In 2014 Russia adopted new legislation as part of the government's relatively new plan to combat tax evasion through financial transfers out of Russia to low-tax jurisdictions (deoffshorisation). In line with this intent, the Russian tax authorities focused their attention on cross-border transactions, including those involving IP assets, because Russian companies often hide a substantial part of their profits from Russian taxation through royalty payments made to intellectual asset management centres outside Russia.
This increased attention to cross-border intellectual asset management has been exemplified by the tax authorities' actions against Oriflame Cosmetics LLC, the Russian division of international cosmetic concern Oriflame.
According to the Commercial Court Case А40-138879/2014, during a tax inspection the tax authorities found that Oriflame Cosmetics LLC had incurred considerable expenses through the payment of royalties to its related Dutch company Oriflame Kosmetiek BV under a sub-franchising agreement. Oriflame Kosmetiek BV transferred a major part of the royalties, received from Russia, to the rights holder, Oriflame Cosmetics SA (Luxembourg), serving as the Oriflame intellectual asset management centre located in a low-tax jurisdiction.
Based on the inspection results, the Russian tax authorities determined that Oriflame Cosmetics LLC is in fact a “permanent establishment" (under Article 306(2) of the Tax Code) of Oriflame Cosmetics SA (Luxembourg) in Russia, and therefore the conclusion of franchise agreements and payment of corresponding royalties were aimed at tax evasion in Russia.
The first-instance commercial court and the appellate instance commercial court found that the tax authorities' finding that the international royalty payments made by the Russian legal entity were illegal was reasonable on the following grounds:
- The end user understood that the Russian legal entity was a “permanent establishment” of well-known international cosmetics concern Oriflame.
- The Russian legal entity, being a company with 100% foreign capital, could not run a business in Russia independently.
- The Russian legal entity paid a huge amount of royalties abroad despite its chronic unprofitability.
Thus, when doing business in Russia international holding companies may face specific tax risks when managing cross-border IP assets. Financial transfers out of Russia, including royalty payments to low-tax jurisdictions, will be considered by the tax authorities in light of both the economic justifiability of expenses and the estimated status of the transferring Russian entity.
In order to minimise these tax risks, international holdings may wish to consider restructuring the Russian part of their business, as certain categories of payment to related foreign companies (eg, royalty payments) may be considered attempts to evade tax.
For further information please contact:
Gorodissky & Partners
Tel: +7 495 937 6116
This is a co-published article whose content has not been commissioned or written by the IAM editorial team, but which has been proofed and edited to run in accordance with the IAM style guide.