On Advisability of New Restrictions on the Deduction of Losses within the Tax Consolidated Group

One of the most pressing problems in the tax sphere discussed during the X Russian Business Week held in Moscow on 13–17 March were changes in the taxation of tax consolidated groups (TCG).

As is known, on 1 January, 2017, amendments to the Tax Code came into force, limiting the deduction of losses for TCGs as well as for all other taxpayers. Within the next three years, for all taxpayers, the right to deduct losses will be limited to 50% of the current year’s tax base. But for TCGs, unlike other taxpayers, the restrictions on deduction of losses are not temporary but permanent. According to paragraph 1 of Article 278.1 of the Tax Code as amended by the Federal Law No. 401-FZ of 30.11.2016, the tax base formed by profitable members of a TCG can not be reduced by more than 50% using losses borne by other members of the group. The losses that remained unaccounted can be deducted only from the future profits of the TCG members who borne them, and under the general rules (taking into account time limits common for all taxpayers).

This measure is extremely undesirable for two reasons. First, because it contradicts the fundamental principles of consolidated taxation accepted in the world practice. The point of consolidation is precisely that profits and losses of TCG members are combined. And members of Russian TCGs pay much more for this opportunity than members of foreign ones (in particular, for the period of their membership in the TCG, they lose the right to deduct losses they had borne before consolidation; all TCG members lose the right to deduct losses borne during their membership in the group, after leaving it or after the cessation of its existence).

Second, the measure itself is completely ineffective. Let us illustrate this with an example. For simplicity, let’s assume that a consolidated group consists of two members: a parent company through which the bulk of the product is sold and which has a profit of 100 billion rubles a year, and a subsidiary company which primarily deals with production and therefore has 60 billion rubles of losses. Before the introduction of amendments under discussion into the Tax Code, the aggregate tax base of the TCG would be 40 billion rubles. Now, the parent company can deduct not 60 billion, but only 50 billion rubles (i.e. 50% of its profits) when forming a consolidated tax base. However, without control over transfer pricing within the TCG, one can easily avoid the increase of the tax burden on the TCG in the given example by increasing the share of products sold through the subsidiary company. As a result, its losses will go down to 50 billion rubles while the profit of the parent company will go down to 90 billion rubles. The consolidated tax base will amount to the same 40 billion rubles as under the previous legislation.

The simplicity of circumventing this rule will undoubtedly induce tax authorities to counteract this by using the doctrine of unjustified tax benefit. The first result of it will be losing one of the main advantages of TCGs, which is that taxpayers and tax authorities are spared from control over price formation in deals within a TCG. Second, tax risks for TCG members will increase so much that this will likely result in refusing to use this institution.

Anna Zolotareva – PhD, Director of the Center for Legal Studies