Russia’s federal tax service issued guidance for lower tax authorities to follow in examining the reasonableness of expenses claimed for intra-group services.
Until now, the tax authorities did not have a unified approach with regard to verifying expenses claimed for intra-group services. The guidance (Letter No. SHU-4-13/12599 (6 August 2020)) instructs lower tax authorities on how to verify expenses claimed in relation to intra-group services and specifically in terms of the economic justification and the sufficiency of supporting documentation with regard to the intra-group services. In particular, the guidance directs the lower tax authorities to verify the following five items, in this order:
The tax authorities often challenged expenses on intra-group services provided by foreign (non-Russian) group companies, since the tax authorities consider such payments to be a mechanism to repatriate profits in favour of the headquarters of MNEs. The tax authorities had not had a unified approach for verifying intra-group services, in particular as regards the following:
The results concerning cross-border intra-company service charges have historically not been favorable for taxpayers. Thus, the guidance and clarifications were highly anticipated.
Taxpayers are to be allowed to submit transfer pricing documentation (or certain components of such documentation) to satisfy the inquiry. In addition, this information may be obtained from the Master file of the MNE group. In connection with this, taxpayers need to verify not only the existence of a transparent methodology used to form the cost of services but also the consistency of its description in both the Master file and the transfer pricing documentation (Local file).
Given that the audit guidance highlights the importance of functional analysis when confirming the commercial value of a service and also in light of the criterion as to whether the entity would be prepared to pay an unrelated, independent third party for similar services on comparable terms or would engage in this activity using its own resources, one option for the taxpayer’s supporting documentation may be to supplement the transfer pricing documentation with a description of the commercial and economic benefits derived from the receipt of the services—that is, a “benefits test.”
The audit guidance puts forward that applying the procedure for determining the price based on the total costs of the service provider's expenses plus mark-up is a standard business practice and may not be considered, per se, as the reallocation of income and loss among MNE companies or to serve as the sole independent grounds for declaring corresponding expenses to be unjustified. However, the federal tax service has not directly commented on the indirect-charge method that is applied extensively in practice when the aggregate amount of the service provider’s costs incurred in the delivery of the services to all recipients is determined and when the cost of services to a particular recipient is determined based on this aggregate pool of expenses and allocation keys. In addition (and unlike the OECD Transfer Pricing Guidelines), the federal tax service has not specified what is an acceptable level of such a surcharge (or mark-up).
The audit guideline recommendations provided to lower tax authorities may give taxpayers hope that the methods for verifying cross-border intra-group services charges and the approaches to challenge them will become less formal and more justified. However, it already appears to be clear that tax audits will be detailed and the process for justifying expenses will not be easy for taxpayers. To prepare, taxpayers may want to analyze existing services agreements to determine if they need to be amended; and collect supporting evidence to confirm the receipt of services, their use in the company's operations, their value for the company, and the absence of duplication costs. In addition, it may be prudent to conduct and include a benefits test in the transfer pricing documentation; to justify the services remuneration structure; to prove the absence of allocation of the shareholders’ costs; to prepare employees and former employees for potential interviews regarding the services; and if the expenses are challenged, to consider a mutual agreement procedure (MAP) process available under an applicable income tax treaty.
For more information, contact the Global Leader of KPMG’s Global Transfer Pricing Services:
Komal Dhall | +1 212 872 3089 | firstname.lastname@example.org
The KPMG name and logo are trademarks used under license by the independent member firms of the KPMG global organization. KPMG International Limited is a private English company limited by guarantee and does not provide services to clients. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.