Russian-German tax practice – Intragroup services and shareholder activity
Contracts on intragroup services traditionally trigger disputes with the tax authorities, first and foremost in the jurisdiction where the group’s companies incurring economically the burden of expenses on such services are located. As a rule, this tends to mean such group subsidiaries as importers, manufacturers or distributors. Russia is no exception. Moreover, Russian subsidiaries and their management are exposed to a far greater extent to tax risks by virtue of the extremely conservative approach adopted by the Russian tax authorities to the deductibility of expenses on intragroup services.
In August 2020 the Federal Tax Service of Russia (FTS) issued a letter dedicated to intragroup services. We talked about this letter in detail in a video blog (link) and as a whole assess the underlying message of the supervisory authorities as positive for the development of law enforcement practice. In February 2021 FTS issued another letter where it focussed entirely on demarcating the concepts of intragroup services and shareholder activity.
Crux of the issue
If the expenses assigned to a subsidiary arose in connection with activity conducted solely in the interests of the group’s shareholders (shareholder activity), they do not reduce the taxable income of the subsidiary, as activity conducted in the interests of shareholders is not a service. The Group as a whole incurs financial losses as a result of double taxation as the company assigning the expenses (for example, based in Germany) is taxed on the Russian-source funds received pursuant to the standard procedure, while the expenses are paid in Russia from net profit. The new letter could exacerbate the current situation, as the demarcation of the concepts of intragroup services and shareholder activity proposed by FTS is at variance with international practice, including German practice.
Shareholder activity in international practice
The OECD classifies activity as shareholder activity based on the following criteria. If the activity is necessary because the parent company is required to comply with specific rules in the country of residence (for example, in Germany), inter alia, in relations with its shareholders, then such activity is being performed in the interests of the shareholders. One can cite as examples statutory reporting in the country of the parent company, the performance of mandatory corporate actions, compliance with the rules on the corporate governance of the group as a whole, and others.
In addition, it is customary in international practice to classify activity related to the protection of investments, in other words, the capital invested in Russia, as activity conducted in the interests of the shareholders.
The Federal Tax Service of Russia on shareholder activity
In the recent letter FTS classifies the following types of activity as shareholder activity:
- Designing of the development strategy of the group as a whole or by segments and regions
- Marketing research on goods and services which have still not been launched on the Russian market
- Assessment of the viability, costs and efficiency of investment projects
- Strategic planning and budgeting
- Preparation of the consolidated financial and management reporting
- Internal audit and control
- Organisation of the financing of the group, organisation of the effective use of funds within the group
- Receipt of ratings, interaction with financial institutions
- Drafting and implementation of group standards, methodologies and policies
Such divergence on the issue as to what constitutes activity in the interests of shareholders is bound to lead to tax disputes in Russia and the duplication of the tax burden of international groups with subsidiaries in Russia. FTS holds that the compensation of costs on shareholder activity can be taxed as Russian-source dividends to foreign shareholders.
What needs to be done in the current situation?
Notwithstanding the current unfavourable development for business, international groups should as in the past adhere to the aforementioned criteria to demarcate shareholder activity and intragroup services. FTS’s position may change in the medium to long term due to the influence of court interpretation and the changing policy of the Ministry of Finance.
At the same time, the approach to documenting the expenses being assigned to Russian subsidiaries must be changed.
Based on our many years of experience, it is frequently the case that clients tend not to think through and even treat superficially the documentation required to designate activity, the expenses on which have been assigned to a subsidiary. This is often attributable to miscalculation by management of the legal situation and tax risks in foreign countries. The sporadic documentation or lack of documentation even results in a disallowance of the deductibility of expenses which might be justifiably classified as expenses on intragroup services, and also financial fines for the Russian company.
Contracts on intragroup services must include not simply a list of the types of activity and projects as a whole: such as corporate governance, management, marketing, financial services, reporting and audit, IT, the introduction of policies, standards, etc. The focus should be a detailed description of the functions assumed by the companies providing services and assigning expenses. In addition, the reporting on services rendered must document quantitative data: the scope of the performed work, the time spent, the other resources allocated to this activity.
BEITEN BURKHARDT lawyers and tax advisors would be delighted to assist you with the preparation of the intragroup agreements and necessary documentation to substantiate respective expenses.
Read this article in Russian at: LINK
 Letter of the Federal Tax Service of Russia from 12 February 2021
Steuerberaterin, Diplom-Juristin, LL.M.