29 December 2023

Transfer Pricing in Russia: Tax Rules & Liability

December 29, 2023

BRACE Law Firm ©

Transfer pricing involves setting prices in transactions between interdependent persons that differ from market prices. This practice aims to optimize taxation and redistribute the total profit of a group of companies.

If transactions are recognized as controlled, the Federal Tax Service (the "FTS") of Russia verifies the completeness of the calculation and payment of the following taxes:

Corporate income tax (except for the portion of the tax calculated regarding the profits of controlled foreign companies);
Personal income tax paid in accordance with Article 227 of the Tax Code of the Russian Federation (the "Tax Code");
Mineral extraction tax (if one of the parties to the transaction is a taxpayer of the said tax and the subject of the transaction is an extracted mineral recognized as an object of taxation for the taxpayer, where taxation occurs at a percentage-based tax rate);
VAT (if one of the parties to the transaction is an organization or individual entrepreneur that is not a VAT taxpayer or is exempt from VAT taxpayer duties);
Additional income tax on hydrocarbon production.

Interdependent Persons

Persons are recognized as interdependent if the specific characteristics of the relationships between them may influence the terms and results of the transactions they enter into. [1] To recognize mutual dependence, the influence that may be exerted due to one person's participation in the capital of others is considered, whether in accordance with an agreement concluded between them or if one person has any other ability to determine decisions made by others. [2] This influence is considered regardless of whether one person exerts it directly and independently or jointly with its interdependent persons. The following are recognized as interdependent persons:

Organizations, if one organization directly and/or indirectly participates in another organization and the share of such participation exceeds 25%;
An individual and an organization, if such individual directly and/or indirectly participates in such organization and the share of such participation exceeds 25%;
Organizations, if the same person directly and/or indirectly participates in these organizations and the share of such participation in each organization exceeds 25%;
An organization and a person (including an individual together with their interdependent persons) who has the authority to appoint (elect) the sole executive body of that organization or to appoint (elect) at least 50% of the composition of the collegial executive body or the board of directors (supervisory board) of that organization;
Organizations whose sole executive bodies or at least 50% of the composition of the collegial executive body or board of directors (supervisory board) have been appointed or elected by decision of the same person (an individual together with their interdependent persons);
Organizations in which the same individuals, together with their interdependent persons, constitute more than 50% of the composition of the collegial executive body or board of directors (supervisory board);
An organization and a person exercising the powers of its sole executive body;
Organizations in which the same person exercises the powers of the sole executive body;
Organizations and/or individuals if the share of direct participation of each previous person in each subsequent organization exceeds 50%;
Individuals, if one individual is subordinate to another individual by official position;
An individual, their spouse, parents (including adoptive parents), children (including adopted children), full and half brothers and sisters, guardian (trustee), and ward.

Controlled Transactions

Transactions between interdependent persons (subject to established specific characteristics) are recognized as controlled transactions. [3] The following transactions are equivalent to transactions between interdependent persons:

A set of transactions for the sale (resale) of goods (performance of work, provision of services) performed with the participation (through the mediation) of persons who are not interdependent. This set of transactions is equated to a transaction between interdependent persons, disregarding the presence of third parties through whom the transactions are performed, provided that such third parties:

Do not perform any additional functions in this set of transactions, except for organizing the sale (resale) of goods (performance of work, provision of services) by one person to another person recognized as interdependent with it;
Do not assume any risks and do not use any assets to organize the sale (resale) of goods (performance of work, provision of services) by one person to another person recognized as interdependent with it;
This applies to transactions where income and/or expenses are recognized in accordance with Chapter 25 of the Tax Code starting from January 1, 2022, regardless of the date the corresponding contract was concluded.

Transactions in the field of foreign trade in goods that are part of one or more commodity groups.
Transactions where one of the parties is a person whose place of registration, residence, or tax residency is a state or territory included in the list of states[4] and territories approved by the Ministry of Finance of the Russian Federation.

