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CISG CASE PRESENTATION

Russia 21 January 1999 Arbitration Court [Appellate Court] for the Northwestern Circuit [translation available]
[Cite as: http://cisgw3.law.pace.edu/cases/990121r1.html]

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Case identification

DATE OF DECISION: 19990121 (21 January 1999)

JURISDICTION: Russian Federation

TRIBUNAL: Federal Arbitration Court for the Northwestern Circuit

JUDGE(S): Dmitriev V.V. (Chairman); Nefedova O. Yu., Shevchenko A.V.

CASE NUMBER/DOCKET NUMBER: A56-15321/98

CASE NAME: Limited Liability Company "Altair" v. Russian Tax Authorities

CASE HISTORY: Unavailable

SELLER'S COUNTRY: Not identified

BUYER'S COUNTRY: Not identified

GOODS INVOLVED: Goods


Classification of issues present

APPLICATION OF CISG: Presumably, as the Court applied provisions of the CISG

APPLICABLE CISG PROVISIONS AND ISSUES

Key CISG provisions at issue: Articles 4(b) ; 30

Classification of issues using UNCITRAL classification code numbers:

4B2 [Scope of Convention (issues excluded): effect of contract on property];

30A [Seller's obligations: includes requirement to deliver the goods, hand over documents]

Descriptors: Scope of Convention ; Property in the goods ; Delivery

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Editorial remarks

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Citations to case abstracts, texts, and commentaries

CITATIONS TO ABSTRACTS OF DECISION

(a) UNCITRAL abstract: Unavailable

(b) Other abstracts

Unavailable

CITATIONS TO TEXT OF DECISION

Original language (Russian): Unavailable

Translation (English): Text presented below

CITATIONS TO COMMENTS ON DECISION

Unavailable

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Case text (English translation) [second draft]

Queen Mary Case Translation Programme

Federal Arbitration Court for the Northwestern Circuit
of the Russian Federation

Case No. A56-15321/98 of 21 January 1999

Translation by Yelena Kalika [*]

The Federal Arbitration Court for the Northwestern Circuit consisting of Chairman Dmitriev V.V. and Judges Nefedova O.Yu. and Shevchenko A.V. adjudicated the cassation claim brought by the Russian Federation Federal Tax Police Department for the City of St. Petersburg. [The claim was adjudicated] in a public hearing in the presence of representatives of the State Tax Inspectorate for the Central District of St. Petersburg (Andreeva L.I., power of attorney No. 04-06/403 of 20 January 1999; Kurbatskaya O.Yu., power of attorney No. 04-06/404 of 20 January 1999; Chabanovsky S.S., power of attorney No. 04-06/405 of 20 January 1999) as well as in the presence of a representative of the Russian Federation Federal Tax Police Department for the City of St. Petersburg (Mukhin M.S., power of attorney No. 18/1 of 5 January 1999). The claim was brought in connection with the decision of 19 October 1998 rendered by the Arbitration Court for the City of St. Petersburg and Leningrad Region [Court of First Instance] on case No. A56-15321/98 (Judges Galkina T.V., Savitskaya I.G., Zagaraeva L.P.).

The Federal Arbitration Court for the Northwestern Circuit

FOUND:

The Limited Liability Company "Altair" ("the Company") commenced an action at the Arbitration Court. The purpose of the action was to find invalid Clause 1 of the decision No. 1-41-01/1356 issued by the State Tax Inspectorate for the Central District of St. Petersburg ("the Tax Inspectorate") on 29 July 1998. [The decision was] to impose penalties [on the Company] in the amount of Russian Rubles [RUR] 2,433,970.60 in connection with the understating of profits. The Russian Federation Federal Tax Police Department for the City of St. Petersburg ("the Tax Police") was brought into the case as a third party. The Claimant also stated more precisely the subject of the claim in connection with his listing business trip expenses as costs.

The Court of First Instance sustained the claim on 19 October 1998.

