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Having a business purpose in a restructuring is not always a panacea

Having a business purpose in a restructuring is not...

On 22 November 2019, the Moscow Court of Arbitration (hereinafter, the Court) passed a decision in the case of X5 Retail Group (hereinafter, the Group), in which the tax authorities challenged a series of transactions the Group’s companies had performed in 2013 in the process of corporate restructuring.


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On 22 November 2019, the Moscow Court of Arbitration (hereinafter, the Court) passed a decision1 in the case of X5 Retail Group (hereinafter, the Group), in which the tax authorities challenged a series of transactions the Group’s companies had performed in 2013 in the process of corporate restructuring.

The court of first instance agreed with the tax authorities that the principal purpose of the Group’s corporate restructuring was to create a “synthetic debt obligation” in the Russian Federation, enabling the Group to understate its tax base in the Russian Federation, redistribute the profit of the Russian business in favour of its foreign entities, and avoid paying taxes in the Russian Federation.

As a result, the deduction of intragroup loan interest expenses of the Russian company of the Group was successfully contested, and all payments made to the Group’s foreign companies in relation to the completed restructuring were reclassified into dividends and subjected to withholding tax in the Russian Federation at the standard rate of 15%.

The total amount of additional tax charged exceeded RUB 1 billion.


In 2013, the Group companies performed a series of intra-group transactions to transfer ownership of the Russian operating companies from foreign holding companies to a Russian holding company (hereinafter, TD).

Ownership was transferred as follows:

–       TD purchased 6.60% of the shares in the Russian holding company (hereinafter, AA) from the Dutch company of the Group (hereinafter, NeCo) for RUB 5 billion. Payment was made in cash;

–       TD purchased 83.4% of the shares in АА from the Cypriot company of the Group (hereinafter, CyCo) for RUB 82 billion. Repayment was partially in cash and partially by offsetting liabilities, while the liability of RUB 66 billion was converted into an interest-bearing loan (hereinafter, the Chose in Action).

Later, as a result of a series of successive intra-group transactions, the Chose in Action was assigned to another Cypriot company of the Group (hereinafter, FinCo), whereupon a “mirror” (interest-bearing) debt obligation was accrued to FinCo in relation to the Luxembourgish company of the Group (hereinafter, LuxCo). 

The Group structure before and after the restructuring is represented diagrammatically in summary below.

Having a business purpose in a restructuring is not always...

During audit of the consolidated taxpaying group (hereinafter, the CTG), the tax authorities concluded that, as a result of the restructuring, the Group had created a mechanism enabling the Group to reduce its tax liabilities in the Russian Federation and to redistribute the profits of the Russian business in favour of the foreign entities without paying any taxes in the Russian Federation or in foreign jurisdictions. Ultimately, based on the concept of “unjustified tax benefit”, the tax authorities challenged the deduction by TD of its interest expenses on the FinCo loan and reclassified all interest payments and the consideration for the shares in AA as a “hidden profit / dividend distribution”, allowing for withholding tax in the Russian Federation to be assessed at the standard rate of 15%, because the foreign companies were not recognised as the beneficial owners of this income.

The Group did not agree with the position of the tax authorities and took legal action. However, the court of first instance supported the position of the tax authorities, inter alia, based on the following arguments:

–       the completed corporate restructuring has not affected the nature of AA’s management or operations, as before and after the restructuring: (i) АА was under 100% control of the Group’s parent company (incorporated in the Netherlands); and (ii) the operations of АА were controlled and coordinated by TD staff;

–       one month before АА was sold to TD, the foreign shareholders (CyCo and NeCo) “artificially” increased the value of the net assets of АА by increasing its share capital by RUB 10 billion and contributing property worth RUB 300 million. CyCo and NeCo performed these transactions using solely the money borrowed from TD;

–       CyCo and LuxCo are not the beneficial owners of the income paid by TD: their only assets are receivables from TD; taxes are not paid / minimum tax is paid on the interest income in the jurisdiction of tax residence; there are insignificant administrative expenses; and the parent company of the consortium (in Gibraltar) exercises complete control of their operations;

–       all restructuring-related transactions were performed successively within a short period of time (in most cases, "day into date") and were actually controlled by one person acting as the sole executive body of the parent company of the consortium (in Gibraltar) which includes the Group. No successive transaction would have been possible without the previous one, which is why all the transactions performed as part of the restructuring actually constitute one transaction whose main purpose was to obtain an unjustified tax benefit.

In preparing its defence, the Group tried to argue that the business purposes of the completed restructuring were so that the restructuring would raise the Group’s market capitalisation, consolidate the ownership structure over the assets, increase transparency, and improve the Group’s credit rating, as well as restructure in order to create the CTG, etc.

In considering the Group’s arguments above, the Court did not rule out the fact that the restructuring could have been aimed at achieving a specific business purpose. However, this purpose could have been achieved if the Group had contributed shares in АА to the capital of TD, which would not have caused the accrual of the debt liability at the level of TD. Nevertheless, according to the Court, the Group chose the restructuring option which enabled it to create a "synthetic" debt obligation and obtain an "unjustified tax benefit" by understating tax liabilities in the Russian Federation and redistributing profits in favour of foreign entities without tax consequences in the Russian Federation and foreign jurisdictions.

Why is it important?

The considered court case demonstrates once again that, currently, the Russian tax authorities are paying close attention to cross-border transactions and restructuring. We would therefore address the following issues:

–       during tax audits, the tax authorities consider the transactions of group companies in conjunction with each other, analysing whether they are interrelated, carrying out predetermination or artificiality tests, and assessing the overall tax effect for the group;

–       the existence per se of a specific business purpose in a transaction / restructuring does not guarantee that the preferred tax treatment will be applied. If the tax authorities decide that the transaction / restructuring is performed in a way prejudicing the fiscal interests of the Russian Federation, and that the taxpayer obtains an unjustified tax benefit (Art. 54.1 of the TC RF), the tax treatment applied in relation to this transaction / restructuring in the Russian Federation may be challenged;

–       the tax authorities of the Russian Federation are ready, starting from next year, to apply the individual provisions of the Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting (hereinafter, the Multilateral Instrument or MLI), which contains the principal purpose test. In accordance with this test, DTT benefits must not be applied to income if the principal purpose of a transaction/chain of transactions is to obtain these benefits2.

With regard to the premises above, we recommend that you read into the case of this Group and take into account the arguments of the tax authorities and the court detailed therein when planning your own cross-border transactions / restructuring. 

How KPMG can help

Our KPMG professionals will be delighted to provide you with comprehensive support in:

–       tax / MLI diagnostics of the performed or planned corporate restructuring / cross-border transactions to identify tax risks, inter alia, based on such factors as “the existence of a business purpose for the transaction”, or “is an unjustified tax benefit obtained by the taxpayer”;

–       developing recommendations to avoid any identified tax risks, including assisting in elaborating arguments (a “defence file”) proving the existence of a business purpose in the restructuring / transaction;

–       disputes with the tax authorities in trial and pre-trial stages.

Should you have any questions, please do not hesitate to contact us.

The Decision of the Moscow Court of Arbitration of 22 November 2019 in Case No. А40-118135/19-75-1540

2The MLI has been effective in Russia since 1 October 2019, and its provisions relating to withholding tax will be applied as of 1 January 2020.


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