Transfer-Pricing Legislation -- When Will It Be Amended?

Henrik Hansen
Senior manager, Transfer Pricing & ITS Department, Ernst & Young
Transfer-pricing reform has been on the government's agenda for the past few years, and a number of bills have been presented to the public. One even made it to the State Duma. Despite this, no amendments have yet been made to the existing rules in Articles 20 and 40 of the Tax Code.

During 2007 the Finance Ministry was tasked with preparing new legislation and duly did so. Nevertheless, it was an alternative bill prepared by the Finance Academy and submitted to the presidential administration by the Russian Union of Entrepreneurs and Industrialist that won the backing of the presidential administration as well as the tax authorities.

It is, however, not yet clear when a final bill will be submitted to the Duma or whether it will be amended prior to that. During discussions with members of the Duma's tax committee and representatives of various ministries, it was emphasized and acknowledged that transfer pricing is a complex issue and no draft legislation will be sent to the Duma before careful consideration has been given to all its aspects. This could necessitate some further work, as the bill, despite its many sensible suggestions, remains unclear in some areas. Further amendments are recommendable in order to provide clarity to both taxpayers and tax authorities.

Additionally, as has been quite sensibly stated, the new transfer-pricing legislation and the upcoming law on consolidated tax reporting should come into force simultaneously. As none of them have been considered in detail, it is far from certain that the transfer-pricing legislation will be enacted as of Jan. 1, 2009, though this is still a possibility.

As for the new bill, it is effectively an update of the existing Article 40, which leverages some of the ministry's suggestions and other comments made by tax advisers, including Ernst & Young. On balance, the result is a bill that in some areas is an improvement relative to existing Article 40 (and the ministry's proposal) but at the same time includes some of the existing weaknesses of Articles 40 and 20, as well as some of the less fortunate suggestions of the ministry's draft.

In relation to controlled transactions, the draft would continue to govern transactions involving goods, work and services, but it also states that the tax authorities have the right to apply the law to transactions involving other subjects of civil rights, including intellectual property.

Sensibly, the bill narrows the range of controlled transactions and is, in this respect, closer to international practice. The aim is to capture those types of transactions in which there might be a tax incentive that causes a deviation from the market price. In this regard it would govern all transactions between resident and nonresident persons if the resident's annual turnover exceeds 1 billion rubles (about $40 million) and transactions between resident, interdependent parties where one party's turnover exceeds the above criterion and where:

• One party is located in a special economic zone or region where the tax rate is lower; or

• The subject of the transaction is a good which is subject to mineral extraction tax on its initial production.

Additionally, in all instances, only controlled transactions with a value above 1 million rubles should be subject to control.

For all controlled transactions, the taxpayer would have to disclose, among other things, information on the prices used, amount of income received and expenses incurred, data sources used to establish and support the transfer price, and information on the party with whom the controlled transaction is entered into. The bill is still unclear in this area, for example with the level of aggregation, and the fear is that this could place a significant administrative burden on taxpayers, in particular when taking into account their general experience with financial reporting.

Further, the bill would provide for a list of additional information that should be made available to the tax authorities in a timely manner -- 10 days -- if requested. In effect, this list corresponds to a form of transfer-pricing documentation that many taxpayers are familiar with from Western countries and includes, among other things, a functional analysis of both parties to a controlled transaction.

In other technical areas, the bill maintains a slightly unique Russian approach to transfer pricing, for example with regards to transfer-pricing methods, calculation of the market price range and use of data sources. However, compared to the current transfer-pricing rules, the bill does offer more alignment with the Organization for Economic Cooperation and Development's transfer-pricing guidelines. And this can only be welcomed by taxpayers, as transfer pricing primarily is an international tax issue where consistency in rules, interpretation, and treatment is of the highest priority.