The Appellate Division did not review the lawfulness and reasonableness of the decision.

In its Cassation Complaint, the Tax Police ask to have the decision reversed for the following reasons:

    -    In connection with the issue of determining the price of the goods imported, the court incorrectly applied Articles 12 and 53 of the Russian Federation Arbitration Procedure Code ("the Arbitration Procedure Code"), Article 166 of the USSR Principles of Civil Law 1991, Article 423 of the Russian Federation Civil Code ("the Civil Code"), Articles 4(b) and 30 CISG, and Clause 12 of the Regulations on composition of expenses in connection with the manufacturing and selling the goods (works, services) included in the cost of the goods (works, services) and on the Procedure to determine financial results for the purpose of taxation of profits ("the Regulations on composition of expenses") [the Regulations] were approved by Resolution No. 552 of the Russian Federation Government issued on 5 August 1992];
 
-    The case should be dismissed in the part concerning the finding invalid the Tax Inspectorate's decision to include the hotel fares in costs because Articles 37(1) and 85(6) of the Arbitration Procedure Code were incorrectly applied;
 
-    The judicial act violates Article 2(5) of the Russian Federation Law "On taxation of corporate profits" and Article 410 of the Civil Code in the part sustaining the claim concerning barter transactions between the Company and the public joint stock company "Lenkhladokombinat No. 1";
 
-    The court violated Article 8(1) of the Russian Federation Law "On taxation of corporate profits" and Clause 12 of the Regulations on composition of expenses in the part correcting the Company's expenses by the differences resulted from storage contracts.

The Company was duly notified of the time and place of the hearing. However, the Company's representatives did not appear in the hearing. In this connection, the claim was reviewed in the absence of such representatives. The Claimant objected to the [Cassation] Claim. The Cassation Instance is of the opinion that the [cassation] claim should be sustained.

In accordance with the current laws, the subject of a claim is a legal or property claim against a respondent concerning some actions, omissions to act, the existence or absence of a legal relationship, or its modification or termination. Grounds for the claim are the factual circumstances presented by a claimant in support of its claim.

Pursuant to Article 102(4) and (5) of the Arbitration Procedure Code, when stating the circumstances serving as grounds for the claim, a claimant shall analyze the applicable rules of substantive law because these rules contain the model of a legal relationship in controversy, i.e., the basis for the claim. Thus, the claimant shall state the rules of law, which, in his opinion, were incorrectly applied by the tax authorities when making a decision in controversy. In support of each circumstance, which is a basis for the claim, it is necessary to state in the claim the necessary evidence as provided in Article 52 of the Arbitration Procedure Code. [Such evidence] shall also be enclosed with the materials of the case.

Only in such case can the burden of presenting evidence denying the claimant's arguments and the burden of presenting objections based on [the tax authorities'] understanding of the rules of law supporting the lawfulness of the decision made be shifted to the tax authorities pursuant to Articles 53(1), 109 and 119 of the Arbitration Procedure Code.

For the above stated reasons, the claimant's argument that it is impossible to impose liability on him in connection with the audit results must be supported by evidence that during the relevant period of time his tax responsibilities were overstated. The Company failed to [present such evidence]. Therefore, the said argument of the Company and, thus, the reasoning of the decision, violate the rules of procedural law.

In accordance with the Russian Federation Law "On taxation of corporate profits", the taxable income is gross profit made by a company reduced (or increased) in accordance with the provisions of the said Law. Gross profit is the sum of gain (loss) realized in connection with sales of goods (works, services) by the company and profits received in connection with non-sale transactions reduced by the expenses in connection with these transactions (see Article 2(2) of the Law). The profits realized from the sale of goods (works, services) are determined as the difference between the gain realized from sale of goods (works, services) and expenses in connection with the manufacturing and selling included in the cost of goods (works, services). [Gain realized] should be stated [without taking into consideration] the VAT and the levy taxes.

