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Legal alerts / 19.7.2019

The Russian Supreme Court has expressed its opinion regarding production equipment being reclassified as immovable property for tax purposes

Starting from 1 January 2019, no movable property is subject to corporate property tax. In the light of this, the problem of having property tax additionally assessed is now becoming topical for business given attempts, in order to levy property tax on the maximum number of facilities, to ‘artificially’ classify movable property as immovable.

Examples of such reclassification can be encountered in recent court judgments: specifically, courts have reclassified, in favour of tax authorities, boiler equipment, a transformer plant and transformers themselves, inner technological pipelines and other items as immovable property. They build their judgment on the argument that components and fixed assets (property, plant and equipment) allegedly form a single unit together with the building in which they are located or which they service and thus are subject to classification as immovable property.

Major payers of property tax, mainly industrial enterprises, often face the problem of equipment being reclassified as immovable property, with amounts of tax, fines and default interest potentially reaching tens of millions roubles.

However, on 12 July 2019 the Russian Supreme Court issued its Ruling No. 307-ES19-5241 in case No. A05-879/2018 based on the consideration of the cassation appeal of Lesozavod-25 LLC (the “Company”). The Ruling has at last set a positive trend in the issue of reclassification:

The tax authority assessed to the Company additional arrears of corporate property tax, as well as amounts of default interest and a fine with respect to wood pellet production equipment that was mounted in the building of a production workshop. The tax authority’s argument was that all above equipment should be classified as immovable property since it is a building together with its components.

The Company applied to the court seeking to challenge the decision of the tax authority. The court of first instance held that the tax authority’s claims were justified. The Supreme Court did not agree with such an approach and sent the case for new trial.

Although the Supreme Court did not resolve the dispute on the merits, it emphasized that when a taxable item is classified as immovable property, not only should an inextricable link between the equipment and the building be taken into consideration, but formal criteria should also be established in the accounts for classifying property as a relevant item of fixed assets. The Supreme Court noted that according to accounting standards equipment does not form part of buildings and structures but constitutes a separate group of fixed assets, save where exclusions are expressly provided for. “If during a tax audit circumstances have been established pointing to the artificial division in bookkeeping of a single item of fixed assets which is immovable property (property, plant and equipment), tax authorities shall not be denied their right to justify the need to levy tax on the property in such situations. Yet, the need for levying such tax must rest on objective criteria the compliance with which <…> would have been clear to any reasonable taxpayer when it enters an item of fixed assets into its books. This should not depend on subjective assessments of experts, and  nor should it result in taxpayers being placed in unequal positions”, the Supreme Court further commented.

Ruling No. 307-ES19-5241 has great practical importance for taxpayers, especially for production enterprises, in that it helps them to defend themselves against unsubstantiated additional tax assessments by a tax authority with respect to equipment (including production equipment).

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