On January 21, 2025, the Constitutional Court of the Russian Federation (the “Court“) issued Ruling No. 2-P (the “Ruling”), declaring certain provisions of the Russian Tax Code (the “Tax Code”) as unconstitutional. The disputed provisions related to the taxation of companies under the simplified tax system (“STS”) when transferring assets to former shareholders as compensation for the fair value of their shares. The Court ruled that taxation should apply to the actual economic benefit received, i.e., the fair (market) value of the share, rather than the “paper” increase in the company’s assets.
Background
LLC “USPEH i N” (the “Company”) transferred real estate assets to an exiting shareholder as payment for the fair value of their share. The tax authorities assessed additional tax on the difference between the asset’s market value and both the nominal value of the share and the asset’s residual book value. Since the Company applied the “income” model under STS, the tax authorities disregarded the fact that the transferred asset was no longer owned by the Company.
Commercial (“Arbitrazh”) courts ruled in favor of the tax authorities. The Russian Supreme Court, however, identified a violation of constitutional principles of equality and legality in taxation and referred the case to the Constitutional Court.
Constitutional Court’s Position
The Court found the disputed provisions of the Tax Code unconstitutional and mandated legislative amendments. Until such amendments are enacted, tax will be levied on the actual economic benefit received, i.e., the fair (market) value of the share acquired by the company, determined based on the company’s net assets or an independent valuation, taking into account the financial losses incurred by the company.
The Ruling takes immediate effect and applies prospectively. Key implications include:
- The Ruling does not serve as grounds for tax refunds unless a tax recovery decision was challenged in due course.
- Final court decisions in similar cases will not be subject to revision if the proceedings have reached the highest possible instance.
- Taxpayers whose tax liabilities arose before the Ruling are exempt from tax penalties.
Implications and Open Questions
The Court stated that the share’s value is determined after its transfer to the company. However, in practice, the transfer often occurs before the final settlement with the exiting shareholder. The lack of unambiguous clarification on the timing of valuation creates a risk that the company’s tax base may be determined without accounting for the disposal of assets, contradicting the approach to assessing the company’s economic benefit outlined in the Ruling.
Additionally, companies are required to redistribute, sell, or cancel the repurchased share within a year by reducing charter capital. The Ruling does not specify the tax implications of these scenarios, leaving room for interpretation by lawmakers and tax authorities. Further clarifications are expected.
Practical Considerations
While the case concerns asset transfers to exiting shareholder, the Court’s approach is relevant to other scenarios where a company acquires a share and compensates the departing shareholder, including shareholder exclusion, buyouts, or refusals to approve share transfers to third parties.
Businesses should consider the new taxation framework when structuring M&A transactions, intra-group restructurings, corporate governance procedures, and resolving shareholder disputes that may result in an exit.
Nordic Star team is available to assist in assessing tax risks and structuring transactions in line with the new requirements.