When making the audit, the Tax Inspectorate and the Tax Police established that, when reporting its taxable income in connection with the imported goods, the Company applied a foreign currency rate as of the date when the goods were placed into a warehouse and not as of the date when a right to property in [the goods] passed [to the buyer]. In the auditors' opinion, it led to the understating the taxable income.

Pursuant to Clause 3.6 of the Regulations on accounting procedures "Reporting assets and liabilities when their price is stated in foreign currency" (PBU 3/95) approved by Resolution No. 50 of the Russian Ministry of Finance on 13 June 1995, the price of main assets, intangible assets, low-cost goods, stock, goods, capitals and other assets and liabilities shall be stated in Rubles at the rate of the Russian Federation Central Bank as of the date of the foreign currency transaction which resulted in [the company's] listing the goods and obligations as assets and liabilities.

Appendix to PBU 3/95 sets forth that the date of an import transaction is the date when a right to property in the goods imported and other property passed to the importer.

Pursuant to Article 223 of the Civil Code, a buyer's right to property in goods purchased under a contract arises when the goods are handed over [to the buyer] unless the law or the contract state otherwise.

Pursuant to Article 164(3) of the USSR Principles of Civil Law 1991, the creation and termination of a right to property in goods, which are a subject of the transaction, shall be determined based on the law in the place of the transaction, unless the parties' agreement states otherwise. A right to property in transit - when an international commercial transaction is involved - shall be determined in accordance with the law of the exporter's country, unless the parties' agreement states otherwise.

Article 30 CISG sets forth that the seller must deliver the goods, hand over any documents relating to them and transfer the property in the goods, as required by the contract and this Convention. Pursuant to article 4(b) CISG, this Convention is not concerned with the effect that the contract may have on the property in the goods sold. Therefore, a right to property in goods passes either in accordance with the law of a state chosen by the parties or in accordance with the law of a state which a competent court finds applicable based on the conflict of laws provisions that it finds applicable.

Pursuant to Article 12(1) of the Arbitration Procedure Code, when it is necessary to apply the law of a foreign state, an Arbitration Court shall establish the existence and the contents of the rules of [foreign law] based on their interpretation and practice in the relevant foreign state. When making the decision, the Court of First Instance violated the said rule of law and failed to state any rule of law of the foreign state in support of its position.

At the same time, pursuant to Article 2-401 of the United States Uniform Commercial Code, when the contract does not provide otherwise, a right to property in goods under a sales contract passes to the buyer at the time and place at which the seller completes his performance with reference to the physical delivery of the goods. If the contract requires or authorizes the seller to send the goods to the buyer but does not require him to deliver them at destination, a right to property passes to the buyer at the time and place of shipment. Article 929 of the German Civil Code 1896 contains the same rule of law.

Some states follow a different approach in resolving this issue. However, as stated above, neither the Claimant nor the Court of First Instance presented any rule of law of a foreign state in support of the Claimant's position.

The Company's contracts provide for the basic terms, i.e., the main rights and obligations of the parties depending on the location of the cargo (goods) in relation to the means of transportation ([for instance,] delivery, payments for the transportation, risks and preservation of the goods). There is a set of rules of interpretation of the INCOTERMS rules whose purpose is to avoid discrepancies in such interpretation. The Claimant's contracts provide for the basic INCOTERMS-90 rules determining the terms of delivery, including the C-terms [according to which] transportation and insurance are paid until the goods are handed over to a carrier in the sender's country (CIP) and the D-terms [according to which] the goods are delivered from a vessel with duties unpaid (DDU). Pursuant to Article 223 of the Civil Code, if Russian law governs the contract, and based on Articles 164 and 166 of the USSR Principles of Civil Law 1991 and on the above mentioned rules of foreign law, a right to property passes to the buyer at the time when the goods are transferred to him, unless the contract provides otherwise. The time of the transfer of goods is the time when they are handed over to the buyer, or to a carrier to send to the buyer, or to a postal service to mail to the buyer without obligations to deliver. Thus, the above stated basic terms are grounds for determining the date on which a right to property in goods passes [to the buyer]. According to the above mentioned terms in the contract, the dates of bills of lading or other transportation documentation are such dates of transfer of a right to property in this case.