If the activities of a Russian organization create a permanent establishment in a state or territory included in the specified list, and the transaction being analyzed is related to this activity, then for that transaction, the organization is treated as a person registered in that state or territory.

The transactions listed above are recognized as controlled if the amount of income from such transactions with a single person (persons) for the corresponding calendar year exceeds 120 million rubles.

A transaction between interdependent persons where the place of registration, residence, or tax residency of all parties and beneficiaries is the Russian Federation is recognized as controlled if at least one of the following circumstances exists:

The parties apply different corporate income tax rates to the profits from the activities within which the transaction was concluded;
One of the parties is a taxpayer of mineral extraction tax calculated at a percentage-based rate, and the subject of the transaction is an extracted mineral recognized as an object of taxation for that party;
At least one party applies the tax system for agricultural producers (the unified agricultural tax) and the transaction is concluded within the framework of such activity, while another party does not apply this special tax regime;
One of the parties is exempt from corporate income tax duties;
The transaction simultaneously satisfies the following conditions:

One party is a taxpayer that accounts for income (expenses) from the transaction when determining the corporate income tax base in accordance with Article 275.2 of the Tax Code;
Any other party is not a taxpayer specified in Clause 1 of Article 275.2 of the Tax Code or is such a taxpayer but does not account for income (expenses) from the transaction when determining the tax base in accordance with that article;

At least one party is a corporate research center as specified in the Federal Law On the Skolkovo Innovation Center, or a project participant in accordance with Federal Law No. 216-FZ dated July 29, 2017, On Innovative Scientific and Technological Centers and on Amending Certain Legislative Acts of the Russian Federation, applying a VAT exemption;
At least one party applies an investment tax credit for corporate income tax during the tax period;
At least one party is a taxpayer of additional income tax on hydrocarbon production, and the income (expenses) from the transaction are accounted for when determining the tax base for that tax.

The domestic transactions mentioned above are recognized as controlled if the amount of income from such transactions between the specified persons for the corresponding calendar year exceeds 1 billion rubles.

However, the following transactions are not recognized as controlled:

Transactions between participants of the same consolidated group of taxpayers (except for transactions involving extracted minerals taxed at a percentage rate or transactions accounted for under additional income tax on hydrocarbon production);
Transactions between persons that simultaneously meet the following requirements:

They are registered in the same constituent entity of the Russian Federation;
They do not have separate subdivisions in other constituent entities or outside the Russian Federation;
They do not pay corporate income tax to the budgets of other constituent entities;
They do not have losses (including carried-forward losses) taken into account for corporate income tax purposes;
There are no other circumstances to recognize their transactions as controlled;

Transactions between taxpayers performed during activities related to hydrocarbon production at a new offshore hydrocarbon field;
Interbank loans (deposits) with a term of up to 7 calendar days inclusive;
Transactions in the field of military-technical cooperation between the Russian Federation and foreign states carried out in accordance with Federal Law No. 114-FZ dated July 19, 1998, On Military-Technical Cooperation of the Russian Federation with Foreign States;
Transactions for the provision of sureties (guarantees) where all parties are Russian organizations that are not banks;
Transactions for the provision of interest-free loans between interdependent persons where all parties and beneficiaries are registered or reside in the Russian Federation.

The foreign trade transactions provided for above are recognized as controlled if the subject of such transactions includes goods from one or more of the following commodity groups:

Oil and products derived from oil;
Ferrous metals;
Non-ferrous metals;
Mineral fertilizers;
Precious metals and precious stones.

The codes [5] for these goods in accordance with the Commodity Nomenclature of Foreign Economic Activity (the "TN VED") are determined by the federal executive body responsible for state policy and legal regulation in the field of foreign trade.

Organizations that performed controlled transactions during a calendar year must submit a notification of controlled transactions once a year, no later than May 20 of the following year. The notification must follow the form and procedure approved by Order of the FTS of Russia No. MMV-7-13/249@ dated May 7, 2018, using one of the following methods:

In hard copy;
In electronic form according to the established format.

