1. Tax Issues in Outsourcing «Alinga Consulting Group»
Alexey Spirikhin
Auditor
«Alinga Consulting Group»
November 15th, 2007

2. Contents Basis for expense recognition
Outsourcing as a tax advantage. What’s reasonable and what’s not?
What to learn from the courts? Recent decisions.
Decreasing risk of tax disputes

3. Basis for expense recognition
From Tax Code of RF
Article 252: “Expenses”
Deductible expenses are those which are justifiable, properly documented and directly related to receiving profits.
Justifiable expenses – economically reasonable expenses estimated in monetary form;
Properly documented expenses - supported by primary documents, and prepared according to Russian Legislation or according to rules applied in the country to which expenses are related;
Directly related to receiving profits – main condition for recognition of expenses.
Article 264: “Other expenses related to production and sales”
The following expenses are recognized as “other” in relation to production and sales:
Expenses on staff leasing (technical and management personnel) by outside companies for participation in production process, management of production process or other functions connected with production and sales (Clause 19);
Expenses for accounting services provided by outside organizations or individual entrepreneurs;

4. Outsourcing as a tax advantage
Tax advantage – reduction of tax payable by decreasing the tax base, receiving a tax deduction or tax relief, application of a lower tax rate, or reimbursement of tax from the government. According to the Supreme Arbitration Court in Decision #53, a tax advantage may be reasonable or unreasonable. Outsourcing is one of many schemes used in Russia for tax advantage.

5. What’s reasonable and what’s not?
Typical indicators of unreasonable tax advantage
For taxation purposes transactions are not accounted for in correspondence with their business purpose;
Taxpayer can’t in fact perform the transactions which resulted in the tax advantage due to the lack of skilled personnel, fixed, production and other assets, etc. necessary for the stated business activities;
Accounting reflects only those transactions which are directly connected with receiving the tax advantage;
Typical indicators of reasonable tax advantage
Taxpayer uses outsourcing for business objective and not only for tax advantage;
All activities which lead to decrease in tax burden are real business activities;
Taxpayer displays financial effect (increased profitability) from applying outsourcing (outstaffing);
The absence of indicators listed in right column.

6. What to learn from court decisions?
Recent statistics from the court practice shows that the courts as a rule uphold the Tax Inspectorate’s position in outsourcing (outstaffing) disputes. The rationale for the application of outstaffing has proven most difficult to prove in the courts.
The main reason decisions go against the taxpayer is that the outstaffing did not facilitate the business goal in any way supported by documentation.
Spending more time and effort on justification and documentation of outsourcing (outstaffing) will help save money and nerves in the future!

7. Recent decisions
One of the latest “positive” cases won by the taxpayer is Decision of Federal Arbitration Court of North-West District, September 28th, 2007 (case #A42-197/2007). The taxpayer applied outstaffing and was able to prove its business goal by submitting to the Court documents demonstrating the growth of revenues and sales volume, which in turn positively affected the financial position of the company!
A very demonstrative court decision won by Tax Office is Decision of Arbitration Court of Sverdlovsk region, May 14th, 2007 (case #A /2007-C6). The client’s use of outstaffing showed nearly every indicator as listed in those of unreasonable tax advantage.

8. Decreasing risk of tax disputes
To decrease the risk of outsourcing being recognized as a “tax avoidance scheme” make sure that:
Documentation process is well organized: scope of work, duties, responsibilities under outsourcing (outstaffing) agreement are clearly outlined and followed closely.
Never apply the terms “outsourcing” and “outstaffing” in primary documentation (agreements, invoices, reports, etc.);
Companies which concluded an outsourcing (outstaffing) agreement are not interdependent (i.e., have the same shareholder, general director, legal address, etc.);
Company-provider is separate firm really working on the market and has a number of clients not only just your company;
Company-provider wasn’t established shortly before you apply for its services;
Continued

9. Decreasing risk of tax disputes (Continued)
To decrease the risk of outsourcing being recognized as a “tax avoidance scheme” make sure that:
The company-client must demonstrate facilitation of its business goal. Must prove that outsourcing (outstaffing) is a necessary solution for personnel, business (production), management problems;
Company-client should receive a positive economic effect from applying outsourcing such as profit growth, cost reduction (production, management etc);
Employees of company-provider have all necessary information about their employment through Provider (especially for outstaffing) in case of tax audit. Remember: the employee works for the Provider NOT Client.

10. Thank you for your attention!
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While filing your profit tax don’t forget to list «Government» in the field «dependents»!
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