The Court of First Instance wrongfully applied Article 119 of the Russian Federation Customs Code, Clause 2.21 of Instruction on filling out annual accounting forms (Appendix No. 2 to the Order No. 115 issued by the Russian Ministry of Finance on 19 October 1995), and Clause 13 of the Regulations on composition of expenses. [This is so] because the said rules of law do not set forth the procedure of accounting for imported goods. Clause 7 of the Regulations on accounting in the Russian Federation, which was approved by the Order No. 170 issued by the Russian Ministry of Finance on 24 December 1994, provides that the primary accounting documents evidencing the fact that a business transaction has been performed are grounds for making entries in accounting documents. Such primary documents must be made at the time of performing a transaction or, if it is not possible to do so, immediately after the performance.

The timely and true making of the primary documents and their handing over [to the other party] in accordance with the procedure and within the period of time set for making entries in accounting documents must be done in accordance with the schedule approved by the enterprise. Thus, this provision states that it is a ground for making entries in accounting documents. It does not state that the Ruble equivalent of the price of goods as of the date of receiving the primary documents - and not as of the date of handing the goods over to a carrier - must be reflected in accounting documents.

In his objections to the Cassation Claim, the Claimant made a reference to the letters issued by the Russian Federation State Tax Service, the Russian Federation Ministry of Finance, and the State Tax Inspectorate for the City of St. Petersburg. The Court leaves this reference without consideration based on Articles 1(1), 4 and 31 of the Russian Federation Tax Code.

Clause 2.2 of the Recommendations in connection with accounting for expenses included in losses by the trade and fast food enterprises, which were approved by the Order No. 1-550/32-2 issued by the Russian Federation Trade Committee on 20 April 1995, sets forth the expenses that should be attributed to "Transportation Expenses". Thus, it directly concerns the accounting procedure in connection with transportation expenses and does not alter the rule on the stating the price of goods.

In such circumstances, the Court of First Instance did not have any grounds to find lawful the Claimant's actions in connection with his stating the price of the goods imported as of the date of their customs clearance, and, thus, [to find] invalid the decision issued by the Tax Inspectorate.

As follows from the materials of the case, the Claimant attributed hotel fares and daily allowances to the cost of goods. [These expenses] were paid in connection with business trips of employees outside of the Commonwealth of Independent States. [The Claimant] failed to ask the said persons to show their passports to make such payments. In the auditors' opinion, it is a violation of the law leading to the understating of profits because there is no evidence that the said persons were indeed on a business trip. Nor there is evidence that the said expenses were made for business purposes. During the hearing, the Claimant partially withdrew his claims and asked to sustain his claims only in connection with hotel fares paid.

The main document regulating the procedure of accounting for business trips abroad and determining the peculiarities of accounting for expenses is Resolution No. 365 of the USSR State Labor Committee of 25 December 1974 approving the Rules on labor conditions of Soviet employees abroad as approved on 20 August 1992.

In accordance with the current rules, CEOs of companies shall send employees on business trips abroad in accordance with an order stating the purpose and length of the business trip and the country of destination. A business trip certificate must [also] be issued. Since a business trip certificate is not being issued when an employee goes on a business trip outside the Commonwealth of Independent States and since the markings evidencing that the border was crossed are made in one's passport, the payment of business trip expenses and hotel fares should be made based on such markings in the passport and on the order [issued by the CEO]. Therefore, the order and the markings made when the state border is crossed evidence that a person was on a business trip outside the Commonwealth of Idenpendent States.

