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Transfer Pricing: Unsolved Issues

Federal Law #227-ФЗ from July 18, 2011, introduced changes to the Tax Code in relation to procedures for transfer pricing and amendments to current tax legislation with regard to price controls for tax purposes.

Russian legislators hope to make Russian transfer pricing procedures correspond with international procedures, as well as to allow tax authorities to monitor price formation for intercompany and similar transactions.

However, Law #227-ФЗ came short of expectations by leaving many issues unsettled. For example, the law appears to apply only to transactions involving goods and services. Other transactions, such as property rights transactions and transactions where prices are established as rates are not subject to transfer pricing control for tax purposes.

Law #227-ФЗ also does not define "transaction" – is it a contract or individual activities conducted by the taxpayer under terms of the contract? It also does define a timeline for considering the transaction complete – whether it is at the time of signing the contract, the time of the implementation of the business activity, or the time that income and expenses are recognized for tax purposes, etc.

Professionals expected additional amendments passed during 2012 to fill the gaps and eliminate ambiguity in Law #227-ФЗ. However, the legislators never considered the amendments, and instead published recommendations and explanations. In particular, recommendations for preparing and filing transfer pricing documents explained how to calculate transaction revenues to determine whether the activity should be qualified as "controlled." The Federal Tax Service recommends calculating revenues "pair-wise," totaling them for each entity acting as a contractor in controlled transactions.

As a whole, it is worth noting that, on one hand, bringing Russian legislation closer to international standards makes it easier to conduct international business and foreign trade transactions, especially for transnational corporations. On the other hand, the new regulations necessitate revising current policies of transfer pricing, especially for Russian companies. Law #227-ФЗ requires taxpayers to prepare extensive and very detailed transfer pricing documentation which demands significant labor resources leading to additional costs. Transnational corporations are more accustomed to this as they have had to prepare similar documentation in the past (for example, according to recommendations of the OECD or the IRS in the USA), however, they also will have to implement certain steps to adapt previously developed documentation to Russian standards.

At the same time, the legislators provided for a transition period to allow taxpayers to adapt to the new regulations. In particular, Law #227-ФЗ introduces an increased threshold for "controllability" for 2012 and 2013, limits penalty charges for price adjustments for tax purposes (no penalties in 2012 and 2013, 20% penalty for audits for 2014-2016, and 40% penalty rate will come into effect in 2017). It also limits the timing of inspections for the first years of the law’s operation (i.e., tax authorities will be able to conduct audits for 2012 only in 2013).

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