Taxpayer Liability for Supplier: Important Precedent by Supreme Arbitration Court

Konstantin Sasov
Senior Associate
Pepeliaev Group

Issue of Defaulting Signatories

In their normal course of business, companies do not pay much attention to the actual signatory of a contract, delivery documents or value-added tax (VAT) invoices on behalf of the supplier. If the documents are prepared on the company’s letterhead, if they bear the company’s seal and signature of the general director and, most importantly, the goods are shipped and fully paid, there are no grounds for believing that the documents were signed by an unauthorized individual. Moreover, Russian civil legislation advocates a simplification of transactions. For example, a contract may be signed by a party without the presence of another party; the signed documents may be sent by mail, fax or e-mail (Clause 3, Article 434 of the Russian Tax Code). Most importantly, a company should make sure that the authorized party initiated the transaction under the contract. Moreover it should be noted here that the party should be the specific company, rather than the company’s representative — an individual. The Russian Civil Code also states that if an unauthorized individual signs a contract on behalf of the company, but the company approves of the transactions in future (for example, through implicative actions), this contract is deemed to have been concluded on behalf of the company (Clause 1, Article 183). Arbitration courts do not discern any shortcomings in documents even if a contract was not sealed or VAT invoices were certified with electronic signatures.

However, the Supreme Arbitration Court in Resolution No. 9299/08, dated Nov. 11, 2008, on the case of ZAO Kestroi 1, ruled that if documents are signed on a supplier’s behalf by an individual whose authority is not confirmed (the signatory denies that he/she is head of the company), the customer may not deduct VAT. In other words, an oral statement from an individual denying that the latter is connected with operations of the company, where this individual holds the position of head of the company, provides grounds for doubting that any transaction was actually performed. In this case the tax authorities may disallow a VAT refund for the customer on the grounds that the latter did not select its business partner with due prudence and may assess default interest and fines.

The tax authorities, leveraging the court ruling and backing of the courts, started to assess en masse additional taxes for “doing business with the wrong guy.” Tax audits began to resemble reports where confidential information on fly-by-night firms registered under forged documents available to the tax authorities was reconciled against the information on suppliers provided by each audited taxpayer. The problem of such an abuse of administrative powers lies not only within the realm of law, but also within the realm of morality: de facto, the state provides tax fraudsters with legal capacity and conceals information on their bad faith practices from users interested in such data and punishes their unsuspecting counterparties.

A Judicial Precedent Overcomes the Issue of Injustice

Within half a year of such tax practice the Supreme Arbitration Court recognized its fallaciousness. In Resolution No. 15574/09 of the Presidium of the Russian Supreme Arbitration Court, dated March 9, 2010, the court ruled that the tax authorities may not disallow the deductibility of expenses for profit tax purposes, if the corresponding company’s expenses were real and were incurred under real business transactions with a business purpose and economic feasibility and the tax authorities had failed to prove that the taxpayer had been aware of material facts relating to the operations of its counterparty, which are relevant for tax purposes.

The Presidium of the Russian Supreme Arbitration Court reached the same conclusions regarding the deduction of VAT in Resolution No. 18162/09, dated April 20, 2010, on the case of OAO Muromsk Railway Switch Plant. The court ruled that there were no grounds for concluding that the information in the VAT invoices had been insufficient or inconsistent, unless the tax authorities established facts to confirm that the taxpayer had known or should have known that the seller provided unreliable or inconsistent information. According to the court, the right to a tax deduction (tax benefit) depends on the actual nature of the taxpayer’s business transactions, which may only be refuted based on the grounds specified in Resolution No. 53 of the Plenum of the Russian Supreme Arbitration Court, dated Oct. 12, 2006.

The Russian Supreme Arbitration Court proclaimed its legal position to be binding on all courts considering similar cases and directly stated this fact in the judicial act. In this situation the legal position of the Russian Supreme Arbitration Court complies with Ruling No. 3991/03 of the European Court of Human Rights, dated Jan. 22, 2009, on the case Bulves AD vs. Bulgaria, and should constitute a reliable benchmark for tax relations in the future.

The new ruling of the Russian Supreme Arbitration Court instructs the tax authorities and courts to establish the facts relating to the conclusion of transactions. Therefore, the taxpayers should pay attention to policies in respect to the selection of future counterparties and documentation confirming the legal capacity of suppliers and their creditworthiness.