Since the Court of First Instance established that there were no such markings [in employees' passports here] and rendered its decision based on invoices issued by the hotel as well as other circumstantial evidence - i.e., [it did so] in violation of Article 52 of the Arbitration Procedure Code - pursuant to Clause 2(i) of the Regulations on composition of expenses, there were no grounds for the attribution of hotel fares [to costs]. Thus, the Claimant's claims should be denied.

As follows from the materials of the case, the Tax Inspectorate found invalid [the Company's] failure to include into its taxable profits the gain realized by the Company when paying off its debt for the services provided under a storage (lease) contract. [The debt was paid off] with the goods. [The services were provided] when making barter transactions involving goods to which different VAT rates applied. [The payment] was made to offset shipments under a sales contract between the Company and the public joint stock company "Lenkhladokombinat No. 1".

The Claimant disagreed with the Respondent's opinion. The Claimant argued that the sum in controversy should not be taken into consideration when determining taxable income because the relevant funds were not in fact deposited to his account. Besides, the Claimant pointed out that there were no barter transactions between the parties. The Claimant argued that he computed the gain realized from the sale of goods (works, services) as the goods were shipped (the works were performed and services were provided) and issued invoices to the buyers (clients) under payment documents.

Indeed, a barter transaction is a contract between subjects to make a natural exchange, i.e., to exchange goods for goods (works for works or services for services). Money is not involved. [However,] it is a balanced exchange of goods which have a certain value. The exchange is [usually] documented in a single agreement (contract). The condition of equality of the [goods] exchanged is the exchange of goods based on the world or contractual prices. The Court's conclusion that there were no relationships between the parties, which were governed by Article 31 of the Civil Code, does not contradict the current law.

At the same time, when accounting for profits realized from a sale of goods (works, services) for the taxation purposes, the offsetting of a debt by any other means is treated as a deposit of funds to the taxpayer's bank account. In this case, the parties terminated obligations by means of offsetting mutual similar claims (see Article 410 of the Civil Code). However, the parties calculated their monetary obligations taking into consideration the VAT. Thus, while there was the same evaluation of the monetary obligations, a difference was created due to the deduction of the VAT because the Claimant's goods were being taxed at the rate of 10% of the price of goods and the services provided by the public joint stock company "Lenkhladokombinat No. 1" were being taxed at the rate of 20%.

Pursuant to Article 2(5) of the Russian Federation Law "On taxation of corporate profits", companies, which sell their goods (works, services) at prices higher than their factual basic cost, the fair market value of the same goods (works, services) at the time of the sale is used for the taxation purposes. [However,] such fair market value cannot be lower than the factual basic cost of goods.

If a company was unable to sell the goods at prices higher than the basic cost due to the decrease in their quality or properties or if the current market prices of these or similar goods were lower than the factual basic cost of such goods, the factual price, at which the goods were sold, should be used for the purposes of computation of taxes.

If within 30 days prior to the sale of goods at prices not exceeding their factual basic cost, the company was selling the same goods at prices higher than their factual basic cost, the prices computed based on the maximum sale prices of such goods should apply to all the transactions for the purpose of taxation.

The Claimant failed to present evidence that he met the above stated requirements as set forth in Article 6 of the Federal Constitutional Law "On arbitration courts in the Russian Federation", Articles 6 and 7 of the Arbitration Procedure Code. The procedure of submission of such evidence is set forth in Article 102 of the Arbitration Procedure Code. Therefore, the tax authorities did not have a duty set in Article 53 of the Arbitration Procedure Code and they correctly determined taxable income based on the factual basic cost of the goods.

As follows from the materials of the case, the Claimant used the provisions of Article 317 of the Civil Code when stating the terms of payments in the contracts. Pursuant to [Article 317], it can be stated in a monetary obligation that it shall be paid either in Rubles in the sum equivalent to a certain sum in foreign currency or in [so-called] units (EKU, etc.).