Comparable Transactions

Transactions are recognized as comparable to the transaction being analyzed if they are performed under identical commercial and/or financial conditions. When determining comparability and making adjustments, an analysis is conducted on the following characteristics that may significantly influence the terms of transactions between non-interdependent persons:

Characteristics of the goods (work, services) that are the subject of the transaction;
Characteristics of the functions performed by the parties in accordance with business customs, including the characteristics of assets used, risks assumed, the distribution of responsibility, and other transaction terms (the "functional analysis");
Terms of contracts concluded between the parties that influence the prices of goods (work, services);
Characteristics of the economic conditions of the parties' activities, including the characteristics of the relevant markets;
Characteristics of the market (commercial) strategies of the parties.

When conducting tax control (including the comparison of conditions between analyzed and comparable transactions), the FTS uses the following information:

Information on prices and quotations from Russian and foreign exchanges;
Customs statistics of the foreign trade of the Russian Federation;
Information on prices (price fluctuations) and exchange quotations contained in official sources of information from government authorities, local governments, and the authorities of the Sirius Federal Territory, as well as official sources of foreign states or international organizations;
Data from price reporting agencies;
Information on transactions performed by the taxpayer.

If the above information is absent or insufficient, the FTS uses:

Information on prices and quotations in published and/or publicly available publications and information systems;
Information from the accounting (financial) and statistical statements of organizations;
Information on the market value of objects of valuation determined in accordance with the legislation of the Russian Federation or foreign states on valuation activities;
Other information used in accordance with Chapter 14.3 of the Tax Code.

Information from the accounting (financial) statements of foreign organizations may only be used to determine the profitability interval for Russian organizations if it is impossible to calculate such an interval based on the data of Russian organizations performing comparable transactions.

Determining the Market Price of a Controlled Transaction

When conducting tax control or considering an application for a pricing agreement, the federal executive body authorized for tax control uses the following methods:

The comparable uncontrolled price method, where prices in the controlled transaction are compared with the market price interval for comparable transactions;
The resale price method, which compares the gross margin of the reseller in the subsequent sale of a product previously purchased in a controlled transaction with the market gross margin interval;
The cost plus method, which compares the gross margin on costs obtained by the seller in a controlled transaction with the market gross margin on costs interval;
The transactional net margin method, [6] which compares the operating margin of a party to a controlled transaction with the market level of operating margin in comparable transactions;
The profit split method, [7] used when it is necessary to redistribute all profit received by the parties to a transaction in the way it would be distributed under ordinary conditions.

The law permits the use of a combination of two or more methods. If no method is suitable, the taxpayer may:

Apply another justified method for determining the market price;
Determine the market value based on an independent appraisal for a one-off transaction.

A one-off transaction is defined as a transaction whose economic essence differs from the organization's main activity and which is carried out on a one-time basis. [8]

Procedure for Tax Audits of Transfer Prices

The audit of the completeness of calculation and payment of taxes regarding transactions between interdependent persons is conducted by the federal executive body authorized for tax control at its location. [9]

The audit is conducted based on a notification [10] of controlled transactions or a notice[11] from a territorial tax authority, as well as when a controlled transaction is identified during a repeated field tax audit or tax monitoring conducted by the FTS.

An audit can only be conducted regarding a specific controlled transaction (or group of homogeneous transactions) of the specific taxpayer that submitted the notification or regarding whom a notice was received. [12]

A decision to conduct an audit cannot be made regarding a controlled transaction for which the taxpayer has applied to the FTS for a pricing agreement [13] for tax purposes for the same calendar year.

Comparison of Transfer Prices with Market Prices

The comparison of transfer prices with market prices follows this algorithm:

Studying the controlled transaction (subject, actions of the parties, their functionality, and risks);
Selecting the method for determining the market price;
Calculating the market price and comparing it with the price in the controlled transaction.

