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      Sub-clause 11, clause 1, Art. 251 of the Tax Code of RF (hereinafter - "the TC RF") stipulates that in a tax base determination the following kinds of income must not be, specifically, taken into account: the property received by a Russian organization (transferee) from another organization (transferor) if no less than 50 % of the authorized (contributed) capital (fund) of a transferee consists of the transferor's contributions, or if no less than 50% of the authorized (contributed) capital (fund) of a transferor consists of the transferee's contributions. In such cases the received property is not regarded as income for taxation purposes only if the above property (with the exception of cash) is not transferred to third persons during one year from receipt thereof.

      Proceeding from the systematic analyses of this rule together with clause 8, Art. 250 of the TC RF, it should be concluded that the rule concerned is applied to cases of gratuitous and irrevocable transfer of property, including cash. Pursuant to clause 8, Art. 250 of the TC RF the income as the property (works, services) or property rights received free of charge, excluding cases specified in Art. 251 of the TC RF, is not recognized as income earned from main activities .

      In this connection there arises the question as to the possibility to apply sub-clause 11, clause 1, Art. 251 of the TC RF to relations between profit-making organizations, since pursuant to clause1, Art. 572 of the Civil Code of RF (hereinafter - "the CC RF") a gratuitous property transfer to the ownership is recognized as a gift, and by virtue of clause 4, Art. 575 of the TC RF a gift is prohibited between profit-making organizations.

      From the formal point of view, proceeding from the statutory characteristics of a deed of gift distinguishing it from other kinds of civil transactions, transactions of a gratuitous property transfer to the ownership between profit-making organizations may be regarded as a gift.

      However, it should be noted that the legislator extended operation of sub-clause11, clause 1, Art. 251 of the TC RF not to every kind of a gratuitous property transfer, but only to cases of property transfer between persons interconnected by participation in the authorized capital. Besides, according to the criteria of participation in the authorized capital established in the rule under consideration, pursuant to clause 1, Art. 105 the CC RF these must be relations between a subsidiary and a parent business companies, i.e. when a parent company by virtue of the predominant participation in the authorized capital of the subsidiary can influence resolutions to be adopted by the latter.

      With due regard for the foregoing, it is necessary to consider distinctions between a transaction of a gratuitous property transfer between a parent company and a subsidiary and a transaction of gift.

      Transactions are defined as deliberate, aimed, and volitional actions performed by natural and legal persons with a view to achieving certain legal consequences. The essence of a transaction consists in the will and its expression by the parties. The will is a determined and motivated desire of a person to gain the objective set.

      In an act of gift the aim of the transferor's will is to satisfy the transferee's interests, i.e. to make a gift to the latter, to enlarge the latter's property at the transferor's expense, and in this sense to enrich the transferee. At that, the transferor has no interest of his own.

      Other characteristics of a deed of gift are: irrevocability of rights assignment, perpetuity of a gift, enlargement of the transferee's property, and diminishing of the transferor's property. Besides, a transferor completely looses a legal title to the transferred property, and this is in line with his will to make a transaction of gift.

      However, all these characteristics are derivative from a gratuitous nature of a gift. A gift takes place when and if the subject of a gift is provided by the transferor free of charge.

      In case a gift is followed by the transferee's consideration, either in the form of a thing or right transfer or the transferee's counter undertaking, pursuant to paragraph 2, clause 1, Art. 572 of the CC RF such contract is not recognized as a deed of gift. In this capacity it is void, and the rules about a feigned transaction should be applied to such relations. These are the rules of a transaction for value which the parties had actually in view (clause 2, Art. 170 of the CC RF).

      At the same time, Professor A.L. Makovski notes that "gratuity being a constructive characteristics of a gift obviously excludes the possibility to regard as a deed of gift such contract whereunder a gratuitous property transfer is followed by a transferee's obligation toward the transferor or any other persons. The complexity, if not impossibility, to separate an obligation from a consideration, an equivalent, should be taken into account"[1]. In other words, even if a gift is formally conditioned by any action to be carried out by the transferee in favor of the transferor rather than by a counter obligation, the transaction of a gratuitous property transfer to the ownership cannot not be deemed a gift.

      This corresponds to the definition of a deed of gift. Pursuant to clause 2, Art. 423 of the CC RF gratuitous is the contract under which one party undertakes to provide the other one with something free of charge or for no other consideration.

