International Arbitration Practice Newsletter (Issue 2, 2015)

Constitutional Court reverses VAT double-charge arbitration ruling against Sony

On 1 July 2015, the Constitutional Court of the Russian Federation ruled that it was unconstitutional to assess Value Added Tax (VAT) on insurance recoveries paid when a buyer defaults on a purchase.

This ruling solved a long-standing problem of major retailers in Russia, arising from a common practice by the Federal Tax Service (FTS) that had resulted in double taxation. The retailer paid the usual VAT upon the sale of goods. If the buyer defaulted, and the retailer was insured against the loss of revenue that resulted, the FTS would assess VAT on any insurance recovery that the retailer received. In Sony’s case, this amounted to RUB 34.2 million in additional taxes.

Sony lost its case against the FTS in the Arbitrazh Court of Moscow, as well as its appeal in the Supreme Court. The Constitutional Court, however, ruled that the Federal Tax Service’s use of Article 162 of the Tax Code to charge the additional VAT was unconstitutional. The court stated that the “receiving of the insurance compensation by the insured under the insurance agreement is not an excuse for the imposition of VAT.” The insurance payment does not produce any additional value.

Arbitrazh Court of Saint-Petersburg and the Leningrad District upholds land ownership rights of Russian companies with “off-shore” connections

On 14 July 2015, the Arbitrazh Court of Saint-Petersburg and the Leningrad District ruled that registration of a company in an off-shore jurisdiction does not disqualify that entity from owning agricultural lands.

The case arose in May, when the Leningrad District committee responsible for administering government property brought an action in the Arbitrazh Court to challenge the transfer of land owned Plemennoy Zavod Lesnoe LLC.

The district government contended that the transaction violated Article 3 of the Federal Law “On Transfer of Agricultural Lands,” which limits the interest in agricultural lands by foreign legal entities, as well as by legal entities with more than 50% foreign capital ownership, to leaseholds only. The government claimed that the ultimate beneficiary of the acquisition was Codals Business S.A., which is registered in British Virgin Islands.

The court dismissed the district government’s claims. It confirmed that the intent of Article 3 is to prohibit only direct possession of lands by foreign residents. In this case, a Russian company was the owner of the land and was a 100% subsidiary of another Russian legal entity, notwithstanding the off-shore registration.

Treaty blocks international arbitration of German assignee’s claims against the Kaliningrad government

In 1998 Dresden Bank and the administration of the Kaliningrad Region signed a credit agreement for US$ 10 million. Two years later the Kaliningrad government renounced its obligations, on the grounds that the process by which the credit was obtained violated Russian law. A German investment company, Sana Consulting & Management GmbH (Sana), obtained an assignment of Dresdner Bank’s rights and sought an ad hoc international arbitration in Brussels against the Kaliningrad government in order to collect the debt.

The Treaty on the Encouragement and Reciprocal Protection of Investments between the USSR and the Federal Republic of Germany prescribed a mechanism for dispute resolution between German and Russian interests. Sana contended that it qualified as a "foreign investor" under the Treaty, and that the debt that it obtained by legal assignment is an "investment" that was expropriated by a Russian governmental entity, the Kaliningrad administration.

Russian representatives responded that the arbitration rights and procedures under the Treaty apply to only two types of dispute: the amount and procedure of compensation repayment; or improper restrictions on the free movement of funds. Sana’s claim did not fit in either of those two categories. Moreover, the Russian side argued that Sana was not a “foreign investor” because, under the terms of the agreement, the loan was not a capital investment; and the actions by the Kaliningrad government had no signs of an expropriation of a capital asset.

On 25 June 2015, the arbitration tribunal rejected Sana’s claim for compensation because it was outside the scope of arbitration defined by the Treaty; and the case did not move forward to trial.

Arbitration reform moves forward in the State Duma

In May 2015, two draft laws to reform Russian arbitration were introduced in the State Duma. One of them concerns the procedure for establishing arbitration courts, as well as other procedural requirements for arbitration cases. The other law would amend several articles of the Arbitrazh Procedural Code and Civil Procedural Code to conform to the changes proposed in the first draft law.

In June 2015, the committee responsible for civil, criminal, arbitrazh, and procedural legislation recommended enactment of the two draft laws on the first reading. However, the committee noted problems in legal drafting and other inconsistencies in some of the draft provisions. Notwithstanding these issues, the State Duma adopted both laws on 1 July 2015, on the first reading, with amendments required within 30 days. The new laws will go into effect on 1 September 2015.

The ART DE LEX International Arbitration team will publish updated information about any proposed amendments and final implementation of the legislative reforms as they become available.