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Bankrupt VAT Trap: Tax risks of purchasing assets from a bankrupt company


Sale offers for assets of bankrupt companies may seem very tempting. At the same time, in order to avoid becoming a prisoner of the situation it is necessary to take into consideration the tax risks associated.

As an illustration let’s consider a dispute with a tax inspection which serves as an example of how a taxpayer may be trapped by the ambiguity of tax legislation.

For the past several years, there has been no unified approach for legislators, tax authorities and courts of arbitration/commercial courts in relation to VAT on purchases of a bankrupt company's assets through liquidation sales. Taking into consideration that tax liabilities are satisfied after all others, the sale of a bankrupt company’s effects is usually not subject to VAT due to the lack of available funds.

However, the Ministry of Finance and the Tax Service, as defenders of public interest, are not satisfied with this situation.

Buyers want to use VAT tax deductions for the sale of bankrupt entity's assets. Tax authorities regularly deny this tax deduction due to the absence of the source of reimbursement in the budget. 

Despite the common practice for consideration of these disputes, in arbitration courts in taxpayers’ favor, the issue is solved only through the courts. Complete appeal procedure usually takes approximately 1.5 years.

Amendments introduced to the Tax Code of the Russian Federation in July 2011 now place tax agent responsibilities in regards to VAT on buyers of bankrupt companies' assets. In other words, a buyer must transfer to the seller the price of sale minus VAT. In this case, VAT is then transferred to the state in full, avoiding the bankrupt company's account. These amendments came into force on October 1, 2011.

Currently the situation is amplified by tax authorities and arbitration courts advocating for the interests of large creditors in bankruptcy cases (first and foremost, banks and leasing companies). On January 25, 2013, Supreme Arbitration Court, not recognizing the account regulations of the Tax Code, noted that buyers of a bankrupt company's assets must transfer the payment for the purchase in full, without withholding VAT!

Consequently, buyers of the bankrupt company's assets became prisoners of the situation:

  • On one hand, they are obligated to transfer to the debtor or to the sale organizer the full amount according to the sale agreement, including VAT, which was specifically pointed out by the Supreme Arbitration Court of the Russian Federation;
  • On the other hand, it will guarantee that they become subject to claims from the tax authorities by not fulfilling obligations of a tax agent, by not withholding and transferring to the tax authorities the VAT amount owed (in breach of Article 161 paragraph 4.1 of the Tax Code).

In other words, the cost of the purchased effects is, in reality, increased by 18% - the amount of VAT which must be paid twice – first included in the purchase price, and later to the state, fulfilling the obligations of a tax agent.

Without a doubt a court would most likely consider claims of tax authorities groundless. But only the court!

The consequences of this controversial situation will be felt by the bankrupt companies as well, as it will most likely decrease the number of those willing to purchase their property.

Therefore, in the process of considering purchases of property and assets of a bankrupt company we encourage you to consider not only the tempting price but also the possible claims of tax authorities and the fact that you will have to defend your position in court.

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