Russian New Transfer Price Review - Case Study Example

RUSSIAN NEW TRANSFER PRICE REVIEW Name: Tutor: Subject: Date: Introduction To every country, taxes matters a lot and therefore each country must design and develop tax policies which achieve their objectives. This is because economic and political environments are becoming complex. Tax ratios vary depending on factors such as opportunity and choice. Countries which have access to rich natural resource revenue have levels of ratio. However, in most countries, tax ratios vary depending on the income level, and it rises if the per capita income rises. The best tax system should be developed by taking into consideration a country’s economic structure, its public service needs and its capacity to administer taxes among many other factors. For example, the public needs and services may exceed the income of the people and therefore a government should take that into consideration. In 2011, Russia made very important tax laws as a response to the economic crisis, especially on the interest rate. The rules became effective as at 2015 and the new transfer pricing system made Russia be the best country worldwide with effective transfer pricing system making it a potential centre for foreign investment despite the political instability experienced in the country. This paper aims to evaluate these Russian tax laws regarding its efficiency, simplicity, and fairness. The paper is also going to focus on the compliance of the new transfer pricing to the traditional transfer pricing. Russia’s Tax System Russia has uniform rates of tax on individual’s income, and this system does not consider the income level of an individual. Every person who is considered to be a permanent resident of Russia is liable for tax on his income as an employee and also as a self-employed person. Those who work overseas also pay some tax to the country. The foreign citizens in Russia are charged tax according to the income they earn in Russia. For most incomes, the individuals are liable for 13 percent tax while non-residents pay a tax of about 30%. For the employed persons, it is the work of the employer to ensure that every month he deducts the tax. The self-employed on the other hand are mandated to file their annual report on tax. The corporate tax of in Russia is divide into two; federal tax and regional tax. These rates are applied to the profits made by the corporate, and the maximum profit tax is 20%. Simplicity is considered to be one of the benefits of the flat tax system. This is because it makes the computation easier for the internal revenue service and also it is straight forward for the taxpayers. Flat tax is only based on one income, and it is, therefore, easier to understand and to report. The other benefit of a flat tax is that it saves taxpayers the financial cost of complying with IRS regulations which normally includes lawyers, accountants, and other resources. Flat tax system removes the issue of double taxation, and this means that those sections of the tax code which are biased are removed and also eliminates the dead tax, capital gains and double taxation of savings and dividends. This is because the flat tax allows the payment of interests and dividends at the individual level. Russia’s flat tax eliminates the country from global taxation, and this enables the country to compete more evenly in the global markets. The system also portrays some fairness because all the citizens are pay taxes at a uniform rate. Those who earn small income pay less while those who earn large income pay more tax, but the rate is the same. The fairness comes in because the system does not discriminate based on income levels as everyone is paying the same percentage. Despite the flat tax system meeting the requirements that a tax system should be simple, easy and efficient, there are some demerits of this system. This system penalizes the low-income earners at the rate as those who earn a high income. The low-income earners will little income left for taxation after purchasing the necessities. Therefore, the high-income earns benefit from the system while the low-income earners suffer. When a country such as Russia implements the flat rate tax, it should dismantle the IRS. IRS employees are likely to lose their jobs under a flat tax system and many view IRS as intimidating and imposing arm of the government. In general, the flat tax rate treats individuals and corporate fairly, but it lacks revenue back up as the government heavily relies on revenue generated from income taxes. Through the introduction of the new tax rules in Russia, business is becoming more efficient. This is because there are significant changes which were made in the corporate world. In the banking sector, the Government made major changes that brought reform to the banks. This reforms improved transparency and corporate standards. There were also some major changes in the company law regarding corporate governance and legal entities of a company. The profit taxation is at 20%, and this is the lowest among main economies. This has increased incentives which are aimed at increasing innovation and modernization of industries. These factors have made Russia a potential centre for foreign investment despite the political instability experienced in the country. Transfer pricing control Effective from 2015, Russia’s new tax rules require that all interest income and expenses be calculated according to the transfer pricing rules. For example, if a bank is transaction party, then it should be compared with the predefined range. The taxpayers have been keen on any uncontrolled transactions between related parties during pricing audits which are conducted by the Federal tax service. Planning on transfer pricing strategies which support tax returns position, company’s business activities and transfer prices practices on a global basis require a thorough knowledge of complex tax structure of a country, regulations, laws and requirements methods. In Russia, the taxing authority is The Federal Tax Service of the Russian Federation (FTS). Law 227 states the transfer pricing within the country and for cross-border transactions. The law reduces types of transactions related to pricing control and it focus on party transactions and it is mainly related to third party transactions. Cross-border transactions are subjected to the following price control; Third party transactions involving goods traded on global commodity exchanges such as minerals and petroleum products if the annual income exceeds 2 million US Dollars. The third party transactions where the counterparty is located in a certain jurisdiction. All party transactions. In the domestic market, any third party transactions which exceed U$2.2 million is subjected to the following transfer pricing control; The subject of transaction is related to mineral extraction tax One of the control parties is exempted from paying profit tax. One of the parties to the controlled transactions is registered under special economic zone There are some parties under the domestic transactions which are exempt from transfer pricing. These include transactions between members of consolidated group of tax payers or if they met the following criteria; Both parties are registered within the same region of Russian Federation None of the parties have autonomous economic sub-divisions in other regions of Russian Federation or pays tax to the budgets of other regions There are no other grounds for the transactions to be controlled. None of the parties is involved in tax losses. The new Russian transfer pricing control rules state that the income of the permanent establishment taxable in the Russian Federation will be determined by taking into consideration assets, functions performed and economic risk was taken. The acceptable methods include comparable uncontrolled price (CUP) method, resale price method, the comparable profits method and