January 1997

by Matthey H. Murray & Michael S. Zamore

For U.S. and other foreign companies the Russian tax system is a labyrinth that is both confusing and expensive. The key to navigating this labyrinth lies in developing both a strong knowledge of Russian tax law and the ability to maneuver quickly with that knowledge in dealing with the Russian tax authorities. To work effectively with the Russian tax system, a company's senior management must dedicate the time and resources necessary to mastering these crucial skills.

The Russian tax system as it currently functions is not based on the notion that profitable business will lead to increased tax revenues. Indeed, current Russian law bases taxation on gross revenues, not profits, which makes taxation in Russia far more burdensome than in many other countries. The situation is made even more difficult because the enforcement of tax legislation leaves wide latitude for interpretation by individual tax inspectors.

The Importance of Information
Information and the ability to withhold it are sources of individual authority in any setting. It has been our experience that Russian tax inspectors understand the power of using or withholding information. Tax inspectors frequently refuse to give specific answers to basic accounting questions. Vague answers from Russian tax inspectors may even result in penalties later for the company involved.

As a precautionary step, a U.S. company should try to document everything, requesting written answers or proposals from tax inspectors. Even more important, however, is to do everything possible to avoid depending on the opinions of the tax authorities. Know the law better than they do and treat skeptically the advice they give. Skepticism is particularly important to exercise when they give a seemingly favorable answer.

What To Do
Tax inspectors' judgments can be challenged. The same skills that work in a U.S. courtroom—mastery of legal detail, knowledge of the opponent's weaknesses, preparation, and tenacity—can help a Western businessperson move through the labyrinth. Success in the tax realm thus requires an intimate knowledge of Russian taxes gained through experience and close monitoring of legal developments. We believe that a foreign taxpayer in Russia should expect to devote anywhere from 10 to 40 percent of senior management time to tax issues.

When confronted with a surprising move by a tax inspector, a private business' first step should be to insist that the official articulate his or her position. We have learned that the most valuable conversations with inspectors are deferential and one-sided, allowing them to formulate clearly their opinion. Until such time as the tax inspectorate has been required to articulate a precise interpretation of the tax law, a private company is not in position to assert or protect its rights.

Another component of a successful strategy is to raise the stakes for the individual tax inspector. When arguing an issue directly with an inspector proves fruitless, one should immediately seek to take the issue to the inspector's superior. This may create an incentive for the inspector to work constructively with a foreign business. There is certainly no guarantee of success, but we have had rulings overturned and exited the labyrinth in this manner. Before going over the head of a tax inspector, however, give him or her notice so you can't be accused later of violating protocol. Once notice is given, move swiftly and decisively to the next level of authority. This article expresses the views of the authors, and should not be construed as a statement of U.S. Government policy. For more information on taxation in Russia, readers are strongly urged to obtain qualified professional advice. For a list of U.S. law firms doing business in the NIS, call the BISNIS Fax Retrieval System and order document #9070.

Matthew H. Murray is President, and Michael S. Zamore Treasurer, of Sovereign Ventures Inc., a Washington, DC management consulting firm specializing in the Russian market.