Agency Agreements and Tax Risks in Russia
This article was first published in Russian on 9 November, 2017 in the journal «Бухгалтерский учет» under the title “НАЛОГОВЫЕ РИСКИ РАБОТЫ С АГЕНТАМИ И ИНЫМИ ПОСРЕДНИКАМИ.”
Most companies in Russia work with agents in some manner. There are significant and real tax risks that these companies should take into consideration.
Agency Agreements and Russian Legislation
In the context of the legal and regulatory framework, agency relations are quite well defined. However, ambiguities and multiple interpretations of certain norms do still exist. The main types of agency agreements today are:
- Commission agreements
- Agency agreements
- Mandate agreements
Chapter 51 of the Civil Code of the Russian Federation is devoted to commission agreements, which is defined as a contract under which one party (the commission agent) undertakes, on behalf of the other party (principal), to make one or several transactions on its behalf, but at the expense of the principal. Paragraph 2, Clause 1, Article 990 of the Civil Code introduces a clarification, which states that under a transaction made by a commission agent with a third party, the commission agent acquires the rights and the becomes obligated, even if the principal was named in the transaction or entered into a direct relationship with the third party for its execution.
In a mandate agreement, the parties are the attorney and the principal. The attorney undertakes to perform certain legal actions on behalf of and at the expense of the other party (principal), while the rights and obligations under the transaction concluded by the attorney accrue directly to the principal (Clause 1, Article 971 of the Civil Code).
By agency agreement we mean an agreement that meets the criteria listed in Article 1005 Civil Code of the Russian Federation:
— in relations arising in connection with the signing of such an agreement, two parties are always involved – the agent and the principal. At the same time, the agent, in performing the obligations assumed under this agreement, interacts with third parties;
— an agent can act either on his own behalf and at the expense of the principal, or on behalf of and at the expense of the principal.
The same article of the Civil Code of the Russian Federation introduces an important clarification – under a transaction made by an agent with a third party on its own behalf and at the expense of the principal, the agent acquires the rights and becomes obligated, even in cases where the principal has entered into a direct relationship with the third party to execute the transaction or was named in the contract. At the same time, under a transaction made by an agent with a third party on behalf of and at the expense of the principal, the rights and obligations accrue directly to the principal.
One of the essential conditions of agent contracts is to establish the remuneration for the performance of the duties prescribed in the contract. In cases where the remuneration amount is not fixed in the contract, it must be paid in the amount equivalent to that which would have been in comparable circumstances when performing similar obligations. This is spelled out in Article 1006.
It is worth noting that the practice of concluding agency agreements was borrowed from the Anglo-American legal system, where, in general, they are concluded for the agents to carry out one-off actions. The Civil Code of the Russian Federation allows for agency agreements that do not specify a period for which they are concluded (Clause 2, Article 971; Clause 2, Article 990; Clause 3, Article 1005). This circumstance only makes such agreements more useful and more widely used.
The advantages of concluding agency agreements seem obvious. They are, by definition, instruments that expand the potential of companies by attracting the services of agency. Also, intermediary agreements can be concluded with the purpose of essentially outsourcing certain non-core functions (for example, transportation and delivery) so that the company itself can concentrate all available resources on its core business.
Risks in Concluding Agency Agreements
As noted above, the current legislation clearly spells out the legal basis for agency agreements. However, practice shows that the conclusion of such contracts – in cases where their provisions do not provide for some very important points – can lead to serious tax consequences.
For those responsible for contracting or accounting within a firm, there are several main “control points,” to watch for.
First, agency agreements should not include provisions that are contrary to the nature of agency relationships.
In this regard, in Clause 1 of the Information Letter of the Presidium of the Supreme Arbitration Court, it was noted that “conditions for payment of the transferred goods no later than a certain period, or, terms of the agreement that speak to the performance of the contract at the expense of the commission agent, and other similar provisions may indicate that the agreement contradicts the nature of agency transactions.”
Thus, tax risks arise primarily from the agent-supplier. If an agency agreement is re-qualified as a purchase agreement, for instance, the authorities can claim that the company has understated its income tax base and value-added tax for the tax period based on the untimely reflection of revenue amounts.
As an example of related judicial practice we can cite the FAS Resolution of the North-Western District dated 03.07.2014 #F07-4526 / 2014 in case #A21-7267 / 2013. In this case, the enterprise had included only the cost of selling thermal energy services in its VAT base. The tax authorities argued that the entire cost of the energy supplied to consumers should have been used. The authorities cited the agency agreement which provided for the supply of energy through the affiliated network. The court ruled in favor of the authorities in the dispute, declaring the additional VAT charged to the company wsa legitimate. The court requalified the agency agreement as a contract to purchase and resell thermal energy.
Another tax risk arises from reporting submitted in an untimely manner. In this case, the customer could be assessed VAT and profit tax caused by untimely reflection of revenue.
Of course, this is due to the fact that, when agency agreements are signed, the customer reports revenue based on reporting received from the agent. This is spelled out in Article 999 and Article 1008 of the Civil Code. In addition, Article 316 of the Tax Code states that when sales occur through a commission agent, then the taxpayer (principal) determines the amount of revenue from sales on the date of sale on the basis of notification of the commission agent on the sale of property belonging to the principal. Within three days of the end of the reporting period in which the sale took place, the commission agent is obligated to notify the principal of date of sale of property belonging to him. Thus, it is best to clearly spell out the time of transfer of the report to the customer in the agreement, taking into account the standards of the Tax Code of the Russian Federation.
