Leasing Taxation in Russia. VAT Recovery Specifics

UnknownLudmila Batalova, Head of Tax Legal Consulting Department, SAMETA
Tax benefits represent a significant advantage of leasing activities as compared with rental or purchase and sale contracts. However, leasing deals are often considered by tax authorities as a means of taxation avoidance and illegal VAT recovery. Therefore, when lessors apply tax deductions with the value added tax recovery amount in accordance with the tax return exceeding 1 million rubles, the tax authorities generally decide that such tax deductions are illegal and refuse to recover VAT. In Moscow as well as in the majority of other Russian regions lessors-taxpayers have to resort to arbitration for tax recovery, however, approximately one-fifth of VAT recovery cases are not decided in favor of taxpayers (2007 data).

The main arguments of tax authorities in refusing VAT recovery to taxpayers may be consolidated in two groups. First, common arguments for all taxpayers claiming VAT recovery: taxpayer's failure to act in good faith, failure to submit the necessary documents to tax authorities or errors in documents (invoices). Second, specific arguments "developed" by tax authorities for leasing companies which may be consolidated under one category — economic inexpediency of transactions: leveraged acquisition of leased property, unsatisfactory (in the opinion of tax authorities) financial & business performance indicators, as well as leaseback transactions.

The notion of taxpayer's acting (failure to act) in good faith has been used in tax dispute resolution for a long time. Following adoption of Resolution No. 53 "On Evaluation by Courts of Arbitration of Justifiability of Taxpayer's Receiving of Tax Benefit" by the Plenary Session of the High Court of Arbitration on October 12, 2006, the taxation experts started to suppose that the evaluative notions of "taxpayer acting/not acting in good faith" would not be used by tax authorities or courts of arbitration.

Instead, the High Court of Arbitration has introduced the notion of tax benefit and has developed the criteria of justifiability of such benefit received by a taxpayer. The Court has pointed out that tax benefit means a decrease of tax liability including, without limitation, decrease of taxable base, tax deduction, tax exemption, application of a lower tax rate as well as the right for tax recovery from the budget. However, the notion of "taxpayer acting/not acting in good faith" is still being used both by tax authorities and courts of arbitration.

Tax authorities come to the conclusion that a taxpayer does not act in good faith based on the results of cross-audits of suppliers (sellers of leased assets) if such audits provide proof of the following: a supplier's actual location differs from the addresses indicated in the documents of incorporation and purchase and sale contracts, a supplier's failure to submit tax returns and accounting statements or submission of tax returns and accounting statements containing incorrect (misleading) information, a supplier's failure to pay taxes to the budget including the value added tax received from a lessor as a result of sale of the leasing assets to such lessor.

In course of arbitration practice certain criteria have been developed for evaluation of such proof of "failure to act in good faith" presented by tax authorities based on the legal views of the Constitutional Court and of the High Court of Arbitration.

The Constitutional Court stated that law enforcement authorities shall not interpret the term "taxpayer acting in good faith" as a term charging a taxpayer with additional obligations not stipulated by legislation; a taxpayer shall not be held liable for the actions of all entities taking part in the multistage process of paying taxes to the budget. At the same time the Constitutional Court repeatedly pointed out that the taxpayer's right to recover value added tax corresponds to the supplier's liability to pay the tax to the budget (for example, Ruling No. 324-O of November 4, 2004).

In view of the above, we believe that despite recent trends in litigation practice positive to lessors-taxpayers one can speak about proof of legitimacy of the application of tax deductions by a lessor only by taking into account the specific circumstances.