions may be concluded. These do not result in an actual change of participant, limited only to entering the corresponding record in the Unified State Register of Legal Entities (EGRUL).

According to Item 1 of Article 170 of the Civil Code, an imaginary transaction, i.e., a transaction committed only for show, without the intention to create corresponding legal consequences, is void. Based on Article 572 of the Civil Code, the legal consequence of performing a donation agreement for a share in the authorized capital of a business entity is the gratuitous transfer of ownership rights to the share from the donor to the donee. The limited liability company must be notified in writing of the assignment of the share (part of the share) in the Company's authorized capital with the provision of evidence of such assignment. The acquirer of the share (part of the share) in the authorized capital exercises rights and bears the obligations of a Company participant from the moment the Company is notified of said assignment.

A donation agreement for a share in the authorized capital of a business entity may be an imaginary transaction if, despite notifying the Company of the share donation, the actual transfer of shares to the donee did not occur, the donor remained a participant in the Company and exercises rights provided by the Law on LLCs, and the donee did not raise any objections regarding the donor's exercise of ownership rights over the shares and did not take measures to protect their right [7].

The execution of imaginary transactions is generally explained by the need to change the registered owner of a share to conceal assets. When proving the fact of a transaction's imaginary nature, it is worth analyzing not only the events preceding and mediating the transaction but also the subsequent state of affairs in the Company, where, despite the alienation of the share, the donor continues to participate in managing the Company, including, for example, via a power of attorney from the donee. The purpose of such a donation transaction is also subject to analysis.

4. Challenging a Donation of a Share in an LLC as a Form of Abuse of Right

A share donation agreement may be challenged on the grounds of Articles 168 and 10 of the Civil Code. This ground may apply both when challenging transactions outside of a bankruptcy case and is very frequently used when challenging transactions in the event of the donor's bankruptcy. According to Item 1 of Article 166 of the Civil Code, a transaction is invalid on grounds established by the Civil Code by virtue of its recognition as such by a court (voidable transaction) or independently of such recognition (void transaction).

In accordance with Article 168 of the Civil Code, a transaction violating the requirements of a law or other legal act and simultaneously infringing on public interests or the rights and legally protected interests of third parties is void, unless the law implies that such a transaction is voidable or other consequences of the violation, not related to the invalidity of the transaction, should apply.

According to clarifications in Item 74 of Resolution No. 25, a transaction violating the requirements of a law or other legal act and simultaneously infringing on public interests or the rights and legally protected interests of third parties is void. Regardless of these circumstances, the law may establish that such a transaction is voidable rather than void, or that other consequences of the violation not related to the invalidity of the transaction should apply to it (Item 2 of Article 168 of the Civil Code).

Item 1 of Article 10 of the Civil Code establishes a prohibition on exercising civil rights exclusively with the intent to cause harm to another person, actions in circumvention of the law with an illegal objective, and other deliberately bad faith exercise of civil rights (abuse of right). The provisions of these norms prescribe that participants in civil turnover act in good faith, i.e., in a manner that does not cause harm to other persons. These norms enshrine the principle of inadmissibility of abuse of right and define the general boundaries (limits) of civil rights and obligations: every subject of civil rights is free to exercise rights in their own interests but must not violate the rights and interests of others.

Abuse of right is understood as the behavior of an authorized person in realizing their right, associated with a violation of the limits on exercising civil rights established in Article 10 of the Civil Code. That is, cases where a person acts within the limits of their rights but either with an illegal purpose or in an impermissible manner (possibly both). In such a case, an abuse of right will occur.

The primary sign of abuse of right is the intent to cause harm to another person, the intent to use a right to the detriment of another. Abuse as a phenomenon manifests in most cases in the fact that, while formally complying with legal norms, the violator attempts to achieve an illegal goal. A formal approach may be countered, in particular, by identifying contradictory, paradoxical, inexplicable circumstances, inconsistency in evidence, and illogical arguments [8].

When assessing the actions of parties as good faith or bad faith, one should proceed from the behavior expected of any participant in civil turnover taking into account the rights and legitimate interests of the other party. By virtue of Part 5 of Article 10 of the Civil Code, the good faith of participants in civil legal relations and the reasonableness of their actions are presumed. The burden of proving abuse of right by the defendant in this case, in accordance with Part 1 of Article 65 of the APC RF, lies with the plaintiff.

