Auditors refuse to unwrap but win

-- 30 January 2009 --
TEXT: J. VERMIN
PHOTO: Kommersant.ru.

 

The Supreme Arbitrazhniy (Commercial) Court of Russia on January 21 decided in favour of PWC. This ends a 3-year battle with the Federal Tax Service over charges that the company evaded millions of dollars in taxes. This might seem like another tax avoidance case, but a closer look suggests a more complicated picture.

In February 2006 the Federal Tax Service charged PricewaterhouseCoopers Audit JSC, a Russian entity of the PWC group, with evading corporate income tax and VAT. In 2002 the company reduced its tax base by funnelling cash to PricewaterhouseCoopers Resources B.V. (now PricewaterhouseCoopers Russia B.V.), a Dutch company. PWC-Resources then seconded its staff to PWC-Audit.

According to the tax office in 2002 PWC illegally deducted over 530 mln. roubles (~ USD18.8 mln) from its income. Apart from a loss of 290 mln. roubles (~USD10 mln) in taxes and penalties PWC would have faced a likely loss of its auditing license should FTS have won the case.

The case revolved around four main submissions made by the taxmen.

Firstly, according to the tax officials PWC failed to provide proper accounting documents to confirm transactions with PWC-Resources. Indeed, although Russian law leaves the forms of accounting documentation to the discretion of the taxpayer the documents must comply with the compulsory requirements set by the Federal Law #129-FZ 'On Accounting'.

Secondly, FTS claimed that PWC did not provide sufficient evidence as to the nature of the services provided by PWC-Resources and therefore there were no grounds for deductibility. Tax officials pointed out that the right to deduct expenses rests on the fact that they were incurred for business purposes. Such descriptions as 'brainstorming with clients,' 'general issues' and 'business activity' by the foreign experts as can be seen from the documents provided by PWC were not sufficient to conclude that the service was provided in relation to the company's business.

Thirdly, the tax authorities tried to apply the comparatively new doctrine of 'unjustified tax benefit' created by courts and articulated by the Supreme Arbitrazhniy Court in the famous Resolution N 53 of October 12, 2006 "On Assessment by the Arbitrazhniy Courts of Justification for Tax Benefit Received by a Taxpayer." The Resolution attempts to implement a 'substance over form' approach ruling that courts must interpret arrangements keeping in mind the 'actual business purpose' of the transactions.

Finally, it was claimed that if employees of PWC-Resources took part in the audits conducted by PWC-Audit a violation of the law on licensing took place since PWC- Audit could not transfer its clients to the Dutch entity which was not licensed in Russia.

This was not an easy battle. PWC lost its case in the Moscow Arbitrazhniy Court, the Court of Appeal and the Court of Cassation. Fortune smiled upon the company when in July 2007, less than two weeks after PWC withdrew its entire audit series for Yukos, the Supreme Arbitrazhniy Court set aside the decisions of the lower courts and sent the case to the court of the first instance for a new hearing. It seemed like a victory, but the lower courts did not follow the SAC's hint and ruled against the company once again. PWC had to climb up the whole system again to have the case considered by the Supreme Court for the second time.

The SAC ruled that the service completion acts signed by the parties is a proper accounting document and a prima facie evidence that the services were provided as agreed in the contract. The onus of proving that the services were not provided or were provided differently as stated in the service agreement is on the tax authorities.

In a similar manner the Supreme Court dealt with 'unjustified tax benefit'. The Court reinstated that the question whether expenses were unjustified from the 'business purpose' point of view is an issue of fact and it must be proved by the FTS. As far as a matter of license was concerned the judges decided that it was perfectly legal for the audit company to outsource some 'consulting' issues.

It is amazing how little new information about law appeared from this long, tedious saga.

The 'unjustified tax benefit' doctrine which succeeded the doctrine of the 'taxpayer acting in bad faith' came out of the battle as it was - a rather loose and widely defined concept. It seems that at the moment the concept can probably provide a good reason for saying in a particular case that the facts do not amount to 'unjustified tax benefit' or vice versa. It does not, however, provide a way of telling whether certain set of facts fall on one side of the line or the other, it is a conclusion not a test.

What follows though from the case is that auditors or consultants in general do not need, at least for the time being, to disclose details of the advice they give to clients in order to be able to justify that services they get from other consultants can be deducted from taxable income. Moreover, one can get an awkward feeling that this issue was the real matter of the dispute: how far the international accounting firm would be willing to go to avoid being dragged into a legal onslaught against Yukos.

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Comments

Great post! Thanks for the information
Useful info. Hope to see more good posts in the future.
Excellent blog post, I look forward to reading more.
Thats what interrogatories to get more information and thats what was needed in this case.
Nice article. Thanks.