1 July 2015
Tax Alert
The approach taken by courts in
applying the dependent agent
concept creates additional risks for
payers of royalties
EY’s Russian Tax & Law practice was
named a leading Tax firm in Russia
in “World Tax 2015,” an annual
guide published by the International
Tax Review.
On 11 June 2015 the Arbitration Court of Moscow District adopted a
Ruling on Case No. A40-138879/14, which has been the subject of much
discussion within the business community. The judicial proceedings
ended with the court upholding the position of the tax authority and
supporting the conclusions of the lower instance courts. The court
asserted that expenses associated with the payment of royalties under
an intra-group subfranchise agreement were not justified for profits tax
and VAT purposes, and it therefore followed that the taxpayer
concerned, OOO Oriflame Cosmetics (hereinafter, “the Taxpayer”), had
received an unjustified tax benefit.
The basis for the court’s decision was its conclusion, based on the Official
Commentaries on the Model Convention of the Organization for
Economic Co-Operation and Development (hereinafter, “OECD”), that the
taxpayer’s activities were activities of a dependent agent of a foreign
company which gave rise to a representation of that foreign company in
the territory of the Russian Federation.
It follows from the text of the cassation court’s
Ruling that a franchise agreement existed
between Oriflame Cosmetics S.A.,
Luxembourg (the Rights Holder), and Oriflame
Kosmetick B.V., the Netherlands (the User).
On the basis of that agreement, a
subfranchise agreement was concluded
between the taxpayer and Oriflame Kosmetick
B.V., under which the taxpayer acquired rights
to use a range of exclusive rights of the rights
holder in its business activities.
Monthly payments under the agreement were
determined as share of the rights holder in the
user’s aggregate revenue at the rate of 5%,
and accounted for a significant portion of
expenses affecting the taxpayer’s overall
financial result.
The 98.4% majority part of the fee received by
Oriflame Kosmetick B.V. (the Netherlands)
under the subfranchise agreement was
transferred to Oriflame Cosmetics S.A.
(Luxembourg), and this led the courts to the
view that Oriflame Kosmetick B.V. (the
Netherlands) was a conduit entity.
The courts also established that Oriflame
Cosmetics S.A. (Luxembourg) had not paid
profits tax in the audited period, indicating
that the royalties which it received were nontaxable.
As a result of the judicial proceedings, the first
instance and appellate instance courts came
to the conclusion that the company had not
been independent in making management
decisions concerning economic activities, and
the payment of royalties had been a tax
optimization tool which affected the
taxpayer’s tax obligations.
For its part, the cassation court pointed to the
fact that the company’s tax returns showed
that it had been making losses for many years
while transactions took place involving large
sums going to interdependent non-residents,
and concluded that the company’s actions
bore indications of an unjustified tax benefit.
In this respect, rejecting the use of the
“piercing of the corporate veil” doctrine set
out in the “Parex Bank” case1 which had been
applied by the first instance and appellate
instance courts, the cassation court refereed
to the provisions of the OECD Official
Commentaries which explain the concept of an
“independent agent”2. Using these provisions,
the court considered whether the activities of
the Russian taxpayer met the criteria
established by the OECD for recognising a
dependent agent. In particular, the court took
the following factors into consideration:

evidence that the taxpayer was subject
to control and not independent in
carrying on business in the Russian
Federation;

the existence of instructions from the
parent company in the form of a
“Success Plan” guide to doing business;

the fact that subfranchise agreements
were concluded only and exclusively with
the Company, which was founded by a
foreign organization.
Having analysed these circumstances, the
cassation court asserted that the business
model used by the Oriflame Group allowed
clients to form the impression that the
company was a representation of Oriflame
Cosmetics S.A., Luxembourg.
Based on these arguments, the court came to
the conclusion that the company possessed
the characteristics of a “dependent agent”,
and that its activities, given that it was
formally registered as a Russian legal entity
while actually carrying on activities in the
name of and in the interests of a foreign
1
Ruling No. 16404/11 of the Presidium of the Supreme
Arbitration Court of the Russian Federation of 24 April 2012 on
Case No. A40-211727/2011 involving AO Parex Bank
2
Paragraphs 37, 38 and 38.3 of the Official Commentaries on
paragraph 6 of Article 5 of the OECD Model Tax Convention
company, had the nature of activities carried
on by a representation of a foreign company3.
Based on the foregoing, the court asserted
that the conclusion of the subfranchise
agreement had had no reasonable business
purpose. Taking into consideration the fact
that Oriflame Cosmetics S.A., Luxembourg,
was the holder of the rights concerned, the
court concluded that its permanent
establishment in the Russian Federation
should not pay royalties and did not have the
right to recognise corresponding expenses
under the subfranchise agreement for profits
tax purposes.
The adoption of this position by the cassation
court resulted in expenses associated with the
payment of royalties being wholly excluded
from the taxpayer’s costs and in the
disallowance of deductions for VAT withheld
by the company as a tax agent on the fee paid
under the subfranchise agreement.
Conclusion:
The OOO Oriflame Cosmetics case is the first
instance of the use by Russian courts of the
dependent agent doctrine.
3
Paragraph 34 of the Official Commentaries on paragraph 5 of
Article 5 of the OECD Model Tax Convention
The conclusions reached by the courts in this
case may create additional risks for Russian
companies in situations where substantial
control and management is exercised by a
foreign parent company.
It may be deduced from the structure and size
of the additional charges imposed in the OOO
Oriflame Cosmetics case that the additional
tax burden in the form of additional profits
tax, VAT and corresponding penalties and
fines which would fall upon a Russian
subsidiary in the face of similar claims may be
more than 46% of the amount of royalties.
It is difficult to anticipate whether the
approach used in this case will become
standard practice. Nevertheless, there is ever
increasing focus on the appropriateness and
economic effect of intra-group expenses, and
any perceived lack of justification gives rise to
significant risks for taxpayers.
For further information, please contact:
Alexandra Lobova
Partner, CIS Tax Policy and Controversy Leader
+7 (495) 705 9730
[email protected]
Alexei Nesterenko
Partner, Tax Controversy Leader
+7 (919) 101 1328
[email protected]
Alexei Malenkin
Partner, Global Compliance and Reporting Group
+7 (495) 755-9898
[email protected]
Irina Luzhina
Manager, Tax Controversy Group
+7 (495) 755 9700
[email protected]
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