In a specific case, the court, taking into account circumstances established in another case regarding the presence of a corporate conflict in the Company, actions by one of the parties to the conflict to withdraw Company assets by collecting a significant sum of money in favor of one conflict party, the circumstances of concluding and approving a settlement agreement, and the chronology of the corporate conflict, rightfully stated that in the conditions of an emerging corporate conflict, the donor's actions to conclude a donation agreement amidst legal uncertainty regarding the fate of the disputed share do not testify to the good faith of the transaction parties.

Considering the haste of the transaction in the absence of objective necessity and expediency, during a period of corporate conflict in the Company, taking into account that the disputed transaction was committed when the alienating party realized the threat of losing their property, the property was alienated in favor of a person interested in relation to the transaction party (whose awareness of the real goals of concluding the disputed transaction is presumed by judicial practice), and the transaction itself is gratuitous, the court of the first instance came to the rightful conclusion regarding the invalidity of the transaction [9].

The exclusive focus of the transaction on violating the rights and legitimate interests of others must be sufficiently obvious, as the legislation presumes the good faith behavior of civil turnover participants. The presumption of good faith and reasonableness of actions by civil legal relations participants means that reasonableness and good faith are assumed. Bad faith or unreasonableness must be proven by the party linking corresponding legal consequences to such behavior. Abuse of right when concluding a transaction is a violation of the prohibition established in Article 10 of the Civil Code, in connection with which such a transaction must be recognized as invalid.

In another case, recognizing a share donation agreement as void on the grounds of abuse of right, the court stated that the share donation agreement was concluded after the court decided to exclude the donor from the Company, was executed gratuitously in favor of an affiliated person — the brother of his spouse — and in the presence of a corporate conflict between Company participants. Collectively, this testifies to the conclusion of the donation agreement with an abuse of right by the defendants solely to prevent the exclusion of the donor from the Company and to retain corporate control by introducing the spouse's brother into the Company [10].

Thus, challenging a donation transaction on the grounds of Articles 10 and 168 of the Civil Code is possible when the executed transaction is aimed at circumventing the law and/or causing harm to third parties. To apply the provisions of Article 10 of the Civil Code for qualifying a transaction as void, it is necessary to present evidence of defects in the disputed transaction that go beyond the defects of a preference transaction or suspicious transactions. This approach to distinguishing the qualification of disputed transactions in insolvency (bankruptcy) cases is outlined in the Determinations of the Supreme Court of the Russian Federation dated April 29, 2016 No. 304-ES15-20061, and dated April 28, 2016 No. 306-ES15-20034. To qualify a transaction as committed with abuse of right, evidence must be presented to the case that in concluding the transaction, the parties intended to realize an illegal interest.

Analyzing practice, examples of abuse of right include the execution of transactions by an authorized person that formally comply with legislative requirements but cause harm to third parties and are actually committed only in favor of a specific participant (if referencing a transaction within the Company).

5. Challenging a Donation Transaction Upon the Donor's Bankruptcy

When concluding a share donation transaction in the authorized capital, if bankruptcy proceedings are initiated against the donor, new risks for challenging such a transaction should be considered. Furthermore, after the introduction of bankruptcy proceedings, such a transaction may be challenged both on "bankruptcy grounds" and "general civil grounds".

The basis for challenging a transaction on "bankruptcy" grounds may be Article 61.2 of Federal Law No. 127-FZ dated October 26, 2002, On Insolvency (Bankruptcy) (the "Bankruptcy Law"). By virtue of Item 2 of Article 61.2 of the Bankruptcy Law, a transaction committed by the debtor to cause harm to the property rights of creditors may be recognized by an arbitration court as invalid if such transaction was committed within 3 years prior to the acceptance of the application to declare the debtor bankrupt or after the acceptance of said application, and as a result of its commission, harm was caused to the property rights of creditors and if the other party to the transaction knew of said goal of the debtor at the moment of the transaction (suspicious transaction).

From Item 5 of Resolution of the Plenum of the Supreme Arbitration Court of the Russian Federation No. 63 dated December 23, 2010, On Certain Issues Related to the Application of Chapter III.1 of the Federal Law "On Insolvency (Bankruptcy)" (the "Resolution No. 63"), it follows that to recognize a transaction as invalid on this ground, the person challenging the transaction must prove the existence of the aggregate of all the following circumstances:

a) The transaction was committed with the goal of causing harm to the property rights of creditors; b) As a result of the transaction, harm was caused to the property rights of creditors; c) The other party to the transaction knew or should have known of said goal of the debtor at the moment of the transaction.

If even one of these circumstances is unproven, the court refuses to recognize the transaction as invalid on this ground.