Yet another risk stems from the obvious economic advantages of agency agreements. Often, based on these alone, the tax authorities will declare that they are primarily instruments for tax evasion. Of course, their distrust of the agreements comes from fact that is a common and illegal practice for such agreements to only fictitiously separate the functions of the principal and the agency in order to create increased tax benefits.
The authorities often point to unjustified deductions to the income tax base that arise from the agent’s use of a special tax regime. They may point to signs that the agent is, in fact, a “one-day firm,” formed for the sole purpose of creating tax benefits. The Tax Service has published an order specifically saying that contractual relations with “one-day firms” represents a high tax risk as they may be considered doubtful, and inevitably lead to additional charges. In this regard, the taxpayer is required to exercise due diligence in choosing a counterparty so that the transactions concluded do not raise doubts about their business purpose.
Judicial practice on this issue has not always favored the taxpayer. Take, for example, Resolution #10AP-1533/2017 of the Tenth Arbitration Court of 27 March 2017, case No. A41-69826 / 16. This resolution ruled in favor of the authority’s demands that the taxpayer pay additional profit tax on the amount of expenses incorrectly declared related to paying remuneration to an agent. The agent had been contracted to assist in locating a real estate byuer. During the related tax inspection, the authorities determined that the contracted agent that did not actually provide agency services to the taxpayer nor did it conduct financial or economic activities. Further, the money received from the taxpayer was transferred to the accounts of firms that also did not conduct financial and economic activities, that did not have personnel, that did not pay remuneration to individuals, and that did not have any assets for doing business. The appellate court case showed that the representative of the taxpayer had not performed due diligence on the agent prior to signing the related agreement.
The Federal Tax Service of Russia has specifically characterized as high tax risk those transaction models that use such fictitious “chains of counteragents,” or generally involve large numbers of agents. In several official Letters, the tax authorities describe in sufficient detail how such schemes work: the principal contacts the agent nominally to perform certain tasks, such as to search for clients. Fees are paid when contracts are signed with customers found by the agent. However, the actual search, negotiations, and preparation of contracts are carried out by representatives of the principal. Thus, the agent only serves to create a workflow documenting fictitious costs in the form of agency fees and, thus, to create unreasonable tax benefits.
The tax authorities commonly look for such instances. Another typical example can be seen in the Resolution of the Ninth Arbitration Appeal Court of 29.01.2016 No. 09AP-56855/2015 in case #A40-12720 / 15 (upheld by Resolution of the Arbitration Court of the Moscow District #Ф05-7955 / 2016 of 17.06.2016).
The case involves a taxpayer who, after an on-site audit, was billed for additional profit tax and VAT related to fees paid under agency agreements which required the agent to sell equipment to third parties for a fixed fee. The taxpayer argued that the agreements were economic in nature and the agent conducted its financial and economic activities independently of the principal.
The court, however, ruled in favor of the tax authorities, who argued that agent’s activities in the audited period were of a technical nature – limited to processing documents on behalf of the taxpayer’s group of companies. Further, they argued, the concerted actions of these companies resulted in an unreasonable tax benefit for the taxpayer in the form of overstated expenses declared in profit tax calculations and the application of unearned VAT deductions.
In addition to the above, when concluding agency contracts, the subject of which are goods (works, services) that are not subject to VAT, the agent ( commission agent) should remember the obligation to calculate VAT on the cost of the agency services. This obligation is directly set out in Clause 7, Article 149 of the Tax Code, and has been repeatedly stated by the Finance Ministry officials (see, for example, Letter No. 03-07-11 / 74 of the Ministry of Finance of the Russian Federation of March 23, 2010).
- The Civil Code of the Russian Federation (Part Two) of 26.01.1996 No. 14-FZ.
- The Tax Code of the Russian Federation (Part Two) of 05.08.2000 No. 117-FZ.
- Semenikhin V.V. Angency Services. 2nd ed., Revised and expanded. Moscow: GrossMedia, ROSBUH, 2016. 873 p. // ATP ConsultantPlus (access mode on 05/29/2017).
- Information Letter of the Presidium of the Supreme Arbitration Court of the Russian Federation of November 17, 2004, No. 85 “Review of the Practice of Resolving Disputes under a Commission Agreement”
- Letter of the Federal Tax Service of Russia from December 28, 2012 No. AS-4-2 / 22619 @ “On the Methods of Financial and Economic Activities with High Tax Risk.”
- Order of the Federal Tax Service of Russia from May 30, 2007 #MM-3-06 / 333 @ “On the Approval of the Concept of a System of Planning On-site Tax Inspections.”
- Shmelev R.V. Agent Agreements in Civil Law of the Russian Federation // SPS ConsultantPlus (access mode 29.05.2017).
We are also ready to provide you with the following services:
- Conducting an audit in several stages.
- Review of the financial statements.
- Carrying out agreed upon procedures.
- Tax audit.
More about services on site: AUDIT SERVICES.
We will be glad to start working with your company.
Head of Audit and Taxation Department
Office : +7 495 988-21-91
Office : +7 495 988-21-91