As a result of the comparison, it is often necessary to adjust the tax bases.

International Groups of Companies

An international group of companies (an "MGC") is recognized[14] as a set of organizations and/or foreign structures without the formation of a legal entity, linked through capital participation and/or control, for which all the following conditions are met:

Consolidated financial statements are prepared for the set of entities in accordance with Russian accounting laws or stock exchange requirements;
The set includes at least one entity that is a Russian tax resident (or a non-resident taxable on activities conducted through a permanent establishment in Russia) and at least one entity that is not a Russian tax resident (or a resident taxable on activities conducted through a permanent establishment in a foreign state).

A participant in an MGC includes:

An entity belonging to the set recognized as an MGC;
An entity whose financial statements are not included in the consolidated statements solely due to size or immateriality;
Permanent establishments of the entities mentioned above.

Country-specific data for an MGC includes information on income (expenses), profit (loss), tax amounts, and other indicators characterizing the activities of the MGC participants in Russia and/or foreign states.

Country-specific data includes the following documents:

Global documentation for the MGC;
National documentation of an MGC participant;
A country-by-country report for the MGC by states (territories).

Taxpayers who are participants in an MGC must submit notifications of participation in the MGC to the FTS. The format,[15] filling procedure, and electronic submission rules are approved by the FTS.

Legal Consequences and Liability for Transfer Pricing Violations

Violations in the field of transfer pricing lead to legal consequences in the form of liability as provided by two articles of the Tax Code:

Article 129.3, Non-payment or Incomplete Payment of Tax Amounts Resulting from the Application for Tax Purposes in Controlled Transactions of Commercial and/or Financial Conditions Not Comparable to the Conditions of Transactions Between Persons Who Are Not Interdependent. A taxpayer is exempt from liability if they submit documentation to the FTS justifying the market level of the prices applied. Non-payment or incomplete payment entails a fine of 40% of the unpaid tax amount, but not less than 30,000 rubles. From January 1, 2023, such an offense will result in a fine equal to the unpaid tax amount on the income specified in Article 105.3 of the Tax Code, but not less than 500,000 rubles.[16]
Article 129.4 [17], Unlawful Failure to Submit a Notification of Controlled Transactions or Submission of False Information in a Notification of Controlled Transactions. Failure to submit a notification on time or submitting false information entails a fine of 5,000 rubles. From January 1, 2024, the fine increases to 100,000 rubles.[18]

Incorrectly filling in individual details in a notification is grounds for liability under Article 129.4 of the Tax Code if the errors could prevent the identification of the controlled transaction. [19]

Incorrect execution of transfer pricing legislation may lead to tax reassessments, blocking of company accounts, and criminal liability. Criminal liability for tax evasion is provided for individuals and legal entities by the Criminal Code of the Russian Federation:

Article 198, Tax Evasion by an Individual.
Article 199, Tax Evasion by an Organization.

In conclusion, when conducting foreign trade, it is vital to consider aspects of interaction with foreign partners, legislative changes, and tax law. The continued foreign trade activities of a company and the minimization of the risk of liability depend on the correct calculation of taxes, timely reporting, and the provision of necessary documentation to regulatory authorities.

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References

[1] Clause 1 of Article 150.1 of the Tax Code of the Russian Federation.

[2] Resolution of the Arbitration Court of the North-Western District dated February 4, 2022, No. F07-19082/2021 in Case No. A56-113866/2020. The company sought to invalidate a customs authority's decision to amend information in a goods declaration. The claimant argued that the appellate court ignored evidence of higher prices for similar goods from other traders and that transfer pricing data did not reflect actual conditions. The court denied the claim because the company failed to provide documentary confirmation and reliable information regarding the declared customs value, meaning the transaction value method could not be used.

[3] Article 105.14 of the Tax Code of the Russian Federation.