When defining harm to the property rights of creditors, it should be borne in mind that this is understood as a decrease in the value or size of the debtor's property and/or an increase in the size of property claims against the debtor, as well as other consequences of transactions or legally significant actions committed by the debtor leading to or capable of leading to the full or partial loss of the creditors' ability to receive satisfaction of their claims under the debtor's obligations at the expense of its property. It is presumed that the other party knew of the transaction committed to cause harm to the property rights of creditors if it is recognized as an interested person, or if it knew or should have known of the infringement of the interests of the debtor's creditors, or of signs of insolvency or insufficiency of the debtor's property.

The goal of causing harm to the property rights of creditors is presumed if, at the moment of the transaction, the debtor met the criteria for insolvency or insufficiency of property, and the transaction was committed gratuitously or regarding an interested person under the following conditions:

• The value of the share transferred as a result of the donation constitutes 20 percent or more of the book value of the debtor's assets;
• The debtor changed their place of residence or location without notifying creditors immediately before or after the transaction, or concealed their property, or destroyed or distorted title documents, accounting reporting documents, or accounting records;
• After the transaction transferring the property, the debtor continued to use and (or) possess said property or give instructions to its owner regarding the determination of the fate of said property.

When deciding whether the other party to the transaction should have known of the indicated circumstances, consideration is given to the extent to which they could have established the presence of these circumstances acting reasonably and exercising the prudence required by turnover conditions. The debtor, having previously incurred unfulfilled obligations, evidently realized that as a result of a gratuitous transaction, creditors would be deprived of property from which they could receive satisfaction.

Furthermore, the presumption established by law regarding the interested person's awareness of the goal of causing harm to creditors' interests via the share donation transaction in the LLC was not refuted by the defendant due to the affiliation of the donor and donee [11].

Challenging a transaction on "bankruptcy" grounds does not exclude the possibility of challenging such a transaction on general civil grounds (Articles 10, 168, 170 of the Civil Code). When qualifying a transaction challenged within a bankruptcy case, the court, justifying the existence of grounds to recognize it as such under grounds provided by Articles 10 and 168 of the Civil Code, must substantiate the motives by which the court deemed it possible to apply said qualification.

The presence of special grounds for challenging transactions in bankruptcy legislation does not in itself prevent the court from qualifying a transaction committed with abuse of right as void under Articles 10 and 168 of the Civil Code (Item 4 of Resolution No. 63, Item 10 of Resolution of the Plenum of the Supreme Arbitration Court of the Russian Federation No. 32 dated April 30, 2009, On Certain Issues Related to Challenging Transactions on Grounds Provided by the Federal Law "On Insolvency (Bankruptcy)"). The mentioned clarifications refer to transactions with defects going beyond the defects of preference transactions or suspicious transactions [12].

The focus of a transaction on reducing the debtor's property or increasing their obligations to cause harm to the property rights of the debtor's creditors on the eve of bankruptcy, in a situation where the other party to the transaction (creditor) knew of said goal of the debtor at the moment of the transaction, is grounds for recognizing the corresponding transaction as invalid under the special rules provided by Item 2 of Article 61.2 of the Bankruptcy Law.

In conditions of competing norms regarding the invalidity of transactions, courts, for proper qualification, should verify whether the violations committed during the transactions go beyond the disposition of Part 2 of Article 61.2 of the Bankruptcy Law.

Thus, the possibility of using general grounds of invalidity when considering a bankruptcy case depends on substantiating arguments and indicating criteria, in the presence of which defects in the transaction go beyond the qualification under Article 61.2 of the Bankruptcy Law. Otherwise, if the sole reason for using grounds under Articles 10 and 168 of the Civil Code is the possibility of using a 3-year limitation period, the court may refuse to satisfy such a claim.

6. Revocation of a Share Donation in an LLC by the Donor

The donor has the right to revoke a donation in the following cases:

• If the donee attempted the life of the donor, the life of any of their family members or close relatives, or intentionally caused bodily harm to the donor;
• If the donee's treatment of the gifted item, representing great non-property value to the donor, creates a threat of its irretrievable loss.

The donor's heirs may demand the revocation of the donation in the event of the intentional deprivation of the donor's life by the donee. Establishing the circumstances of the donee committing actions aimed at attempting the donor's life, the life of any of their family members or close relatives, or intentional causation of bodily harm to the donor is the prerogative of the courts of the first and appellate instances. By virtue of their inherent discretionary powers necessary for administering justice and arising from the principle of the independence of judicial power, they resolve the case based on establishing and investigating all its circumstances. In a specific case, the courts did not accept the resolution of a senior district police officer regarding the consideration of a statement on battery as such evidence, since it lacked conclusions about the intentional causation of bodily harm to the donor on the specified date [13].