      The objective of a gratuitous property transfer between a parent company and a subsidiary is not to do a favor to the transferee, but to manage the property in connection with business activities. Pursuant to paragraph 3, clause 2, Art. 2 of the CC RF business means individual activities carried out at one's own risk with a view to systematic profiting from property use, sale of goods, performance of works, or provision of services by persons registered in such capacity in a statutory manner.

      Property transfer between a parent company and a subsidiary is effected with a view to use such property more effectively with due regard for the specific state of affairs in the parent company or subsidiary and is ultimately aimed at gaining a favorable economic effect by the property transferor, in other words, at receiving a consideration. At that, such transfer does not entail termination of the parent company incorporator's powers respecting control over the property, since by exercising its shareholder's (member's) rights it has the possibility to participate in management of the transferee company. Moreover, as regards the case specified in sub-clause 11 , clause 1, Art. 251 of the TC RF, the matter is about a so-called "deciding" participation, when a property transferor both legally and actually has the possibility to direct the will of its subsidiary. In this connection, there is specifically no such characteristics of a gift as irrevocability of rights assignment, since the transferred property may be later on returned, practically at the parent company's discretion. Besides, one may say that the transferor's property is not altogether lost since there is a sufficiently obvious connection between the property disposition by the parent company in favor of its subsidiary and, for example, increase of the parent company's shares (membership units) in its subsidiary's capital conditioned by the increase of the latter's assets at the expense of received property.

      Loosing part of its assets in the form of property disposition, the parent company receives a partial "compensation" on account of increase of the subsidiary's property market value and, hence, increase of its own interest therein. This fact, in particular, is taken into account in determination of a share (membership unit) value payable in withdrawal from the company (Art. 94 of the CC RF).

      Material benefit of a parent company may be expressed in more deferred economic results of a property transfer transaction, for example, in expansion of its subsidiary's activities by using the property received, increase of its profit, and as a result, increase of dividends to be paid, etc.

      As to the cases of gratuitous property transfer by a subsidiary to its parent company, there is no complete gratuity either, since in certain circumstances the parent company assumes the subsidiary's risks of default on the latter's obligations to the third parties, in particular, in the form of vicarious liability for the subsidiary's debts in the event of the latter's insolvency (part 2, Art. 105 of the CC RF), liability to the subsidiary's members for the damage inflicted thereon by the parent company (part 3, Art. 105 of the CC RF), etc.

      Accordingly, a gratuitous property transfer between a parent company and a subsidiary cannot be regarded as a gift, but should be treated as another kind of transaction which though is not provided for by the law directly, is not contrary to the law, which is in line with clause 2, Art. 421 of the CC RF.

      Another approach is also possible. As, for example, A.Yu. Kabalkin, Doctor of Law, noted "it is necessary to take into account that some of gratuitous relations fall under operation of the rules of other branches of law - family, administrative, labor law"[2]. Actually, regulation of a parent and a subsidiary companies' relations under a deed of gift by the rules of the TC RF attaches a legitimate nature to this transaction, i.e. such transaction may be regarded as directly provided for by law, by Art. 251 of the TC RF. to be exact.

      Legitimacy of such kind of transactions is confirmed by current corporate law. Pursuant to Art. 27 of the Federal Law On Limited Liability Companies a company's members are obliged to contribute to the company's assets following the decision of the general meeting of the company members. The contributions to the company's assets are made in cash unless the company charter or resolution adopted at the general meeting of the company members provide otherwise. At that, the contributions to the company assets do not change the rate and the face value of the membership units in the authorized capital of the company.

      Contributions to a company assets are made free of charge and this does not entail increase of the scope of the company members' rights in management thereof. However, proceeding from the objective of these transactions - effective business activities carried out by a business entity in the interests of its founders - the legislator does not regard even such transactions as deeds of gift.

      Similarly, the legislator admits and directly provides for the possibility of a gratuitous property transfer in the course of investment activities. Pursuant to the Federal Law On Investment Activities in RF Carried Out in the Form of Capital Investments, investment activities mean investment and performance of practical actions with a view to gaining profit and/or achieving another useful result. Thus, an investment objective may be not only gaining profit in the form of a consideration, but also achievement of an effect useful for the property transferor (for example, creation of production facilities which in the future will make it possible for the investor, within the framework of separate relations, to be supplied with necessary products). In this cases investments will be made for free, if to proceed from the definition in clause 2, Art. 248 of the TC RF that property (work, services) or property rights are deemed received free of charge if receipt of such property (work, services) or property rights is not connected with the transferee's obligation to transfer the property (property rights) to the transferor (or to perform work for the transferor, provide services to the transferor). However, since the investor receives the required consideration, there are no grounds to speak about necessity to apply the rules of a deed of gift to this case.

