Jus Aureum Wins Thin Capitalization Case in the Russian Supreme Court

A resounding legal dispute heard upon a lawsuit filed by Novaya Tabachnaya Kompaniya Limited Liability Company against the Federal Tax Service's Inter-District Inspectorate No. 3 for major taxpayers (Case No. А40-87775/2014) has resulted in the Supreme Court of the Russian Federation giving a negative answer to the question of whether the interest paid on controlled debt is convertible into dividends where a Russian company is the lender. 

The legal battle marked the first time the nation's supreme judicial authority invoked the rules laid down in Article 269 of the Tax Code following a memorable case involving the Severny Kuzbass coal-mining company and capped by Resolution No. 8654/11 of the Presidium of the Supreme Arbitrazh Court, dated November 15, 2011, which had served as the touchstone for the accumulation of adverse court practice in disputes over the so-called thin capitalization.

The rules limit the subtraction of interest accruals during the assessment of profit tax on loans drawn by Russian taxpayers from their foreign shareholders or from their Russian affiliates and define the obligation of Russian borrowers to withhold profit tax during the disbursement of such interest as dividends. 

The vast majority of arbitrazh courts so far have sided with tax authorities, ruling that the application of Article 269.4 of the Tax Code (which equates interest to dividends) should not be excluded even where the interest is paid to a Russian lender affiliated with the borrower's foreign shareholder. 

Now, however, the Russian Supreme Court concluded in Case No. А40-87775/2015 that as interest is paid to a Russian recipient, the Russian borrower should not be expected to pay dividends as a tax agent (Article 269.4 of the Tax Code). The interest in such cases is not to be treated as dividends. 

The resulting resolution is likely to prompt courts to take a less formal approach to intra-group funding for Russian companies by emphasizing the fiscal nature of the thin capitalization rules and the inadmissibility of their broad interpretation. 

The ground-breaking hearing in the case took place on March 16, 2016 under the chairmanship of Justice T.V. Zavyalova of the Supreme Court's panel for economic disputes, with the other Justices involved including M.V. Pronina as the rapporteur and N.V. Pavlova. 

Novaya Tabachnaya Kompaniya LLC was represented in court by senior associate Nikita Shcherbakov and attorney at law Aleksandra Ambrasovskaya who had worked on the case under the direction of partner Tatiana Vladimirova.

RBC published an article on this case, please click HERE to view it.