At the request of an interested person, the court may revoke a donation made by an individual entrepreneur or a legal entity in violation of the provisions of the Bankruptcy Law at the expense of funds related to their entrepreneurial activity within the six months preceding the declaration of such person as insolvent (bankrupt).

7. Defects of Will in Donating a Share in an LLC

When concluding donation agreements, it is necessary to consider that such transactions carry a heightened risk of being challenged due to defects in the donor's will. A defect of will is understood as the formation of a transaction party's will under the influence of circumstances generating a discrepancy between the true will of such party and their expression of will. Consequently, a transaction committed by a citizen who was in such a state at the moment of its commission that they were unable to understand the significance of their actions or control them cannot be regarded as a transaction committed by their will [14].

Defects of will include:

• Fraud is considered not only the communication of information not corresponding to reality but also intentional silence regarding circumstances that a person should have communicated given the good faith required by turnover conditions (Item 2 of Article 179 of the Civil Code). A transaction committed under the influence of fraud may be recognized as invalid only if the circumstances regarding which the victim was deceived are causally linked to their decision to conclude the transaction. The intent of the person committing the fraud must be established. A transaction committed under the influence of fraud by a third party may be recognized as invalid upon the claim of the victim, provided that the other party or the person to whom the unilateral transaction is addressed knew or should have known of the fraud.
• Transaction committed under threat of violence. A transaction committed under the influence of violence or threat is voidable and may be recognized by a court as invalid upon the claim of the victim (Item 1 of Article 179 of the Civil Code). The law does not establish that violence or threat must originate exclusively from the other party to the transaction. Therefore, a transaction may be challenged by the victim even if the violence or threat originated from a third party, and the other party to the transaction knew of this circumstance. Furthermore, the threat of causing personal or property harm to persons close to the counterparty or the use of violence against these persons is also grounds for recognizing the transaction as invalid. It should be noted that the law does not link challenging a transaction based on Items 1 and 2 of Article 179 of the Civil Code with the presence of criminal proceedings regarding facts of violence, threat, or fraud. Circumstances of the use of violence, threat, or fraud may be confirmed by general rules of evidence (paragraph 5 of Item 99 of Resolution No. 25).
• Transaction committed under the influence of delusion. A transaction committed under the influence of delusion may be recognized by a court as invalid upon the claim of the party acting under the influence of delusion if the delusion was so substantial that this party, reasonably and objectively assessing the situation, would not have committed the transaction if they had known the actual state of affairs.

A general criterion for challenging donation transactions on one of the indicated grounds is proving the fact of distortion of the donor's will resulting from the impact of one of the indicated factors.

8. Assessment of NDFL (Personal Income Tax) When Donating a Share in an LLC to an Individual

When executing a transaction to donate a share in the authorized capital, tax risks must be remembered. Income of individuals received from individuals via donation of shares in the authorized capital of organizations is not subject to Personal Income Tax (NDFL) if the donor and donee are family members and/or close relatives in accordance with the Family Code of the Russian Federation. By virtue of Article 210 of the Tax Code of the Russian Federation (the "Tax Code"), when determining the tax base, all income of the taxpayer (individual) received by them in both monetary and in-kind forms, or the right to dispose of which has arisen, as well as income in the form of material benefit, is taken into account.

Income received by an individual upon the gratuitous transfer of shares in the authorized capital of organizations to them, as well as income received by them from the sale of shares in the authorized capital of organizations, is an object of NDFL taxation. A tax rate of 13% is established for such income for individuals who are tax residents of the Russian Federation. When selling a share (part thereof) in an organization's authorized capital, the taxpayer has the right to reduce the amount of taxable income by the amount of actually incurred and documentarily confirmed expenses related to obtaining such income.

Expenses directly related to the execution of a sale and purchase transaction for a share in an organization's authorized capital may include, in particular, expenses for acquiring said share (in case of its paid acquisition). In addition to the above, Item 18.1 of Article 217 of the Tax Code must be considered, according to which income of individuals received from individuals via donation of shares in the authorized capital of organizations is not subject to NDFL if the donor and donee are family members and/or close relatives in accordance with the Family Code of the Russian Federation (spouses, parents and children, including adopters and adoptees, grandparents and grandchildren, full and half (sharing a common father or mother) brothers and sisters).

If the fact of the sham nature of the donation agreement and the actual execution of a sale and purchase transaction is established, the additional tax assessment will be based on the market value of the subject of the agreement—the share in the authorized capital. Similarly, i.e., based on the market value of the share, the tax base of the donee from the income received in the form of the donated share in the authorized capital will be calculated [15].

