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‘Tax Reconstruction’ and Article 54.1 of Tax Code

Valentin Moiseev
Head of Taxes
Andrey Gorodissky & Partners (AGP)

‘Tax Reconstruction’ and Article 54.1 of Tax Code

Last Friday, the media reported that in mid December last year a letter from the Finance Ministry, signed by the First Deputy Prime Minister Anton Siluanov, was issued to the head of the Russian Federal Tax Service Mikhail Mishustin. Although the letter has not appeared in general public sources so far, the intimation of RBC saying they read the letter can be trusted.

According to them, the Russian Finance Ministry holds that tax authorities are not required to apply a so-called ‘tax reconstruction’ method, i.e. to compute the actual tax liability as if taxpayer did not evade tax liability.

Which means allegedly that, when charging tax arrears and penalties for tax evasion, it is not necessary to apply the reconstruction method, i.e. to compute the actual tax liability of a business with due regard for costs and expenses actually incurred and tax deductions for which the business would otherwise be eligible, etc. This is communicated in the letter of the Finance Minister Anton Siluanov to the head of the Federal Tax Service (FTS), Mikhail Mishustin, as reported by Forbes referring to RBC. What does it mean in practical terms?


Since August 2017, Article 54.1 of the Tax Code aimed against abusive exercise of taxpayer right has been in effect. The Article bans any reduction of tax liability if:

  • such reduction is due to distortion of information concerning business operations (i.e. source documents do not reflect the taxpayer’s actual operations);

  • the deal (transaction) was implemented by a person other than the taxpayer’s counterparty or a transferee of the counterparty’s obligations transferred by operation of law or under a contract (typically, such other person is a dummy counterparty having no resources for performance of the obligations toward the taxpayer);

  • the deal (transaction) is aimed at evading tax liability.

Almost immediately after adoption of the above-mentioned Article on October 31, 2017, FTS issued its Letter No. ЕД-4-9/22123@. The Letter explains that the Article does not provide for computation of the actual tax liability and that tax authorities, having discovered any of the above-mentioned factors, should fully deny the taxpayer any deduction of costs and expenses related to the deal concerned.

This Letter essentially appears to be a policy document of FTS issued as guidelines for inferior tax bodies to follow. As a result, local tax offices are denying taxpayers’ eligibility for VAT and profit tax deductions where a tax audit has showed that purchased goods, work or services come not from the taxpayer’s counterparty, but from third parties. And it does not matter for tax inspectors that relevant purchase costs were factually incurred, goods actually delivered and, consequently, no evasion of tax profit could be in place. Courts tend to support such approach of tax offices and cases where they do not follow it are very rare (Kuzbasskonservmoloko case, А27-17275/2019). It ends up that VAT and profit tax are assessed not on added value and profit per se, but on sales volume, which contradicts the economic rationale of taxation. Thus, additional tax charges in the context of interpretation of Article 54.1 of Tax Code by the Finance Ministry and FTS go beyond amounts already charged from taxpayers as set by law and constitute a punitive mechanism over and in addition to penalties set by the Tax Code.

How it was before

Before adoption of Article 54.1 of Tax Code, the anti-‘tax optimization’ fight was conducted by relying on the “unjustified tax benefit” concept formed by the Supreme Abitrazh Court in its Plenum’s Ruling of October 12, 2006, No. 53. In its Ruling, the Supreme Arbitrazh Court notes i.a. that it is exactly the unjustified tax benefit which should be denied to the taxpayer, i.e. the taxpayer should be charged with taxes which the taxpayer would have paid it had not involved the optimization schemes. With regard to deliveries from dummy counterparties, this means that, if goods were actually delivered the market value thereof should reduce the tax base because the taxpayer would have paid the price of the goods even if it had purchased them from a good faith supplier.

New Testament

However, if a tax audit of the taxpayer has been commenced after enactment of Article 54.1 of the Tax Code, the ‘old’ approach of the Supreme Arbitrazh Court is not going to be applied – tax officers and courts will be relying on the new article of the Tax Code, namely, the most severe interpretation thereof. Even the lack of evidence of collusion between the taxpayer and its counterparty will hardly make the taxpayer secure against applying that article, as the taxpayer’s scheme involvement intent is not a condition to denial of tax deductions. So, the risks for businesses have grown significantly because due to an erroneous (possibly, unwanted) choice of its counterparty the tax payer may be required to pay both VAT and profit tax on the delivery amount and a penalty equal to 40% of tax arrears.

That said, one should treat very seriously the choice of counterparties, both suppliers and purchasers, and to keep in mind the emerging trend, according to which proceeds received by resellers from sale of the taxpayer’s goods are included in the taxpayer’s base (e.g., case of NPF Tekhnokhim (А40-32793/2017).

How to accommodate to modern times

If claims are still made, it is worthwhile to consistently press the point that ‘tax reconstruction’ should be applied. Notwithstanding the position of the Finance Ministry and a number of courts, the Supreme Court has not so far expressed itself against the ‘tax reconstruction’ concept. Furthermore, the Constitutional Court too may heed the arguments for economic unreasonableness of the newly suggested taxation approach.