the profit split method. The CUP method is the priority method which is applied when information regarding at least one comparable transactions. The CUP method compares the price charged for the property transferred or the services transferred in a controlled transaction to charges charged on the transfer of property or services in uncontrolled transactions. Any difference noted indicates that the commercial and financial relations of the business are not in arm’s length, and the prices in the uncontrolled transactions may need to be replaced by the price in the controlled transaction. However, application of more than one method is allowed. The Russian tax code specifically states that for the purpose of determining profitability range of Russian companies, the accounting and statistical data of the foreign organizations may be used only if the Russian comparables are not identified. Management fees are carefully analyzed by the tax authorities and significant efforts are required to sustain claims for deduction claims. The law states that deduction should be done if the general criteria for tax deduction are met. These criteria require that the expenses be economically justified and that they should be supported by appropriate documents. The government of Russia provided the general guidelines and procedures on how the new Russia’s Federal tax laws should be applied. In 2012, many corporate restructured their intra-relations to ensure that they will be in compliance with the new transfer pricing. The taxpayers also were able to identify controlled transactions which made them review their pricing systems. They also drafted some relevant documents and submitted them for negotiations on the pricing agreements. The new rules on transfer pricing, however, do not meet the traditional transfer rules. This is because they have some ambiguities in some of the legislative provisions; it is time-consuming process of completing tax notification and inadequate clarity regarding the approach to controlling the arm’s length level of the intergroup. The transfer pricing also includes advanced pricing arrangements (APA). This was introduced by the new pricing rules and can be concluded at a maximum of three years. The APA is mainly targeting large “taxpayers” and they vary on the level which the taxpayer is. A person can be considered to be a “large taxpayer” if the annual Federal tax exceeds RUB 75 million to 1 billion and also if the total annual revenue equals RUB 1 billion to 20 billion. To ease the burden of the taxpayers, the concerned authorities have taken measures, and these measures include; extending the deadline for submitting controlled transactions notification, exempting from control certain financial transactions with contractual terms which were set before the new rules became effective and issue clarifications regarding certain potential groupings of transactions. PWC of Russia’s transfer pricing professionals has advised the Finance Ministry on how to deal with technical issues related to the application of an international transfer pricing rules which are currently used by members of OECD as well as specific contents of the current transfer pricing. Comparison of Russia’s Transfer pricing to Australia’s system The transfer pricing system of Australia has similarities and differences to that of Australia. One of the similarities is that both rules provide clarifications on the preparation and the submission of transfer pricing documentations for control purposes. The other similarity between the transfers pricing is that in both a taxpayer is required to submit a notification to the tax authority regarding any controlled transactions that took place at the end of the financial year. There are some differences between the rules of transfer pricing in the two countries. The main difference is on penalties on interest. In Australia, the penalties are applied to transfer pricing while in Russia; they are not applicable. Interests in the Russian transfer pricing are determined when there is excess in tax, and the excess will be refunded together with the interest. The interest is calculated from the day when the excess tax was collected up to the day when the excess is refunded. Australia’s transfer pricing policy has simple measures for both small transactions and in the favour of SMEs. The system also has measures applicable for low value adding intra-group service. Low value adding intra-group services are simple transactions with limited tax revenues at stake. The penalties in Australia’s transfer pricing rules are not only applied to interests but also to other aspects of transfer pricing. One of the penalties which are applied to the adjustment of the transfer pricing is on scheme shortfall. This occurs when a tax commissioner declared that a tax payer has received a scheme benefit which includes all transfer pricing policy adjustments, the taxpayer must be penalized. Penalties also apply where a taxpayer fails to take reasonable care. This penalty varies depending on whether the tax payer has completely failed to take reasonable care or has acted recklessly. The other penalty arises when a false or misleading statement is given by the tax payer and the tax commander determines the extent of the statement. A penalty can be given if the taxpayer is found to disregard relevant rules. The tax payers are also expected to make a review n order to ensure that transactions and results are reviewed at the appropriate time and intervals. This also helps in ensuring that the impact of material changes in businesses are considered and documented. In Russia, any adjustment to the transfer pricing must be reflected on the income tax returns and in some cases in the VAT and the mineral extraction tax. In Russia, a tax payer can be penalized if he or she fails to prepare a transfer study because it is a requirement. The study requires only documentation of only the income which accrues from controlled transactions. Initially, there was a set threshold of up to R$ 100 million but from 2014 onwards, there is no threshold set. Preparation of the study document does not necessarily need to follow the guidelines which are given by OECD, and it can be presented in any format. The penalty for underpayment arises from non-compliance with the transfer pricing regulations, and it is normally forty percent of the underpaid tax. Conclusion Russia has uniform rates of tax on individual’s income, and this system does not consider the income level of an individual. Every person who is considered to be a permanent resident of Russia is liable for tax on his income as an employee and also as a self-employed person. Those who work overseas also pay some tax to the country. Simplicity is considered to be one of the benefits of the flat tax system. This is because it makes the computation easier for the internal revenue service and also it is straight forward for the tax payers. Flat tax is only based on one income, and it is, therefore, easier to understand and to report. The other benefit of a flat tax is that it saves taxpayers the financial cost of complying with IRS regulations which normally includes lawyers, accountants, and other resources. The fairness comes in because the system does not discriminate based on income levels as everyone is paying the same percentage. Through the introduction of the new tax rules in Russia, business is becoming more efficient. This is because there are significant changes which were made in the corporate world. In the banking sector, the Government made major changes that brought reform to the banks. This reforms improved transparency and corporate standards and Russia is a potential centre for foreign investment despite the political instability experienced in the country. Work Cited Feinschreiber, Robert, and Margaret Kent. Transfer Pricing Handbook: Guidance for the OECD Regulations. Vol. 588. John Wiley & Sons, 2012. Read More