The Supreme Court spoke out against discrimination against foreign shareholders

If a foreign shareholder of a company used its profits to increase the authorized capital, this operation is not subject to tax, the Supreme Court of the Russian Federation recognized. A Russian shareholder in a similar situation does not pay tax, and the position of a foreign investor should not be worse, the economic board decided. Lawyers note that the precedent is “rather aimed at encouraging investors from friendly states.” In this case we are talking about an Iranian bank.

The Supreme Court (SC) considered a dispute regarding the taxation of an operation to increase the authorized capital of a Russian organization at the expense of its profits by decision of a foreign shareholder. The decision was made as part of a dispute between the Russian JSC Mir Business Bank and the tax inspectorate, which, after an audit, assessed income tax on income paid to a foreign legal entity. The total amount of tax, penalties and fines amounted to 94.3 million rubles.

The reason for the claims was that in October 2020, the bank’s sole shareholder, the Iranian Bank Melli Iran, decided to send 1.45 billion rubles. retained earnings of a subsidiary to increase its authorized capital. According to tax authorities, the Iranian shareholder “received dividends and immediately used them” to increase the authorized capital of the organization, so the bank, as a tax agent, had to withhold and pay income tax on income to the budget.

The bank appealed this decision to the Federal Tax Service, but only achieved a reduction in the fine from 7.2 million to 3.6 million rubles. Arbitration courts of three instances recognized the tax claims as legitimate. The bank appealed to the Supreme Court, insisting that no cash payments were made to the foreign shareholder and that there was no source of taxation. The case was transferred to the economic board, which overturned the tax authorities’ decision.

According to Art. 309 of the Tax Code (TC), income of a foreign organization from sources in Russia that is taxed includes dividends paid to a foreign shareholder by a Russian organization, regardless of the form of their payment. At the same time, the Supreme Court noted, under Art. 251 of the Tax Code does not take into account income in the form of the value of additionally received shares or the difference between the par value of new and originally existing shares when increasing the authorized capital of a subsidiary, if in the end the share of participation does not change.

Accordingly, the Supreme Court decided, the Russian shareholder does not pay income tax if the profits of a subsidiary are used to increase its authorized capital. There is no similar rule in the Tax Code for foreign shareholders, the Economic Board admitted. At the same time Art. 24 of the 1998 Double Taxation Agreement (DTT) between the Russian Federation and Iran provides that nationals of one state will not be subject to “more burdensome” taxation in the other than local businesses. That is, a ban has been established on “discrimination based on the residence of the income recipient,” the Supreme Court explained. The norm applies to taxes on income and capital, which include income tax.

Moreover, the Supreme Court clarified, this does not mean providing preferences or “complete identity of taxation conditions for Russian and foreign persons,” but the differences “cannot be arbitrary, in the absence of economic and other reasonable reasons for differentiation.” According to the Supreme Court, there is no fundamental difference in the position of the Russian and foreign shareholders who decided to use retained earnings from previous years to increase the authorized capital in the absence of payments.

Since the Tax Code does not consider the benefit of a domestic shareholder from the increase in the value of the company’s capital as taxable income, then “there is no reason to subject a foreign shareholder who has retained the capitalization of the Russian organization to more burdensome taxation.” The position of the tax authorities “clearly does not correspond to the main objectives of the agreement” with Iran and “does not contribute to the promotion of investment,” the Supreme Court decided.

“In 2023, one of the most interesting categories of tax disputes were cases involving the consequences of increasing the authorized capital of a Russian organization at the expense of retained earnings of foreign participants,” notes Nikita Zharov, head of tax practice at Tax Compliance. According to him, the question of whether in such a case the foreign participant of the company has income “has always been debatable and was considered ambiguously by financial authorities and courts,” including in international practice.

Senior partner of Pepelyaev Group Rustem Akhmetshin clarifies that the economic board did not give a direct answer to this question. However, according to Taxology partner Alexey Artyukh, since the Supreme Court talks about “the economic benefit of a shareholder in the form of an increase in the value of a financial investment in capital,” it essentially “qualifies it as income.”

“The Supreme Court placed the main emphasis on the principle of non-discrimination enshrined in agreements on the avoidance of double taxation,” notes Mr. Zharov. There is such a clause in almost every DTT, Mr. Akhmetshin adds, its meaning is that “a foreign entity cannot be subject to more burdensome taxation than its own citizens and companies.” However, in practice, this principle “was almost never remembered before,” says Rustem Akhmetshin: “It is extremely important that the Supreme Court shows that such norms are not an empty phrase.”

Lawyers consider the decision of the board to be precedent-setting. “The position of the Supreme Court on specific tax disputes almost always influences practice,” explains Rustem Akhmetshin. Now, by increasing the authorized capital of a company in the Russian Federation at the expense of its retained earnings, foreign investors can avoid tax costs and transaction costs that would arise in the situation of the actual payment of dividends and their reinvestment, explains MEF Legal adviser Denis Khramkin. Nikita Zharov calls the decision “long-awaited for all taxpayers with foreign participation.”

Mr. Khramkin admits that the position of the Supreme Council “is dictated by the need to create incentives for friendly foreign investors to reinvest profits earned in the Russian Federation.” At the same time, Mr. Zharov clarifies, “it is unclear whether this decision will be applicable to the actions of shareholders from unfriendly countries with which DTTs have been suspended (by decree of the President of the Russian Federation of August 8, 2023— “Kommersant”” According to Alexey Artyukh, after this date, investors from unfriendly countries “should not count” on the application of this position of the Armed Forces.

Anna Zanina, Evgenia Kryuchkova