9. Classification as Non-Operating Income When Donating a Share in an LLC to a Legal Entity

Donating a share in an LLC between legal entities is prohibited (Article 575 of the Civil Code). However, Article 251 of the Tax Code exempts from taxation income received gratuitously by a parent organization from a subsidiary and vice versa, which is principally prohibited by Item 4 of Article 575 of the Civil Code. When re-qualifying a donation transaction into a sale and purchase agreement, or when donating a share in the authorized capital to an individual, it should be noted that operations for alienating shares in the authorized capital are not subject to VAT (Item 12 of Article 149 of the Tax Code).

Expenses incurred in connection with the donation in the form of the value of the donated property and other expenses related to its transfer, according to Item 16 of Article 270 of the Tax Code, are not subject to accounting when the donor calculates corporate profit tax. The donee legal entity accounts for property received via donation, for the purposes of calculating corporate profit tax, as non-operating income (Article 250 of the Tax Code). When calculating said tax, the valuation of received profit is carried out based on the market value of the received property (Article 40 of the Tax Code), but not lower than its residual value. If a donation transaction is recognized as a sham covering a share sale and purchase agreement, the tax authority will assess an additional profit tax amount for the donor based on the market value of the share.

In conclusion, it must be noted that donating a share in the authorized capital is a permissible transaction. However, when executing it, it is necessary to thoroughly verify grounds for challenging it, including those that may arise in the future. It is advisable to execute donation transactions only between relatives, while excluding goals for the transaction that do not correspond to good faith.

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References

[1] Resolution of the Arbitrazh Court of the West Siberian District dated October 1, 2021 No. F04-4783/2021 in case No. A75-12039/2020.

[2] Resolution of the Arbitrazh Court of the North-Western District dated June 15, 2020 No. F07-949/2020 in case No. A56-13206/2019.

[3] Resolution of the Arbitrazh Court of the Urals District dated October 5, 2020 No. F09-5239/20 in case No. A07-16137/2019.

[4] Resolution of the Arbitrazh Court of the Far Eastern District dated October 28, 2021 No. F03-5588/2021 in case No. A51-2090/2020.

[5] Resolution of the Arbitrazh Court of the Urals District dated June 27, 2022 No. F09-2747/22 in case No. A60-11702/2021.

[6] Resolution of the Arbitrazh Court of the Far Eastern District dated July 4, 2016 No. F03-4875/2015 in case No. A59-248/2013.

[7] Resolution of the Presidium of the Supreme Arbitration Court of the Russian Federation dated December 13, 2011 No. 10467/11 in case No. A21-3566/2010.

[8] Determination of the Supreme Court of the Russian Federation dated July 25, 2019 No. 306-ES19-3574.

[9] Resolution of the Arbitrazh Court of the West Siberian District dated March 17, 2022 No. F04-860/2022 in case No. A46-6203/2021.

[10] Resolution of the Arbitrazh Court of the Urals District dated June 30, 2022 No. F09-3941/22 in case No. A50-17451/2021.

[11] Resolution of the Arbitrazh Court of the Moscow District dated November 16, 2021 No. F05-13932/2021 in case No. A41-29181/2019.

[12] Letter of the Department of Tax and Customs Tariff Policy of the Ministry of Finance of Russia dated December 2, 2014 No. 03-04-07/61655 On Determining the Tax Base for Personal Income Tax when Concluding an Agreement for Donation of a Share in the Authorized Capital of an LLC Between Individuals and in Accordance with Article 34.2 of the Tax Code of the Russian Federation.

[13] Resolution of the Arbitrazh Court of the Far Eastern District dated December 10, 2021 No. F03-6391/2021.

[14] Letter of the Department of Tax and Customs Tariff Policy of the Ministry of Finance of Russia dated December 2, 2014 No. 03-04-07/61655 On Determining the Tax Base for Personal Income Tax when Concluding an Agreement for Donation of a Share in the Authorized Capital of an LLC Between Individuals and in Accordance with Article 34.2 of the Tax Code of the Russian Federation.

[15] Letter of the Department of Tax and Customs Tariff Policy of the Ministry of Finance of Russia dated December 2, 2014 No. 03-04-07/61655 On Determining the Tax Base for Personal Income Tax when Concluding an Agreement for Donation of a Share in the Authorized Capital of an LLC Between Individuals and in Accordance with Article 34.2 of the Tax Code of the Russian Federation.