Pursuant to Clause 3.9 of Appendix No. 2 to the Instruction on filling out annual accounting forms, which was approved by the Order No. 97 issued by the Russian Federation Ministry of Finance on 12 November 1996, Column 120 "Other sale expenses" and Column 130 "Other non-sale expenses" must contain the data not reflected in other Columns of the Form No. 2 "Report on gains and losses".

In particular, the Column "Other non-sale expenses" shall reflect:

      -    Credits and debits on which the statute of limitation has expired;
-    Sums received to offset debts which were written off as losses in previous years;
-    Penalties, fines, damages and other sanctions in connection with a breach of contract which are either imposed on or acknowledged by the debtor, including losses suffered in connection with such a breach of contract;
-    Insurance premiums and payments from other sources in connection with natural disasters, fires, failures and other unordinary events;
-    Profits received in previous years which have been discovered in the current year;
-    Listings of excess property discovered as a result of an audit as assets;
-    The difference arising out of payments made in Rubles based on the official rate of a relevant foreign currency or in units as required by contract.

It follows from the above that the difference between such sums is the difference between the computations of monetary obligations stated in Rubles in the amount based on the foreign currency rate (or in units) on the date when the obligation arose and on the date when it was fulfilled (terminated).

The positive differences between such sums shall be included in taxable income. The negative differences do not decrease taxable income, i.e., for taxation purposes this sum must be added to the profits of the company. The reason for the exclusion of negative differences from taxable income is in their absence from the list of non-sale expenses [that must be taken into account] when taxing profits (see Clause 15 of the Regulations on composition of expenses).

Since the Claimant failed to meet the requirements stated above and in Article 8(1) of the Russian Federation law "On taxation of corporate profits", the tax authorities lawfully established that [the profits] were understated and correctly imposed the relevant sanctions.

The argument of the Claimant and of the court that [the Claimant] overpaid taxes does not meet the requirements of Article 52 of the Arbitration Procedure Code because [such argument] was made without any analysis of primary documents and was based only on the letter of the Deputy Head of the Tax Inspectorate. The letter contradicts the facts of the case including direct evidence presented by the Tax Inspectorate.

When rendering this decision, the Court also took into account that Chapter VI of the Russian Federation Tax Code does not set forth liability in the form of recovering the sum of understated profits. At the same time, Article 122(1) of the Tax Code sets forth liability for non-payment or partial payment of taxes due to understated taxable income. However, since the present case involves a dispute over whether or not the decision rendered by the Tax Inspectorate prior to the Tax Code coming into force should be found invalid - and not a dispute over whether or not the sums of the sanctions either written off or recovered in a judicial proceeding should be refunded - pursuant to Article 8 of the Russian Federation Law "On coming into force of the first part of the Tax Code of the Russian Federation", there is no ground for a change (decrease) of liabilities stated in the decision of the tax authorities. The issue of a taxpayer's liability in case of his failure to perform the decision issued by the Tax Inspectorate must be decided in accordance with Article 54 of the Russian Federation Constitution and Article 8 of the Russian Federation Law "On coming into force of the first part of the Tax Code of the Russian Federation".

For the above stated reasons and based on Articles 174 and 175(2) of the Arbitration Procedure Code, the Federal Arbitration Court for the Northwestern Circuit

HOLDS:

The decision of 19 October 1998 rendered by the Arbitration Court for the City of St. Petersburg and Leningrad Region on case No. A56-15321/98 is reversed.

The claim is denied.

The Limited Liability Company "Altair" must pay the state fee in the amount of RUR 834.90 in connection with the adjudicating the case by the Lower Court and the state fee in the amount of RUR 417.45 in connection with the Cassation Claim.

The Chairman
Dmitriev V.V.
      Judges
Nefedov O.Yu.
Shevchenko A.V.

FOOTNOTE

* Yelena Kalika, JD Pace University School of Law, has studied at the Moscow State Law Academy, interned with a Moscow law firm, and is an Associate at the Pace Institute of International Commercial Law.

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