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. Last Updated: 07/27/2016

Business Taps Forward in the Tax Twilight Zone

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The fear of arbitrary justice is hanging over the business community as a barrage of back tax claims keeps raining down.

In recent months, oil majors TNK-BP and Sibneft, mobile phone operators VimpelCom and MegaFon, shipping giant Volgotanker, cigarette maker Japan Tobacco International and regional telecom company Dalsvyaz have been saddled with millions of dollars in back tax bills.

None, however, topped the more than $27 billion in tax claims that have all but bankrupted oil major Yukos.

"People are looking at tax policies more closely," said Steven Snaith, head of PricewaterhouseCooper's tax and legal practice in Russia. "Overzealous" authorities have shown a very black-and-white view of the tax code, Snaith said, even though the law is replete with gray areas.

One hotly disputed point of ambiguity, which gained notoriety in the unfolding Yukos affair, is the legal difference between "good faith" and "bad faith" taxpayers.

"There are no clear criteria for what constitutes lawful and unlawful tax avoidance under Russian law," said Olga Boltenko, a lawyer at Haarmann, Hemmelrath & Partner. In practice, virtually any tax dispute viewed through the lens of bad faith can be ruled in favor of the government, she said.

Even government officials acknowledge that ambiguity is part of the current system.

"Our legislation still contains norms which allow dual interpretation, and [that] leads to a huge number of arguments between tax authorities and taxpayers," Deputy Prime Minister Alexander Zhukov told President Vladimir Putin earlier this month, according to the Kremlin's official web site.

The Constitutional Court ruled in 2000 that the authorities cannot force good faith taxpayers to take any additional steps outside of their regular business routine to prove their tax minimization efforts are not an attempt to evade taxes.

But since the term "good faith" is not defined, virtually any company can be ruled to be a bad faith taxpayer by a judge's arbitrary decision, Boltenko said. A company would need to prove the contrary if it is to avoid the authorities declaring some of its transactions void.

Some schemes, like transfer pricing, are explicitly defined as tax evasion. Chapter 40 of the Tax Code allows authorities to claim additional tax payments from companies whose prices -- including in deals between internal structures -- are over 20 percent lower or higher than average market prices.

In more ambiguous cases, however, "a structure that can be perfectly legitimate for one taxpayer is not necessarily appropriate for others," said Petr Medvedev, head of Ernst & Young's tax practice for the CIS.

"For example, the mere sale of goods to an offshore entity does not necessarily constitute a tax violation," Medvedev said. But it can be considered one if the seller fails to provide a non-tax-related reason for the transaction.

With government tax revenues on the rise, businesses are jittery about being accused of not contributing enough to the pot.

Last month alone, tax revenues topped 316.4 billion rubles ($11.3 billion), which is 17.1 percent of the tax revenues planned for the entire year. January revenues are more than twice the revenues received in the same month last year, according to Federal Tax Service figures.

"The means of fighting illegal tax optimization should not only match the government's fiscal goals, but also align with the [goal of] protecting taxpayers from unfounded claims from the tax authorities," said Sergei Borisov, president of Opora, which supports small and mid-size business development.

To understand whether their tax practices are sustainable, companies are looking at how administrative authorities interpret the law, Snaith said.

Companies are following "the principle of exclusion," which drops those practices that have been defined by courts as bad faith tax avoidance, Boltenko said.

These include using one bank for government transactions and a different bank for transactions with private-sector partners; creating third-party accounts for business transactions; and making deals with suspiciously young suppliers or companies created for the sole purpose of tax minimization.

Taxpayers should be able to prove that their structures and transactions are not merely supported with accounting documents, but are also "justified from a business or economics point of view," Medvedev said.

"The list goes on and on," Boltenko said, adding that as long as the ambiguity between good faith and bad faith remains, there are no foolproof solutions.

Mature legal systems in the West must also address tax evasion disputes, but a tradition of relying on legal precedents in Britain or the United States, for example, takes much of the ambiguity out of the process.

Russia does not have a strong system of precedents, Snaith said, making it seem as though judges make arbitrary decisions in each case.

The government has been making noises about erasing the gray areas.

"Taxation criteria must be clear and [must] prevent arbitrary interpretation, which will allow the lawful practice of tax optimization to be distinguished from criminal cases of tax evasion," Putin recommended last summer in a letter to parliamentarians as work on the 2005 budget began.

The Finance Ministry also proposed last year to include drafting better definitions of "good" and "bad" tax optimization on this year's legislative agenda.

A spokesman for the ministry was unable to say whether the plan is still in the works.

But a high-ranking government official, who spoke on the condition of anonymity, said "the mechanisms for clarifying the difference between lawful tax minimization and illegal tax evasion are currently being discussed."

Experts were skeptical that such moves would remove businesses' fears of becoming the next Yukos.

"I doubt that any single definition inserted in the Tax Code would remove the ambiguity in treatment of this issue," Medvedev said.

Snaith agreed that "writing endless definitions" would not solve the problem.

The government needs to clearly state its principles in pursuing tax evasion, he said.