A foreign entity’s income from sales of assets. Almin Rabinovich and Nataly Postnikova’s article in Finansovaya Gazeta

Let us analyze how a foreign entity pays taxes if it sells assets in the form of real estate located on the territory of the Russian Federation.

Almin Rabinovich

Head of Accounting and Tax Consulting Department, ООО FinExpertiza

Natalya Postnikova

Head of Projects of Accounting and Tax Consulting Department, ООО FinExpertiza

-In the event of payment of tax on income from sales of real estate, expenses on purchase of this real estate may be deducted, if the foreign entity provides the buyer (the tax agent) with documented data on the incurred expenses (par.4 art.309 of the RF Tax Code). If the foreign entity spent money to purchase real estate, the buyer should have no further questions on this matter. However, the situation is more complicated if the foreign entity carried out the settlement with property or as setoff. In this case, the tax agent should pay special attention to documentation of the actual payment with monetary funds.
According to law, the expenditures recognized in the event of sale of assets, purchased goods and equity shares mean the cost of their acquisition. In case of depreciable assets, the expenditure is residual value, i.e. the cost of acquisition reduced by accrued depreciation (sub-par. 1, 2.1 and 3, par. 1, art. 268 of the RF Tax Code).
If the accrual method is applied, the expenditures recognized for taxation purpose should be recorded in the reporting period they are related to, regardless of when actual cash transactions occur (paragraph 1, article 272 of the RF Tax Code). This means that the RF Tax Code does not make a correlation between a taxpayers’ right to record expenditures with the actual payment of cash. At the same time, the tax base of a foreign entity is determined not on accrual basis, but on the basis of payment, and their liability to withhold income tax of a foreign entity occurs only in the event of actual payment. In this case, the amount of tax is determined in rubles in accordance with the bank’s exchange rate as of the date of cash payment to the foreign entity (par.5 art.45, par.2 art.287, par.5 art.309, par.1 art. 310 of the RF Tax Code). According to this logic, we may conclude that expenditures of a foreign entity reducing its income should be determined on payment basis. Anyway, the use of this approach by tax authorities cannot be excluded.
Which documents will certify costs of a foreign entity 
The costs of a foreign entity incurred for purchase of real estate can be certified by documents testifying to the amount of expenses. This is explained, for example, by the Department of the Federal Tax Service in Letter No 20-12/93067 dd 15 December 2005. These documents include contracts, payment documents, a notification sent to the entity and shareholders which informs on the price and conditions of sale of a share to a third party. The same is stated in Letter 03-07-08/254 of the Ministry of Finance dd 13 November 2008, wh ere supporting documents are also listed: sale and purchase contracts, invoices, certifying the payment of property in accordance with the sale and purchase contract, excerpts from bookkeeping of the head office of the foreign entity, statements of property value issued by technical inventory authorities. Both Letters state the necessity to provide payment documents confirming the actual payment. That is why, in order to avoid possible tax risks, the tax agent should receive from the foreign entity a confirmation of the actual cash payment, or expenditures due to which the foreign entity had receivables from its Russian purchaser paid via setoff. In practice, it may lead to an entire chain of noncash settlements. All this also applies to the sale of shares of companies, more than 50 per cent of assets of which are directly or indirectly comprised of real estate, located on the territory of the Russian Federation (par.4 art.309 of RF Tax Code).
What if there are no supporting documents
If the tax service does not have confirmation of the cash payment, it may reject deduction of costs and accuse the tax agent of lowering the income of the foreign entity.
Examples of such disputes may include court cases on a foreign entity’s actual contribution to the charter capital of a Russian entity in the amount giving the right to apply a reduced rate to dividends received by the foreign entity. Thus, under case No А14-13723/2013, a tax agent disputed the decision of a tax authority on additional charge of income tax due to rejection in reduced rate stipulated by par. 2 art.10 of the Tax Treaty between the Government of the Russian Federation and the Kingdom of Sweden. The refusal of the tax authority is explained by the fact that application of the reduced rate requires an actual contribution to the charter capital in the amount exceeding 100,000 USD. Since the shareholder received the shares free, the shareholder did not make an actual contribution to the charter capital. The Court of Appeal and the Court of Cassation invalidated the decision of the tax authority. The basis for the courts’ decision was not the actual payment, but the ownership. By Decision No310-КГ15-17102 of the Supreme Court of Russia dd 21 December 2015, the tax authority was rejected to submit the cassation claim for consideration by the Chamber for Commercial Disputes of the Supreme Court of Russian Federation.
In another tax dispute, the tax authority also rejected the right to apply a reduced rate in accordance with par.2 art.10 of the Tax Treaty between the Government of the Russian Federation and the Republic of Cyprus on the ground that when a foreign entity paid for the shares of a Russian entity, it used promissory notes of third parties, the term of payment of which had been prolonged several times and which were not paid as of the date of tax review. The case was lost by the tax agent in two courts and submitted for another consideration. However, the Commercial Court of the North Caucasus District stated that copies of sale and purchase contracts and copies of documents supporting the payment under contracts, in particular, copies of bank statements, or payment orders, or confirmation of a depository clearing company, may be used as documents supporting the contribution to the capital of the Russian company. The courts conducted incomplete analysis of the tax authority’s claim on the entity’s failure to submit such a documented confirmation, including payment documents (Resolution on Case No А53-25996/2015 dd 30 January).