Russia's New Export: The VAT

A foreign company that has never done business in Russia calls a law firm in Moscow to ask about procedures for setting up an office here. But before it even registers its name or hires an employee in the country, it can find itself subject to Russia's 20 percent value-added tax for the legal services provided during that telephone call.

"The Russian authorities' position, apparently, at least some of them ... is that you were talking with this person about activity in Russia, so it's subject to VAT," said Chris Moore of Coudert Brothers' Moscow practice.

That can happen even if the company chooses never to enter the Russian market. "They may say, 'Sorry I asked, we'll go to Nigeria,'" Moore said.

Accountants, lawyers, consultants and other providers of services have confronted this issue on a regular basis for the past several months. The problem is one of the many gray areas in Russia's tax legislation -- in this case, the lack of definition of a "place of economic activity" that determines whether a client company must pay VAT on services it receives.

Some tax authorities have sought to impose VAT on transactions such as counsel by telephone to a prospective multinational client who has no representation here -- and hence, no "activity" -- or Russian companies that are seeking advice on doing business in the United States.

"It becomes sometimes a little bit awkward," said Alex Chmelev, an attorney with Baker & McKenzie in Moscow. "[Clients] say, 'Wait, why is there VAT on my invoice?'"

Until last year imposition of VAT was judged according to where the service in question was provided. But amendments to the law on VAT in April 1996, which were spelled out in instructions last fall, changed the standard to the amorphous "place of economic activity." And it's not always easy to determine whether Russia is that place.

The rationale, lawyers say, was to stimulate trade by removing VAT on export of services, emulating VAT legislation in the European Union. But the EU laws were drafted for a very different economy, and include far more instructions to tax bodies about which circumstances they cover. That means different tax inspectorates in Russia come up with their own legal interpretations.

Foreign lawyers and investment lobbies, including the American Chamber of Commerce in Russia, now are pushing the government tax authorities for clarification of the question of "place of economic activity." Moore believes clearer guidelines might be issued by administrative agencies within six months.

In the meantime, firms face ambiguities on almost a daily basis. If a foreign client owns shares in a Russian subsidiary, "does that shareholding in a Russian company create a 'place of economic activity?'" said Chmelev. "I could argue both ways. ... You need kind of a clear test."

The lack of clarity matters because the 20 percent VAT assessed on legal services or consulting adds a hefty amount to a client's bill. If the service provider thinks VAT is not applicable, and does not pass along the charge, the client saves a bundle. But if that decision is deemed wrong by the state tax authorities in a future audit, the firm could face punishingly high penalties for avoiding VAT.

A group of foreign lawyers now is working to establish uniform standards for the applicability of VAT. Otherwise, different interpretations of the law could lead to the same service costing 20 percent more at one firm than another.

Although the place of economic activity is a murky question, some aspects of VAT law were cleared up in a December "information letter" by the Higher Arbitration Court, which recapped cases on VAT. The rulings were split roughly evenly between tax inspectorates and enterprises that had lodged appeals.

"They do seem to be looking at the law and making the right decisions," said Neil Budd of Watson, Farley & Williams, which prepared a summary of the court's letter. "It's quite good from a point of view of seeing a court that isn't prepared to do just what the tax inspectorate wants it to do."

Among the decisions the firm cited:

?Receipt of a loan is not subject to VAT.

?A taxpayer which fails to pay VAT in the mistaken belief that it is entitled to exemptions is subject to penalties.

?A taxpayer is not liable to sanctions where it had made mistakes in calculating tax payment, but corrects them itself prior to a tax audit.