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. Last Updated: 07/27/2016

Judicial Disputes Concerning Taxation of Leasing Transactions

UnknownGalina Akchurina
One of the basic tax claims concerning leasing transactions relates to the refusal to provide deductions on VAT paid by the leasing company to the supplier of the leased property and involving borrowed assets and additional VAT and profit tax charges concerning leaseback transactions, which are recognized by the tax authorities as economically unfounded.

A situation where leased property is purchased by the lessor using credit funds is typical, but is a reason for the tax authorities to refuse to deduct VAT with reference to Constitutional Court decision No. 169-O on April 8, 2004. This decision specifies that the payment of VAT to the supplier using the property obtained under a credit agreement should be considered as real expenses, which allow deducting VAT only in the moment of fulfillment of the taxpayer's obligation to disburse a loan.

At the moment the courts support the position of taxpayers. Specifically the courts admit that Chapter 21 of the Tax Code doesn't limit the taxpayer's right to get a VAT deduction based on the payment of goods using credit funds and it doesn't connect this right with when the loan was disbursed. The same position is also declared by the Finance Ministry and a Supreme Arbitration Court decision dated Oct. 12 that says justification of obtaining a tax advantage can't depend on how funds for conducting the business activity (using internal funds, using the credit funds, issue of securities or increase of share capital) were obtained or on the effectiveness of using the capital.

However, taxpayers should take into account that the courts also follow a Constitutional Court decision dated Nov. 2, 2004, in resolutions of such disputes. Courts will try to find out if there is a reason to suppose that the loan will not be disbursed by the taxpayer in future. In connection with this, organizations should prepare documents confirming the payment of loan wholly or partly on the date of proceeding.

It is important to note that the courts are less loyal toward taxpayers when the tax authorities have submitted evidence that the loan used for purchasing the leased property was paid using another loan. In case the court defines that the taxpayer's own funds are not enough to pay the loan the court shall refuse to provide the VAT deduction with reference to deficiency of the real expenses. We suppose that this position is not based on applicable legislation and on judicial practice. As long as it is not proved that there is no business activity, the transactions concluded are fake, or that there is an agreement confirming a line-up between the taxpayer and the loaner to avoid tax payment, the refusal to provide a VAT deduction is not based on the law.

In recent times, the tax authorities submit the evaluation of a taxpayer's financial position prepared according to methods specified in the administrative order of the Federal Agency of Financial Restructuring dated Jan. 23, 2001, as evidence of paying the loan using internal funds. Reference to this document is not correct, because the implementation of this order doesn't expand to this action.

The qualifying mark of a leaseback contract is that the seller of the property and the lessee is the same person. The conclusion of this agreement is connected with tax advantages, particularly, with the right to implement accelerated capital allowance, the possibility to record the leased property on the lessee's balance and the possibility to calculate amortization etc. The position of tax authorities concerning the evaluation of such transactions is as follows. Expenses for leasing payments, accelerated capital allowance can't be recognized as economically feasible expenses because the seller of the property and the lessee is the same person. As long as the property really doesn't drop out of the possession and exploitation of the lessee the conclusion of this agreement can give evidence of the transaction with the goal to minimize the tax burden. At present, the economic feasibility of leaseback transactions is defined by a Supreme Arbitration Court decision dated Jan. 16 of this year.

However this doesn't mean that the parties of the leaseback agreement should not prove the real commercial goal of an agreement, taking into account that these transactions are used for obtaining tax advantages. In particular, the taxpayer should have the following documents to avoid unfounded tax claims. In particular, documents confirming the requirements of the organization to have free-floating assets (a business plan or technical and economic feasibility studies). It's quite desirable to have evidence of using the funds obtained for the property for the goals connected with the commercial activity of the taxpayer. Moreover, the parties of this transaction should have documents confirming the profitability of the leasing agreement for the lessor.