Thin Capitalisation

The coal mining company Severniy Kuzbass has challenged the decision of the tax authorities barring deduction from taxable income of interest on a loan extended by a non-resident (case number A27-7455/2010).

Boris Silin

Muranov, Chernyakov & Partners
+7 495 783-74-50

The courts of three instances ruled for the company: interest on a loan provided by a non-resident constitutes non-operational expenditures and, therefore, tax deductible because these issues are governed by a double tax treaty between the Russian Federation and the creditor’s country of residence.

Not satisfied with the decision of the courts, the tax collectors applied to the Supreme Commercial Court of Russia.

In a plenary session of three judges on August 12, 2011 the Supreme Commercial Court referred the case to Presidium. The reason why the matter was sent to the Presidium of the Supreme Commercial Court was an ambiguity in resolving the conflict between international tax treaties and domestic legislation.

According to the opinion set out in the ruling of 12 August 2011, general provisions of double tax agreements do not

apply if there are more specific provisions of national tax legislation on that particular matter.

The ruling seems logical and reasonable since DTAs cannot take precedence over national legislation on those issues that are not adequately dealt with by national tax laws.

Overall, the position set out in the ruling of the Supreme Commercial Court in the case A27-7455/2010 is crucial for the due diligence of the activities of Russian residents. It will also help to optimize lending by non-residents to Russian companies.

Thus, any analysis of the activities of Russian legal entities it is now necessary to pay special attention to the structure of receivables, the presence of non-resident creditors of the Russian Federation, the classification of interest. This is needed to identify risks associated with new tax claims.

It is obvious that now lending by non-residents to Russian legal entities will become more sophisticated (for example, loans by offshore organizations which are not formally members / shareholders of the debtor, a Russian resident).

Muranov, Chernyakov & Partners