Taxation of International Transactions: Why Foreigners Keep Overpaying VAT in Russia

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As a general rule, sales of goods, works and services by Russian companies are subject to value-added tax. However, some cross-border services are exempt from VAT. Pursuant to Article 148 of the Tax Code, the exempt cross-border operations are:

• transfer of patents, licenses, trademarks, copyrights and similar rights;

• software and database development, adaptation and updating;

• advisory, legal, accounting, engineering, advertising, marketing and data processing services, research and development;

• staff leasing; and

• rent of movable property except motor vehicles.


Under Article 149 of the Tax Code some services are VAT-exempt when provided both within Russia and cross-border (lease of office space to accredited representative offices and branches of foreign legal entities, residential lease, certain medical services, most insurance and banking operations, and pilotage and ship servicing). Starting from 2008 the list of exempt operations in Article 149 of the Tax Code will also include the licensing and transfer of exclusive rights to patents, innovations, useful models, industrial design, software, computer databases, microchips design and know-how.

Unfortunately, some foreign companies don't do their tax homework properly. Consequently, Russian service providers charge them VAT on operations that are actually exempt under Russian tax law. VAT might be charged by mistake. On some occasions Russian service providers maliciously bill their foreign clients 18 percent VAT, while reporting the operation to tax authorities as exempt. It is impossible to recover such overpaid VAT from the state. An attempt to recover VAT from the Russian service provider might involve complex litigation in Russian courts.

Some cases of overpaid VAT arise not from taxpayer error or malice, but from the misinterpretation of tax law by tax authorities.

From time to time, the Finance Ministry and Federal Tax Service issues letters articulating their interpretations of uncertain provisions of the tax law. In some interpretations Finance Ministry and Federal Tax Service limit the scope of tax relief compared to the actual text of the Tax Code. Formally, the letters are not binding for taxpayers. However, letters of the Finance Ministry are binding for tax inspections. Therefore, many taxpayers prefer to follow them even at their own loss in order to reduce the risk of tax controversy.

For example aircraft ground handling is VAT-exempt under Article 149 of the Tax Code. However, in several letters from both the Finance Ministry and the tax authorities limited the exemption to a number of ground handling operations specified in Orders by the Federal Air Transport Service No. 125 and the Transportation Ministry No. 110. Based on these letters many airports charge VAT on some ground-handling operations.

However, the Tax Code itself does not limit the relief to any set of operations and exempt all ground handling services. The Federal Arbitration Court of Moscow Circuit affirmed an unlimited VAT exemption of ground handling operations in two decisions of Dec. 23, 2005, and Aug. 16, 2006. By going to court, some tax payers have substantially cut their tax bill.

It should be noted that every time a taxpayer departs from the Finance Ministry and Federal Tax Service interpretations he should be ready to defend his position in arbitration court.

However, careful preparation and proper representation in court can help taxpayers take advantage of uncertain provisions of Russian tax law.