Baker & McKenzie: Russia to adopt new transfer pricing rules

The Russian government has been working on new transfer pricing rules for several years, but now businesses can realistically expect that rules, with heavy documentation requirements for taxpayers, will be adopted this year.

On February 19, 2010, the Russian State Duma, the lower chamber of the parliament, adopted the draft law in its first reading. It is expected that the legislative process (adoption of the law in second and third (final) readings by the State Duma, approval by the upper chamber, and signing by the President) will be finalized by July 2010 with the new transfer pricing rules coming into effect starting from January 1, 2011.

The draft law completely revises the existing transfer pricing provisions of the Russian Tax Code, which are considered undeveloped and inefficient due to poor implementation. According to the draft law, the rules will be more technically detailed, sound and more in line with the OECD Transfer Pricing Guidelines. The key provisions and changes of the draft law are as follows.


Related Parties

The draft law significantly expands the list of criteria under which parties can be deemed related for tax purposes. The courts retain the right to treat parties as related under other criteria if such relationships affected the results of transactions between the parties or their economic activities.


Controlled Transactions

By way of a background, under the existing rules the Russian tax authorities can exercise control over the following types of transactions for transfer pricing purposes: (i) transactions between related parties; (ii) barter transactions; (iii) cross-border transactions, and (iv) transactions with price fluctuations over 20% for identical goods or services within a short period of time.

The draft law reduces the list of controlled transactions and now focuses on cross-border transactions, transactions with related parties, certain types of commodities (such as oil and oil products, metals and precious stones), and with foreign entities registered in certain low-tax jurisdictions. Certain domestic related-party transactions, including transactions exceeding 1 bln rubles (approximately 33 mln U.S. Dollars) per calendar year, are also subject to transfer pricing review. Russian taxpayers forming a consolidated taxpayer group under the draft law on tax consolidation would not be subject to transfer pricing control. The draft law on tax consolidation for profits tax purposes has not yet been submitted to the State Duma, but is expected to be adopted before the end of 2010.


Functional Analysis

According to the draft law, a functional analysis must be performed as a part of the transfer pricing analysis (functions performed, commercial risks assumed and assets used by the parties to a controlled transaction must be considered).


Sources of Data

The proposed list of sources of data is fairly detailed and includes exchange quotes, statistical data of the Russian customs authorities, information of the state authorities, financial reporting, publicly available data bases, as well as other sources of information not specifically mentioned. However, the law does not set forth how these sources should be prioritized.


Transfer Pricing Methods

The proposed rules enhance the existing transaction-based transfer pricing methods (comparable uncontrolled price, resale price, and cost plus), with additional three methods: (i) the processed product price method, (ii) transactional net margin, and (iii) profit split. The comparable uncontrolled price method is the primary method to be applied provided at least four comparables are available. The profit split method may be applied only in the last resort. In all other cases, the best method rule applies.


Market Price Range

The existing 20% safe harbor for price deviations will be abolished. Instead, the draft law provides for a market price range determined on the basis of the inter-quartile range of prices used in at least four comparable transactions between unrelated parties.


Corresponding Adjustments

Unlike the existing rules, the new rules are intended to avoid double taxation of parties to a domestic transaction through corresponding adjustments. However, the draft law does not provide for such a mechanism in a cross-border context.


Documentation Requirement and Penalties

Taxpayers with a value of controlled transactions exceeding 10 mln rubles (approximately 335,000 U.S. dollars) per calendar year will be subject to extensive documentation requirements. They may be subject to a 40% penalty if they do not submit, or submit incomplete, inaccurate or untimely, transfer pricing documentation and transfer pricing adjustments are made.


Advanced Pricing Agreements

Taxpayers may be entitled to conclude unilateral and multilateral advanced pricing agreements. However, this possibility would only be made available staring from 2012 and only to companies registered as the “largest taxpayers.”

Overall, there seems to be a strong political will to have the Russian tax authorities apply the new rules. It remains to be seen whether Russia will be prepared to properly implement the new rules and whether tax officials will gain the necessary knowledge and experience in making transfer pricing adjustments under the rules, which are supposed to follow the OECD standards. In any event, most large and mid-size taxpayers in Russia should start working on compliance with the Russian documentation requirements and adjusting their transfer pricing policies in light of the upcoming changes.


For questions regarding this article please contact Arseny Seidov, partner, or Roman Bilyk, senior associate.