[4] Order of the Ministry of Finance of Russia No. 86n dated June 5, 2023, On Approving the List of States and Territories Providing a Preferential Tax Regime and/or Not Providing for the Disclosure and Provision of Information When Conducting Financial Operations (Offshore Zones).

[5] Order of the Ministry of Industry and Trade of Russia No. 267 dated February 3, 2022, On Approving the List of Commodity Codes in Accordance with the Unified Commodity Nomenclature of Foreign Economic Activity of the Eurasian Economic Union, Transactions Regarding Which Are Recognized as Controlled in Accordance with Article 105.14 of Part One of the Tax Code of the Russian Federation.

[6] Decision of the Arbitration Court of the City of St. Petersburg and the Leningrad Region dated June 8, 2021, in Case No. A56-113866/2020. The applicant sought to invalidate a decision on customs value adjustment. The customs office noted that the transfer pricing information provided did not contain criteria for price formation. The declarant explained it used the transactional net margin method. The court found the customs decision lawful.

[7] Decision of the Arbitration Court of the Novosibirsk Region dated May 25, 2021, in Case No. A45-31054/2020. The applicant sought to invalidate a customs value adjustment. The customs authority argued that transfer pricing aimed to capture markets and redistribute profits between parent and subsidiary companies. The court found no grounds to grant the claim as the customs decision complied with the law.

[8] Letter of the Ministry of Finance of Russia No. 03-01-RZ/20100 dated April 29, 2014, On the Application by Insurers of the Provisions of Section V.1 of the Tax Code of the Russian Federation.

[9] Article 105.17 of the Tax Code of the Russian Federation.

[10] Order of the FTS of Russia No. MMV-7-13/249@ dated May 7, 2018, On Approving the Form of Notification of Controlled Transactions, the Format for Submitting the Notification in Electronic Form, the Procedure for Filling Out the Form, and the Procedure for Electronic Submission.

[11] Order of the FTS of Russia No. MMV-7-13/421@ dated August 26, 2019, On Approving the Form of Notice of Controlled Transactions and the Procedure for Sending the Notice by the Tax Authority Conducting a Tax Audit to the Federal Executive Body Authorized for Tax Control.

[12] Letter of the Ministry of Finance of Russia No. 03-01-18/7-127 dated September 6, 2012.

[13] Order of the Ministry of Finance of Russia No. 60n dated March 29, 2018, On Approving the Procedure for Concluding a Pricing Agreement for Tax Purposes Regarding a Foreign Trade Transaction Where at Least One Party Is a Tax Resident of a Foreign State with Which a Double Taxation Treaty Has Been Concluded.

[14] Article 105.16-1 of the Tax Code of the Russian Federation.

[15] Order of the FTS of Russia No. MMV-7-17/124@ dated March 6, 2018, On Approving the Format of Notification of Participation in an International Group of Companies, the Procedure for Its Completion, and the Electronic Submission Procedure.

[16] Federal Law No. 539-FZ dated November 27, 2023, On Amending Parts One and Two of the Tax Code of the Russian Federation, Certain Legislative Acts of the Russian Federation, and Recognizing Certain Provisions of Legislative Acts of the Russian Federation as Void.

[17] Resolution of the Thirteenth Arbitration Appellate Court dated December 28, 2018, No. 13AP-30112/2018 in Case No. A26-4595/2018. The inspectorate penalized a company under Article 129.4 of the Tax Code. While the company and its permanent establishment were interdependent, transactions can only be recognized as controlled under Article 105.14. The court found the penalty unlawful.

[18] Federal Law No. 539-FZ dated November 27, 2023, On Amending Parts One and Two of the Tax Code of the Russian Federation....

[19] Clause 10 of the Review of the Practice of Courts Considering Cases Related to the Application of Certain Provisions of Section V.1 and Article 269 of the Tax Code of the Russian Federation, approved by the Presidium of the Supreme Court of the Russian Federation on February 16, 2017.