      Taking into account the foregoing, it is possible to generally conclude that if in relations between a parent company and a subsidiary a gratuitous property transfer is aimed at satisfaction of the parties' interests defined in the contract, and either directly or indirectly presupposes receipt or possibility to receive economic or social results by the transferor, this transaction is not regarded as a gift. Concurrently, the rules of the TC RF which do not stipulate receipt of the property as income subject to taxation are applicable to this case.

      For example, in case a contract of a gratuitous property transfer by a parent company includes a clause stipulating that a transferee shall undertake to use received money in a more effective way ensuring receipt by the transferor of profit in the form of dividends, the contract should not be deemed as an investment one, since it does not contain a specific obligation to pay a part of the profit or income within a particular period of time and does not provide for the transferor's rights to manage and to control the use of the transferred property accrued under the contract. At the same time, a contract of a gratuitous property transfer cannot be regarded as a deed of trust, since the property is transferred to the ownership.

      Apart from the foregoing, taking into account that the above mentioned comparative analysis of a transaction of gift and a transaction of a gratuitous property transfer between a parent company and a subsidiary has, to a certain extent, an appraising character and has not been a subject of court proceedings, it is necessary to evaluate the risk of invalidation thereof because of their inconsistency with law prohibiting a gift between profit-making organizations, first, with respect to the circle of persons who may challenge this transaction, second, with respect to the consequences thereof.

      In principle, pursuant to procedural laws of RF a public prosecutor is entitled to apply to court or to join the case at any stage of proceedings if it is necessary to protect rights of individuals and legally protected interests of the public or State. However, in light of the latest tendencies revealed in the course of the judicial reform, the issue of limitation of a public prosecutor's rights of action in those cases when a law violation affects interests of profit-making organizations which can and should independently dispose of their rights, is under consideration.

      Theoretically, tax authorities may also raise the issue of invalidation of transactions, though only in cases related to tax recovery. Pursuant to paragraph 6, clause 1, Art. 45 of the TC RF tax authorities may assert that it is necessary to change the legal qualification of transactions concluded by and between a taxpayer and third persons, and that an obligation to pay a tax has arisen. However, the actions related to tax recovery must be taken ad litem.

      Besides, the change of the legal qualification of a gratuitous property transfer transaction to a transaction of gift does not prevent the application of sub-clause 11, clause 1, Art. 251 of the TC RF thereto, since in this case it is also a gratuitous property transfer between a parent company and a subsidiary that takes place. Therefore, there are no grounds for tax assessment and, hence, there is neither interest nor causes for contestation of such transactions by tax authorities. This is confirmed by the tax authorities' position with respect to application of sub-clause 11, clause 1, Art. 251 of the TC RF, as well as by the absence of such kind of cases from the court rulings.

      The organizations involved in the transaction are not interested in its challenging, since its consummation is in line with their interests. The more so that their interconnection through participation in the authorized capital decreases the risk of the possibility that the transaction concerned will be challenged.

      At the same time, it should be taken into account that shareholders of the legal entity transferring the property may demand invalidation of the transaction. Since the property transfer is not attributed to the cost price, it should be effected on account of the net profit which may be also used for dividends payment. Therefore, the shareholders may assert that their rights to dividends are violated in connection with the gratuitous property transfer.

      However, in any case a transaction invalidation will result in the property return only. Qualification of a gratuitous property transfer as a transaction of gift should entail no other consequences, unless an intent to use the transferred property in a wrongful, punishable manner is discovered. Besides, in civil relations this should not result in application of Art. 169 of the CC RF setting forth consequences of a transaction which is contrary to the fundamentals of law and order and the morals, since the public interest related to payment of taxes in connection with the transaction will not be infringed.

      Therefore, it is possible to conclude that a gratuitous property transfer transactions between a parent company and a subsidiary are not contrary to law, and sub-clause 11, clause 1, Art. 251 of the TC RF is applicable thereto.

D. E. Tiagai,
Doctor of Law,

V. P. Sumin,
associate lawyer

[1]  Comments to the Civil Code of RF (Part 2). International Center of Financial and Economic Development, Moscow, 1996, p. 306.
[2]  Civil Law. Part 2. Law of contract, in Vostochnyi Ekspress MTK, M., 1998, p. 132.

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