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Agents are commonly used in business. In spite of their prevalence, however, relationships involving agents harbor tax traps that can land a company in court. However, the majority of problems can be avoided if they are thought through before the contract is written.

The First Trap: The Right to Withhold Compensation

The tax base for the Value Added Tax (VAT) on the sale of merchandise can be determined at the time prepayment is received or when the shipment is received (Article 167 of Russia’s Tax Code). At first this provision may seem like it would not affect agents, who are only subject to VAT for compensation, but it is not so simple.

Commission (agent) contracts, which involve an agent in billing, often stipulate that the agent withhold his compensation from the overall sum he receives. This makes sense: if the money initially goes to the agent, it makes little sense for the agent to transfer  the entire sum to the principal (client), only then for the principal (client) to restore the compensation due to the agent.

However, this situation gives the tax authorities grounds for claiming VAT on advances from the agent, not just the principal. The tax authorities say that when an agent receives an advance payment, the agent simultaneously receives an advance on his own compensation as any amount from any deal can be kept as payment for  services rendered.

The courts tend to disagree, pointing out that the agent’s tax base includes his compensation, but not the advance received from a contractor while fulfilling work for the principal (see, for example, the Moscow District FAC Resolution on March, 26, 2007 № JA-A40/1751-07). That is, the court ruled that the tax authorities’ claims in this case are unreasonable. Defending oneself from them in court is relatively easy.

A court case can be avoided entirely if the agent contract stipulates that only the agent has the right to withhold compensation after the principal has confirmed the statement from the agent. In that case, the agent would no longer have the right to withhold compensation from an advance payment, which would remove any basis for such claims from the tax authorities.

The Second Trap: When to Pay VAT

This trap is also related to advance payments, but the danger is now for the principal. Article 167 of the Tax Code of the RF stipulates that the VAT tax base is determined either when payment or prepayment is received for goods, work, or services,. However, when an agent is involved, the money initially goes to him. The resulting situation is that the funds go to one entity (the agent), but the tax obligation falls on another (the principal). Moreover, this obligation concerns sums which the agent has not yet transferred to the principal, and so the principal does not know the amount until receiving the agent’s statement.

This presents a tax risk for the principal. One solution is to stipulate in the agent contract that the agent must notify the principal about receiving the advance payment before the end of the quarter. Therefore the principal would only be obligated to pay VAT after receiving notification from the agent, and would prevent the principal from being held responsible for not paying a tax he was not even aware of (Letter of the Federal Tax Service № ММ-6-03/202 dated February 28, 2006; Western-Siberian District FAC Resolution on December, 13, 2006 #F04-8319.2006(29331-A27-42)).

The Third Trap: Compensation For Expenses

The Civil Code stipulates that the principal must compensate an agent not only for his services, but also for expenses incurred while carrying out the work (Article 1001 of the Civil Code). However, the tax authorities often perceive the movement of sums between the contracting partners as a basis for the tax base for both VAT and the Profit Tax. Courts have ruled numerous times that the tax authorities’ position is not supported by the Tax Code since this compensation is not connected to rendering of the agent’s services (see, for example, the Supreme Arbitration Court Decision on April 2, 2008 № 4446/08; Decree of FAS of the Moscow Region from November 19, 2007 №KA-A40/11709-07; FAS of the North-Western Region on February 26, 2007 on case №A56-19948/2006). Similar court decisions are made concerning the Profit Tax from the amount of compensated expenses — i.e. they are not included in the tax base (see North-Western District FAC Resolution from April 6, 2006 #A05-17340/2005-13).

However, it is also possible to reduce the risks in this case: the contract should contain a separate section laying out the obligations for compensating expenses although this section should not be associated with the section dedicated to compensation for services.  In addition, when transferring these sums the purpose of payment should be specified as "reimbursement for expenses," and the corresponding section of the contract should be referenced.

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