The Russian Supreme Court has formulated its position regarding the application of a reduced profit tax rate by residents of Special Economic Zones

A taxpayer that was a resident of a Special Economic Zone ("SEZ") in Samara Region had taxes additionally assessed on an amount of non-sales income arising from foreign exchange gains generated when the taxpayer acquired foreign currency to purchase production equipment.

Following the tax authority, courts of three levels held that the taxpayer was not eligible to apply the reduced tax rate to income of this type.

The courts proceeded from the fact that the construction was still in progress and the facility could not have been used to make a profit from production activity. The courts further held that neither the SEZ Agreement nor the business plan provided for such an activity in the SEZ as generating a foreign exchange gain.

The Judicial Board for Economic Disputes of the Russian Supreme Court set aside the judgments and held the decision of the tax authority to be invalid.[1] Now, we have a position of the highest court that is clear-cut and corresponds to the real circumstances of investment activity.

The Russian Supreme Court pointed out that a SEZ resident is not only engaged in industrial and production activity, but primarily makes investments and contributes the capital required for such operations.

In the Russian Supreme Court’s opinion, the objective link between the income (expenses) under consideration and taxpayer’s operations in the SEZ are relevant for the application of the reduced tax rate by a SEZ resident. The link is present, among other cases, when certain income (expenses) occurs at the stage of investments in facilities that will be used in order to be engaged in activity in the SEZ.

Otherwise, SEZ residents would be unable to apply a reduced tax rate at the stage of investments and the application of such reduced tax rate would be confined only to the revenues from the sale of products (work and services). This does not follow from article 284(1) of the Russian Tax Code or from the Law on SEZs, and nor does it conform to the goals of incentives and state support of investments.

Given the negative case law on this matter, the Russian Supreme Court expressed its opinion also with regard to the facts of the case which influenced its conclusion that the taxpayer had been eligible to apply the reduced tax rate:

· the foreign currency had been purchased in the amount the taxpayer required to make payments under its contracts with foreign suppliers of equipment;

· the foreign currency had been used for the intended purpose;

· the investments had been provided for by the Agreement and were actually made; and

· the construction operations had started and were being carried out in reality.

PG comment: When applying a reduced profit tax rate to exchange gains relating to business activity in a SEZ, taxpayers should take into consideration the need to prove the facts above.

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