Federal Tax Service explanations of control over expenses for intragroup services
Russian organizations with foreign participation often incur expenses for intragroup services, i.e. services provided by related foreign companies. Most Russian enterprises that are part of international groups of companies incur expenses for so-called management fees.
Such expenses, as a rule, come under the scrutiny of tax authorities as confirmed by the Federal Tax Service Letter dated August 06, 2020 about certain issues of taxation of intragroup services.
This letter examines in sufficient detail the approaches to tax audits of expenses for intragroup services both for confirming that services were in fact provided and for assessing their commercial value for a specific Russian company.
These approaches may be used by Russian companies buying intragroup services as recommendations for documentary confirmation of expenses, as well as for distinguishing between the costs of intragroup services intended for developing and increasing their profitability and the costs of so-called “shareholder activities” intended to serve the interests of shareholders (or other group companies). The costs of shareholder activities cannot be recognized as providing services benefiting the Russian company that has incurred them, so they are not economically justified expenses and cannot thereby be deducted for profit tax purposes.
Intragroup services and shareholder activities
The Federal Tax Service Letter dated August 06, 2020, which given its content, may be referred to as the recommendations provided by the Federal Tax Service for intragroup services, provides a fairly broad list of “ordinary” intragroup services and examples of shareholder activities.
Types of intragroup services
The following services may be recognized as intragroup services:
- Regular administrative support;
- Financial services, legal advice, HR, internal control, internal audit;
- Services related to production development and sales (e.g. advertising and marketing services, services for improving company performance);
- IT services (e.g. software development and deployment, software support, maintenance of software and communication channels, data storage and processing, advice on maintenance of information systems and data centers);
- And other services.
Not recognized as services:
- Receipt of information about the activities of a company part of an international group of companies;
- Participation in profit distribution;
- Participation in general meeting of shareholders, exercise of the right to receive dividends;
- Ensuring that other companies of the group comply with the laws of other countries (including audit and preparation of consolidated statements);
- Purchase of shares (including expenses related to the parent company’s relationship with investors);
- Ensuring that other companies of the group (including direct participant in a Russian organization) comply with the requirements of a foreign stock exchange;
- Any support activities to ensure corporate governance for the international group of companies.
Expenses recognized under certain conditions:
- Provision of global policies, strategies, and standards
Our consultants look forward to reviewing your company’s intragroup services and assisting in classifying them into (i) economically justified expenses, (ii) costs of acquiring experience and competencies that may be recognized as being beyond the needs of a Russian company, and (iii) shareholder activities.
Documentation to support services actually rendered
The recommendations provided by the Federal Tax Service for intragroup services provide an approximate list of documents and evidence which, according to the Federal Tax Service, may clarify the type, volume and content of services, and accordingly, confirm that they have in fact been provided and their commercial value for the Russian company that has bought them. These documents should therefore be available in addition to statements of services rendered, especially if these statements are drawn up on standard templates with very few details.
Our consultants look forward to reviewing how intragroup services are invoiced in your group of companies as well as assisting in preparing documents confirming the provision of services, the need to involve foreign companies of the group in operations and processes and the economic outcome achieved as a result whilst taking into account the recommendations provided by the Federal Tax Service and based on the actual list of intragroup services and the procedure for their invoicing in the group.
We can give recommendations on the inclusion of special conditions in contracts for intragroup services to avoid requests for each type and case of service provision.
Expenses are recognized as economically justified if “an organization is willing to pay an independent entity for similar services provided on comparable terms or is willing to carry out this activity on its own.” This approach is consistent with the reasoning provided by the Organization for Economic Cooperation and Development (OECD).
In other words, any service provided to a Russian company must have an economic or commercial value.
Tax authorities will assess “whether expenses are incurred to derive gains”, but a negative financial result from the use of the service received may not be the only reason for recognizing expenses as economically unjustified, and when “deliverables are not used due to objective circumstances”, this does not indicate that the expenses incurred for these deliverables are not justified. To determine whether expenses are justified or not, the Federal Tax Service will also consider how often similar services are purchased by other companies operating in the same industry as well as “other publicly available information.”
The costs of experience and competencies required for the group to comply with reporting standards or the laws of other countries are not recognized as economically justified expenses for a Russian company.
Service fee pricing
International groups of companies often use the following procedure for setting the price of intragroup services: a markup (margin) usually applied in the specific field of activity is added to the actual costs of the foreign company that has provided services. In their recommendations, tax authorities specify that applying such pricing model should not be considered a redistribution of income and losses among the companies of the group or as the only necessary ground to recognize the relevant costs as unjustified.
This is definitely positive although tax authorities also point out that it is necessary to have a formalized transparent methodology for determining the cost of intragroup services. And the uniform application of this methodology throughout the group of companies must also be confirmed.
Our consultants look forward to assisting in formalizing for your group of companies a methodology for calculating fees for intragroup services or in adapting the relevant part of the group’s transfer pricing documentation.
Verification of cost duplication
In the recommendations provided by the Federal Tax Service, particular attention is paid to the so-called “duplication” of services. A payment for identical services made to several suppliers is deemed to be a duplication of services. When assessing whether expenses are duplicated, tax authorities do not limit themselves to establishing that department names are the same or that employees fill positions with similar names, but they consider the functionality, experience, and competencies received by the Russian company as a result of the provision of intragroup services.
Our consultants can assist in identifying the signs of service duplication by reviewing your company’s organizational structure, internal regulations, and job descriptions.
If you have any questions about:
- The preparation of notices of participation in international group of companies;
- Transfer pricing;
- How to document expenses for intragroup services;
please feel free to contact us. We are always happy to help.